ANALYSIS: I was disappointed listening to #JimCramer on Friday Feb 6th’s Mad Money show.

He basically said ETFs are only for short-term trading while extoling the virtue of low cost index funds … Boo-yah! What do you think ETFs are Mr. Cramer? Only good for short-term trading? How about asset allocation and diversification, the two cornerstones of prudent portfolio management. Research shows that one needs at least 30 to 40 stocks to diversify a domestic stock portfolio (and likely double that if you are a global investor) or, if you live in a “terribly” sector diversified market index like Canada, even more than that.

It is hard enough for teams of portfolio managers and analysts managing large cap mutual funds in Canada to follow that many stocks and beat the markets on a risk adjusted basis … individuals do not stand a chance of beating the markets on average. Numerous studies on the markets show that 85 percent or more of all active fund managers do not beat the markets consistently after fees. Depending on the size of your portfolio, transaction costs alone versus ETFs would likely negate any superior performance not to mention that it is only equities.

Being able to really diversify your portfolio means you need bonds and cash equivalents too. You would need at least 20 corporate bonds, long with a hand full over government bonds, to fulfil that requirement adequately. For individual investors actively using bonds; spreads and commission are “toxic” to returns.

LET’S LOOK AT THE FACTS

While it is true you end up owning some pretty bad stocks in an index fund, the benefits of diversification and reducing portfolio volatility are far more important than falling in love with company management as stock investors tend to do. Recalling how great the management of Bear Sterns and Lehman were days before their demise should remind investors that it is better to be Ford lucky than GM proud. For those of you who don’t get that reference, Ford refinanced its debt prior to the crisis and did not need the bailout like GM and Chrysler who were not as lucky. An individual investor playing the auto sector probably did not fare too well.

Because it is when the markets go bad that investors panic in fear and sell at the worst possible times, not when the markets are strong and going up. Right now, rather than looking for the next gem of a stock, one should be taking some equity money off the table and diversifying into, bonds, gold, cash, or foreign currencies that help lower portfolio volatility when equities may decline. ETFs simply make global asset allocation efficient and cost effective versus similar transactions in individual securities.

Diversification is our best tool for having a smoother ride in your portfolios. Learning how to build globally diversified portfolios with ETFs is the main feature of our upcoming speaking tour across Canada. Come on out and learn how to build lower volatility globally diversified portfolios.

Here are some rules of thumb to go by:

1. Longer the horizon, the lower the volatility
2. More diversified, the lower the volatility
3. Multi-asset classes, the lower the volatility

Larry Berman is the host of Berman’s Call on BNN. He is Co-Founder of ETF Capital Management and The Independent Investor Institute — an organization dedicated to providing unbiased education to Canadian investors. Register for Larry’s fall speaking tour at www.etfcm.com