Outside the Box: Don’t be a patsy with your ETF trades, says this ex-Lehman boss

Here’s the least original statement of 2017: There are a lot of different exchange-traded funds.

Equity ETFs. International ETFs. Fixed-income ETFs. Currency ETFs. Commodity ETFs. Volatility ETFs.

There are more… plus leveraged and inverse versions of most of these leveraged and inverse versions of most of these.

ETFs have made it possible for everyday investors to invest like George Soros. Except most everyday investors inevitably do a much worse job than George Soros.

Just because you can doesn’t mean you should

ETF innovators have managed to securitize just about anything. I think we reached the last frontier in August when a Libor ETF was announced (leveraged, naturally). So you can trade Libor, you can trade a basket of junior silver miners, you can trade double inverse volatility, you can trade the shape of the yield curve, and you can trade Indonesia.

But I’ll bet the people who are investing in Indonesia haven’t done a lot of work on Indonesia.

And I’ll bet there are people speculating on the yield curve who haven’t done a lot of work on the yield curve.

Moral of the story: Just because you can do these things doesn’t mean you should.

One thing a lot of investors don’t realize is that professional investors put an awful amount of time and effort into research.

I do a fair amount of research in the course of writing newsletters. Sometimes I meet with a portfolio manager who is working on the same trade.

That portfolio manager will have had a team of analysts working on it for months. So when he ends up buying that Indonesia ETF, he has done all the work, and he is pretty freakin’ sure.

Many investors haven’t done the work. They don’t have the time (they work day jobs), and they don’t have the scale (they don’t have a team of analysts working with them, with access to all the market data in the world).

Nobody likes to think of themselves as the patsy at the poker table. But you can’t compete with the pros.

Read: More active managers are beating the market, but it won’t last

Despite what I’ve said, ETFs are your friend

I am no financial Luddite. I think the ETF is one of the top five financial innovations of the last 100 years. Giving people access to stuff they never had access to before is a great development.

Thirty years ago, you, as a retail investor, couldn’t buy into the Indonesia market at all. Probably the only way to do it was to be Mr. Big Time Portfolio Manager and access foreign markets through a big broker like Goldman Sachs.

So I would never be so paternalistic as to suggest that people should be prevented from trading this stuff for their own good. No. What I am saying is:

1. Macro trading is a lot of work.

2. You probably don’t have time to do the work.

3. So you should be realistic about your expectations.

If you accept that and still really want to be a dedicated ETF investor, here’s what you need to do:

Determine your asset allocation, and pick some broad-based, low-cost ETFs, keeping concentration and correlation in mind. Try to avoid making radical changes to the portfolio unless absolutely necessary. And think long term, as in five to 10 years, not one to two years.

Sounds simple? If it does, it kind of shouldn’t.

Jared Dillian is a former Lehman Brothers head of ETF trading who has traded through two bear markets. He says a downturn is coming soon and elaborates in this free special report.

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