Know What Tools You Own & How to Use Them

In All, Everyday Life, Retirement by Brian Imrich

Traditional investing can get a little boring. We think of traditional investing as owning stock or bonds directly or through a mutual fund or ETF, but sometimes it can be hard to ignore the gains that other alternative investments are making at a given time. It is also easy to convince ourselves that these new investment options are the wave of the future and the tried and true investment strategies no longer seem as exciting.

An Exchange Traded Note (ETN) bearing the ticker XIV recently provided a good reminder of how painful an alternative investing strategy can be if it doesn’t go as planned. This was a product designed to move in inverse relation to the VIX, or the Chicago Board Options Exchange Volatility Index. Stated simply, as long as market volatility remained low, the price of XIV would increase. On the flipside, when we experienced a rapid market correction recently, the share price of XIV fell by over 80% in one day, and then it fell further to what amounts to a loss of around 96% before it was announced that the ETN would be closed and investors paid out at liquidation value.

It is easy to blame the creators and managers for the failure of XIV, but the problem is really in the application. It was not hidden that XIV was capable of and likely to fall to a point of no return. This ETN was designed and promoted to be traded, not held for a long period of time. However, after seeing gains of over 180% in a 12 month period, it became both difficult for those who knew better to let go of their position, and easy for those who did not know any better to start investing in the doomed financial product.

This is just one example, and an important one because it is both very recent and has eliminated a large amount of perceived wealth for investors, but there are of course others. Does it mean that XIV was an inappropriate addition to a portfolio? For the average investor, under most circumstances, absolutely. But that is a matter of understanding what the investment is or does and why and how it does it, and then forming an opinion about the utility within your portfolio.

A large part of our job at GPS Financial is acting as your portfolio bouncer. Before we select a fund, ETF, or other investment for a portfolio we scrutinize the holdings, management, investment techniques, history, direction, and a number of other factors. If we aren’t comfortable with any one of these factors we would rather play it safe and keep the investment out of your portfolio before it has the opportunity to start any trouble.