ITA Wealth Management

The above question, that of ETF price evaluation, was recently asked on an investment forum. I replied that it is the wrong question and here is my reasoning.

• If one is asking how to price an ETF there is an underlying question or assumption that the ETF is priced incorrectly and there are market inefficiencies within the group of stocks that make up the ETF.
• Why does one want to own an ETF is the more basic question?
  • To populate an asset class where one is not finding individual stocks.
  • To permit investments in the international market.
  • To better find non-correlated investments such as commodities.
• What is your investment philosophy?

  
  

  • Do you know you can outperform index funds through the selection of individual stocks?
  • How convinced are you of the importance of asset allocation?
  • What constitutes a diversified portfolio?

If we begin with the assumption that the market is basically efficient, then the price of an ETF will be very close to its net asset value or the value of all the stocks that make up the ETF.  It is not necessary to evaluate each stock held by the ETF.  In fact, it is not necessary to evaluate any of them.

The reason for purchasing ETFs is to build a broad diversified portfolio across a number of asset classes.  The asset classes will included the U.S. equity market, international (developed countries), emerging markets, bonds, and REITs.  Beyond those basics, one may branch into timber and other commodities.  An international REIT is another possible asset class.

To own or not own an ETF is not determined by price.  Rather, one needs to think through the process of how they want to use ETFs in the construction of a portfolio.  That process is explained and put into action over on the Premium Content side of this blog.

Lowell Herr

Photograph: Tail section of Air Force One – Reagan Library in California

Step 3 of “The Big Investing Lie” goes like this. “If professional investors know how to get better investment performance, then their performance as a group ought to be better than everybody else’s, right?”

Is the following true?

“Professional investors and everybody else together make up the total market, so if professional investors outperform everybody else, then they must outperform the market.”  Page 89 of Michael Edesess’ book.

Let that logic soak in for a few minutes.  Edesess is on to something.

Lowell Herr

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