ETFs Are a Special Type of Mutual Fund 2
ETFs Avoid the Expense of Fund Managers 2
ETFs Are Traded on Exchanges 4
ETF Investors Have Hidden Costs Through
the Bid-Ask Spread 7
The Creation/Redemption Process Keeps ETF
Share Prices Close to the Market Value of the
Underlying Shares 16
ETF Performance Is Not Weighed Down by
Transaction Costs 21
ETF Shares Are Often More Tax-Efficient
Than Mutual Funds 21
Special Risks of ETFs 22
Conclusion 23
Endnotes 24
Chapter 2 The Multifaceted Stock Market: A Guide
to Different Investment Styles 25
The First Decision: Stocks, Bonds, or Cash 26
Size Matters 29
Each Investment Style Has Multiple ETFs 34
Midcap ETFs 35
All-Cap or Total-Market ETFs 37
Growth and Value ETFs 39
Conclusion 40
Endnotes 40
vii
Chapter 3 A One-Step Strategy for Selecting
Superior Investments: Indexing 43
Investments That Track Market Indexes Have
Outperformed Most Mutual Funds 46
The Evidence in Favor of Indexing 47
Indexing Has Delivered Greater Profits
Than the Average Mutual Fund, Except in
the Small-Cap Area 49
How a Few Mutual Fund Managers Have
Beaten the Indexes 50
Conclusion 52
Appendix 3—Index Construction
Methodologies 53
Example of Index Construction—Equal
Weighting 53
Example of Index Construction—Price
Weighting 53
Example of Index Construction—Capitalization
Weighting 54
The Newest Indexing Scheme—Free-Float
Weighting 55
Endnotes 56
Chapter 4 Investment Risk: A Visit to the
Dark Side 57
Drawdown—An Intuitive Measure of
Investment Risk 58
How to Use Drawdown 59
A 40-Year History of Bear Markets 64
What if Your Investment Was Not Around
During a Bear Market? 70
Example of Risk Assessment: An Emerging
Market ETF 73
Market Risks and Planning for Your Future 77
Appendix 4A: Where to Find Quantitative
Investment Risk Information 79
viii CONTENTS
Appendix 4B: Calculation of Drawdown with a
Spreadsheet 79
Appendix 4C: Volatility of Past Returns as a
Risk Measure 83
Endnotes 86
Chapter 5 How Well Are Your Investments Really
Doing? Risk-Adjusted Performance 87
The First Risk-Adjusted Performance
Measure—Annual Gain-to-Drawdown
Ratio 88
Another Risk-Adjusted Performance
Measure—The Sharpe Ratio 91
Risk-Adjusted Performance Review 94
Conclusion 96
Appendix 5A—Calculation of the Compounded
Annual Rate of Return 96
Appendix 5B—Calculation of the Sharpe
Ratio 98
Endnote 101
Chapter 6 Diversification: The Only Free Lunch on
Wall Street 103
Reduce Risk, Not Profits, with
Diversification 104
Diversification Versus Picking Only
the Best 106
How to Determine What Should Be in the
Optimal Portfolio 107
Example—Determining a Good Mix of Stocks
and Bonds 108
Interpretation of the Sharpe Ratio 110
The Uncertainty of Future Investment
Returns 110
Conclusion 113
Endnote 113
CONTENTS ix
Chapter 7 The One-Decision Portfolio 115
A Risk-Reducing Investment Mix 116
Indexes Used to Test the One-Decision
Portfolio 119
Performance History for the One-Decision
Portfolio 119
The One-Decision Portfolio for Less-
Conservative Investors 123
ETFs You Can Use to Create Your Own
One-Decision Portfolio 125
Rebalancing 126
Why Only U.S. Investments Are Included in
the One-Decision Portfolio 127
Conclusion 128
Appendix 7—A Brief Discussion of the Bond
Market 129
Credit Risk 130
Interest Rate Risk 131
Intermediate-Term Bond ETFs 133
Endnotes 133
Chapter 8 When to Live Large: An Asset Allocation
Model for Small- Versus Large-Cap
ETFs 135
Why Market Capitalization Matters 136
Trading Rules 138
Results 139
Real-World Implementation with ETFs 143
Conclusion 145
Appendix 8—ETF Distributions and Taxes 147
ETF Share Prices Drop by the Amount of a
Distribution 149
Endnotes 150
x CONTENTS
Chapter 9 Boring Bargains or Hot Prospects?
Choosing Between Growth and Value
ETFs 151
The Concept of Relative Strength 154
History of Relative Strength Changes Between
Growth and Value 156
Recognizing the Emergence of a New Trend
Using the Relative Strength Ratio 161
Results with Small-Cap Value Versus
Growth 166
Results with Large-Cap Value Versus
Large-Cap Growth 169
Real-World Implementation with ETFs 170
Conclusion 171
Endnotes 173
Chapter 10 When Is It Safe to Drink the Water?
International Investing 175
How to Identify Whether the Long-Term
Trend Favors U.S. or Foreign Stocks 181
Results of Using the EAFE/S&P 500 Asset
Allocation Model 184
Outlook for International Investing 187
Conclusion 188
Endnotes 189
Chapter 11 What Bonds Can Tell You About Stocks:
How to Use Interest Rates 191
A Basic Introduction to the Bond Market 192
Why Rising Interest Rates Have Usually (But
Not Always) Been Bad for Stocks 193
An Indicator of Rising Interest Rates 196
Yield Curve Indicator 197
Interest Rates and the Implied Economic
Forecast 198
The Rules for the Yield Curve Indicator 199
CONTENTS xi
Track Record for the Yield Curve Indicator 201
Composite Interest Rate Indicator 203
Conclusion 205
Endnotes 205
Chapter 12 It’s a Jungle Out There: Selecting from
Among Different ETFs with Similar
Investment Objectives 207
The Drawdown Chart—A New Tool 208
Example 1—Small-Cap ETFs 211
Example 2—Growth Versus Value ETFs 214
Example 3—Utility Sector ETFs 218
Conclusion 221
Endnotes 222
Chapter 13 The Ultimate ETF Investment Program
in Just 30 Minutes Per Month 223
The Ultimate ETF Investment Program 224
Step 1: Diversification 224
Step 2: Decide Whether International or U.S.
Stocks Are Favored; If U.S. Stocks Are
Favored, Evaluate the Interest Rate
Climate 227
Step 3: Select the Best Investment Style from
Large-Cap Value, Small-Cap Value, Large-Cap
Growth, or Small-Cap Growth 228
Results of the Ultimate ETF Strategy 231
Conclusion 232
Endnotes 235
Appendix Internet Resources for ETF
Investors 237
ETF Sponsor Websites 238
General ETF Websites 239
Index Provider Websites 239
Current and Historical Market Data 240
Fundamental Economic Data 241
Index 243