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Outperform Stock Market With Lower Risk

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( ETF Expert) -- Investors have become so accustomed to the notion of "risk on" and "risk off," many have cast aside one of the most hallowed principles of success. Reducing the possibility of loss (also known as "risk"), after all, requires assets that don't move in the same direction.

How does an ETF investor know whether his investments are zigging simultaneously, rather than zigging and zagging independently? There are a number of free Web tools, though I might recommend the Select Sector SPDR tracker for first-timers.

I often check correlation coefficients among ETFs in my client accounts. If there are too many high-positive correlations (0.75 to 0.99), I recognize the likelihood that those may not be distinguishing themselves from one another. If there are too many high-negative correlations (-0.75 to -0.99), I'm unlikely to be achieving anything more than what can be accomplished with two ETFs: SPDR S&P 500 Trust (SPY) and iShares Barclays 20+ Treasury Bond (TLT).

Constructing a portfolio that has seven or nine or 11 or 15 ETFs, each moving without regard to any other investment, each offering its own potential for financial gain, would be akin to discovering the Holy Grail. It's not going to happen. On the other hand, you can combine a variety of low-correlating assets that concomitantly reduce risk and outperform popular market benchmarks.

For instance, over the past six months, the S&P 500 SPDR Trust has returned 6%. That doesn't sound too shabby, although risking the entirety of one's capital on an all-stock portfolio can be terribly unnerving.

Over the same six months, a portfolio with equal amounts of these seven ETFs significantly outperformed the S&P 500. What's more, the "collection" did so with a fraction of the risk. (Note: The risk is lower, both in terms of an aggregate "beta" and in terms of diversification vis-a-vis low-correlating assets.)

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