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How You Should Play The Great ETF Selloff

Are you missing out on big profits by not owning ETFs?

Exchange Traded Funds (or ETFs) now have over a TRILLION dollars in assets. Theyve been promoted as the worthy successor to mutual funds, a way to make stock investing easier, and much more.

But are they right for you?

This is a trillion-dollar question, so today Im going to help you with this tough decision. First, Im going to explain what exactly an ETF is and how it might fit into your investing strategy. Then, Im going to describe some of the particular conditions of this market, and why they should make you think twice about going the way of the ETF. Finally, Ill show you the tools you need to take advantage of the stock pickers market.

To start, what exactly is an ETF? Well, ETFs are marketed as mutual funds for the 21st century. But are they really?

There are a few key differences. Mutual funds operate by pooling the buying power of many individual investors to buy a basket of stocks or bonds, and then delivering a share of the profits that big pool of money creates. ETFs promise much the similar thing, but with lower costs, the ability to trade during market hours (mutual funds are only priced once per day, after trading closes), and are much more specialized, allowing you to invest in a very small slice of the market if you so desire. For instance, there are:

• ETFs that are meant to track the major indices
• ETFs that track only a certain sector
• ETFs that short a sector and go up when the stocks in that sector go down
• ETFs that track the price of gold and other valuable commodities

And this just scratches the surface. There are endless options, limited only by the ETF providers imagination. And because these funds are exchange traded just like stocks, they allow investors to customize their portfolios.

One big difference is that to date, all ETFs are essentially indexes. Once the ETF provider decides he wants to track, say Australian stocks, he creates an ETF with a representative group of Aussie stocks. There is no management of the ETF–it simply does whatever the underlying stocks do. There are index mutual funds that follow this same strategy, but most mutual funds have active management. A manager or team of investment professionals is constantly changing the composition of the mutual fund in an effort to create the highest return for the funds shareholders.

While mutual funds have been around since the Great Depression, ETFs are barely twenty years old. So, while there are some intrinsic benefits to holding an ETF, theyre not as time-tested as the traditional investment vehicles like stocks and mutual funds.

For example, some ETFs are especially susceptible to big price swings during after-hours trading so be sure to place your buy or sell order during market hours. And, outside of the major ETF families (like iShares), many ETFs have low trading volume, which could raise your transaction costs if you trade them frequently.

Now, from 2009 to 2011, I used ETFs as part of my strategy for Blue Chip Growth. However, towards the end of last year, a pivotal shift began to emerge in the ETF arena.

Back in 2009 we began investing in ETFs as a way to participate in the upward movements of entire hot sectors. Stocks were trading in a pack, and the best way to scoop up some extra profits was in sector ETFs. However, here we are two years later, and stocks are now moving independently of their sectors, removing what was the core benefit of the ETF sector strategy. We have seen, and will continue to see, far greater returns from individual blue chip stock picks.

This is now a sink-or-swim market. Investors are becoming picky, selecting only premium stocks, and it pays to single out these winners and not try to play the whole sector.

Because our system has proven its ability to isolate fundamentally superior stocks, why would you waste your time in watered-down sector ETFs that include weaker stocks?