Smart vs. Not-So-Smart Diversification

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Diversification Through the Right Exchange-Traded Funds (ETFs)

Diversification is a crucial part of any investment strategy, and now achieving proper diversification has become even easier with exchage-traded funds (ETFs).

ETFs provide easy access to many investments. However, not all ETFs are created equal.

Some ETFs can help you achieve broad diversification in your portfolio, but others may not.

Surge in ETF Investing

As individual investors look for ways to grow their portfolios after the most recent market downturn, many of them are turning to ETFs.

According to the National Stock Exchange (NSX), investors have plowed more than $40 billion into ETFs this year.

The interesting part is which ETFs are getting the most money. Three of the ETFs that have received the most money through June 30, 2009 are as follows:

– UNG – U.S. Natural Gas ($3,428 million)
– TIP – iShares Barclays TIPS ($4,959 million)
– SDS – ProShares UltraShort S&P 500 ($3,027 million)

Smart Diversification

Those investors who are putting money into TIP are achieving a superb benefit through the inflation protection they are receiving by investing in Treasury Inflation Protected Securities (TIPS).

Decent Diversification

Investors who are putting their money into UNG are also achieving some diversification by putting part of their portfolio into the commodities market, but they could do better. Finding a broad-based commodity ETF like DBC (the PowerShares DB Commodity Index Tracking Fund) instead of a narrowly tailored commodity ETF that only invests in natural gas, provides greater diversification and protection.

Not-So-Smart Diversification

The investors who are putting their money into SDS are taking on more risk because SDS uses leverage to boost returns. Unfortunately, leverage also boosts losses.

Individual investors really should avoid leveraged ETFs.