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Investors Should Not Live by ETFs Alone

The concept of getting help investing in ETFs along the lines of a managed portfolio will appeal to plenty of people who are not comfortable or confident enough to do it themselves but who don't have enough capital to retain an account manager. But because these products offer little to no forward-looking analysis, they amount to a disservice, as small accounts aren't entitled to more than a computerized rebalancing of a backward-looking portfolio.

Another drawback is that many of the products don't make use of all of the ETF families or products. Most of the ETFs offered are from iShares, which is not ideal because no single provider can have the best product for every single slice of the market.

Worse, these portfolios use just a narrow spectrum of ETFs from those families, offering only broad-based ETFs such as iShares S&P 500 or iShares Russell 1000 (IWD). By sticking with only the biggest, broadest ETFs, these portfolios deny investors access to a lot of innovative ideas and the chance to add value.

I view these products as top-down portfolios. As a top-down manager, I make decisions about market capitalization, style, volatility, yield, countries and sectors. The current batch of ETF portfolio products for the most part ignores countries, sectors, volatility and yield, and focuses only on market capitalization, style and domestic vs. foreign investments, "foreign" being a much broader focus than selecting exposure to individual nations.

It's worth noting that Fidelity allows more customization in its ETF portfolio than other firms. But if you can create your own portfolio with no input from the firm, you don't need to be under the umbrella of the product.

There are many useful applications for ETFs in a diversified portfolio. There is no doubt that the product line will become more useful as competition spurs innovation. But blind over-reliance on any one type of investment is a mistake, and that's definitely true for ETFs.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider The New Ireland Fund to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. At the time of publication, Nusbaum had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.
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