Replies to post #1097 on A.I.M. For Exchange Traded Funds (ETFs)

[OldAIMGuy]

Re: Benefits of diversified investments vs benefits of individual stock volatility...............

Dear Cindy, Excellent question. As a diehard stock picker for decades, it seemed an easy question to answer back in 1992. Back then there were no such things as ETFs (but there were closed end funds). The usual Mutual Fund was diversified across many different business sectors as well as diversified by multiple holdings in each sector. These were very bland investments for AIM. At best they followed the trend of broad market indexes - at worst they never managed to do as well as the indexes. So, the decision was pretty easy. Only if an account was very small in value did one use mutual funds with AIM.

If an account was large enough, then one could single out companies from a variety of business sectors and then have at least some diversification even if one had very few holdings in each sector. "Single Stock Risk" still played havoc with such portfolios, however.

With the advent of exchange traded mutual funds and specifically business sector funds the issue got a bit more cloudy. With Sector ETFs we gain a lot of diversification in numbers of companies in a sector. With multiple sectors we gain diversification similar to what a traditional mutual fund might have.

Yes, there's decreased intra and interday volatility with ETFs but we reduce "single stock risk" by a substantial amount. The sectors still follow a trend and the best stocks in that sector with be the trend leaders on the way up. If the market gets frothy, sometimes those best stocks will also be the ones leading the sector downward if they've become overbought during the rise.

So, since Mr. Lichello's model doesn't trade all that frequently when relatively standard settings are used, we don't miss that much "action" using ETFs.

Think of using an ETF sector fund as being an excellent filter for Signal To Noise. It tends to decrease the noise and therefore make the true signal more apparent. With AIM and ETFs the trend is what is going to be the dominent activity generator. You can expect multiple orders in the same direction rather than a lot of reversals. A typical pattern would be a bunch of buys, like what would have happened in 2008, then followed by a long series of sells.

The net effect in the long term tends to improve overall returns by reducing the number of severe losses. Think of it as taking three steps forward and only on back while an individual stock might take 4 steps forward but then two back.

Of course, if we now see 10 years of cyclical market with essentially zero slope, AIM will improve overall returns because of capturing whatever volatility occurs. In some studies I've done, AIM and a well selected group of very mature and high dividend paying stocks did better than owning a bunch of very high BETA stocks in total return. Again, these stocks didn't trade often, but quite effectively. Along the way there were also dividends collected.

So, I hope this helps a bit. ETFs transformed my own efforts as an individual investor. I own very few individual company stocks any more. ETFs and CEFs are all that I currently own in my IRA, for instance.

Best regards, Tom

[ls7550]

Hi Cindy.

One option that you might like to consider is to drive volatility.

For example you might use the vWave stock/cash indicator to create your own virtual Index comprised of part DDM (2X Dow) and part conventional Dow (1X), with the vWaves stock element representing DDM exposure and the cash representing 1X Dow exposure. So if the current vWave was 79% stock, 21% cash the virtual index would be allocated 79% DDM and 21% DOW (for an overall equivalent of 179% stock exposure). Unitise the combination to produce a current (virtual) value, and update over time.

At your review date, first update the virtual index unit value and then apply AIM (part stock, part cash) to that in the normal manner (adding or reducing to/from real DDM/DOW holdings when AIM indicates a trade).

Its an additional layer to manage, but not that difficult, and I suspect you'll find the effort worthwhile.

I'm personally using something along this line for my speculative element (around 10% of my total fund value, against which I've estimated and target a 20% to 40% p.a. return), but in a more aggressive manner and on a day trading basis that primarily only targets volatility capture benefits alone (little/no regard to price appreciation capture benefits).

Best. Clive.

[Toofuzzy]

Hi Cindy

>>>I am new to AIM and have read the boards and Lichello's book. Does the decreased risk in using sector ETF's outweigh the increased volatility of individual stocks in terms of the effectiveness of AIM?<<<<

I will second Tom's reply. ETFs and mutual funds can't go to zero. That is very important with AIM since it has you buy as a security goes lower.

You can diversify by style (large, small, forien, REIT, bond) or by industry.

Don't try to maximize returns by getting fancy. Getting rich slowly avoids going broke fast.

Toofuzzy