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Come up with a good investment idea and it seems someone will always figure out a way to exploit it. So, here we have exchange traded funds (ETFs), which have ultra low management costs, trade like stocks and follow indexes just like mutual funds. Financial planners love ‘em for asset allocation plans, even if the average investor hasn’t quite come around. But the crooks have—just ask the guy from UBS that recently lost billions on the trading desk, trading guess what? And why is that guy smiling as they lead him in handcuffs in and out of court? I’d like a look around his apartment—closet, floorboards, mattress.

Every good investment idea lately seems to be seized and corrupted faster than normal people have a chance to understand it.  Still, I think ETFs can be a great component of a sensible portfolio. Some ETFs, like those at Vanguard, are simply different share classes of the same mutual funds Vanguard has been running for years. If you stick with that type of ETF, there are several advantages for the long term (not day trader, not crazy, not nervous Nellie) investor:

• Rebalancing is much easier and more precise because you know the exact price of the shares you’re moving
• You get a much lower management cost for the same market basket as the mutual fund
• They’re more tax efficient because the manager doesn’t need to cash in shares every time somebody wants their money—the only capital gains are the ones you generate yourself, for yourself, by selling your personal shares (unless the underlying index changes, at which point the manager may do some buying and selling)

There are a few things to be careful of, however:

• Go with a company you’ve heard of. Everyone and their brother has an idea for an ETF, and some of them are too small or thinly traded to have a real market.
• Choose one based on a recognized index. The smart guys have figured out that calling something an “index” fund is a great way to deceive the Main Street investor who’s heard that index funds are a good thing. Anyone can make up a market basket and call it an index. Make sure the underlying index has some validity.
• Be very careful before buying one of the so-called active ETFs. They haven’t been around long enough to have any track record. I’m no fan of “active” investing anyway.
• Check how closely the trading price clings to the Net Asset Value (NAV). This has been a problem with bond funds, which don’t trade on an exchange like stocks. Some experts think you should stick with mutual funds for ETFs. Be aware that some ETFs can also vary from their NAV especially in specialty asset classes or highly volatile markets. During the flash crash there were some real roller coaster moments.
• If you have to pay commissions, you may be just as well off going with a mutual fund. If, however, your account offers free trades on ETFs, they deserve consideration

ETF investing has some real advantages, but like all investments your individual picture should be examined with a financial planner. You need to consider your own level of knowledge, risk tolerance, and current investments before seizing any “great idea”.

And will someone tell me why that UBS guy is smiling?

You remember the last time, right? For me, it’s actually which last time–the tech bust in 2002, the October crash in the 80s, the flash crash, the hyper-inflation during the Carter administration?–and since I’ve been around long enough, I’ve heard at least a dozen times, “This time it’s different”. Uh, no, it’s not. It’s still scary. The market will always be unpredictable. In your investing life you can absolutely count on several dramatic crashes. You will see your net worth and investment value take plunges worse than an unmoored elevator.

My nomination for dumbest guy on the planet was interviewed in the Wall Street Journal this morning. Apparently, he was watching the ticker when Apple stock took a plunge, so he sold a chunk. But according to the WSJ, when it began rising later in the afternoon, he was off line and missed buying it back on the upswing, for which he was regretful. Dumb as a box of rocks. Has this idiot never seen the advice to sell high and buy low? Sadly, he has had plenty of company in the last few days.

For about a year now, I’ve heard people bemoan how they shoulda’, coulda’ bought in March, 2009 (instead of going to cash or bonds, as most did) and what a great stock market run up they therefore missed. And so what is the average investor doing since Monday? Going to cash and bonds. I don’t know why people can’t get this right–maybe it’s the same as learning to steer into a skid–just too much against instinct.

What you should be doing right now is laughing at the market. If you follow the advice of your friendly neighborhood financial planner (me!) you’d have an appropriate asset allocation plan in place–a diverse basket of investment types, including a cash emergency fund, stocks, bonds, real estate, and internationals. And some of them would be sinking like a stone. In fact, I can pretty much guarantee that your net worth has dropped in the last few days. No one can diversify out of all market risk and in our very interdependent world, it’s next to impossible to find investments that are negatively correlated. But diversification can limit and protect that risk as much as is possible in a turbulent world. If the zombies arrive at the gates, nothing will help. Short of that, my guess is that the U.S. government and Apple computer (along with a lot of other cash heavy companies) aren’t going bust anytime soon.

Unfortunately, what’s good for the individual bill payer and investor isn’t exactly what’s good for the economy right now, but do it anyway. Economists want us to spend right now. But in periods of uncertainty, individuals paying individual bills need to cut those and hang on to their dough. So probably you should put off the world tour, the brand new car, or the McMansion purchase for now, unless the family chariot is up on blocks.

Don’t sell your investments and go to cash. In fact, put any investment cash into whatever part of your asset allocation is doing the WORST, that’s called rebalancing or buying LOW, which is what you’re supposed to be doing, right?

I don’t recommend any significant investment in individual stocks in a prudent investment plan, but I know some of you like to dabble anyway (okay, I do too, but only a little). If you’re going to do this, I highly recommend Better Investing’s recommended methods of evaluating investments (they used to be NAIC–National Association of Investment Clubs) and if you follow it, you already have a wish list of stocks you’d like to own. Well, take a look–maybe they’re “on sale” right now.

That’s really it–sit tight, turn off the tube, get off the internet, and try to calm down. With a decent asset allocation plan, you’ve done all you can to influence the universe. And if you don’t have a plan, well, ahem, you need a financial planner. I’ll look forward to hearing from you. But take a deep breath, okay?