Reader Nitin sent in a link to an article called “Protecting the Investments of the Bad Investor,” which was recently featured in Yahoo Finance.

I agree with the overall premise that there are many investors who are not doing well, getting below average returns by buying, holding and selling at the wrong time.

The article goes on to state that “the Pension Protection Act of 2006 is encouraging increased use of asset-allocation funds, such as target-date and lifecycle funds, particularly as defaults in defined-contribution plans.”

I guess the idea is to protect investors from themselves, and their untimely decisions, by establishing a group of “default” investments. What that means is that someone decided that a default investment will do better than you could do on your own.

This may be correct in some cases, but the problem is with the default investments, which are pegged to be asset allocation funds like target-date and lifecycle funds. However, the study admits that asset allocation funds severely under-perform equity funds, but they “have prevented significant losses due to fear-based selling.”

Huh? I am simply dumbfounded by the fact hat one study can come up with that much garbage.

Are you now supposed to invest in underperforming asset allocation funds, which then will lose as much or more in a bear market scenario? Translation: Get less of a return but lose more since the obvious conclusion is to Buy and Hope through any type of market environment.

Don’t believe it?

I wrote the article “Do Lifestyle Funds Provide More Security” in early 2003, just before the bear market ended. It clearly confirms that Lifecycle and other allocation funds suffer just as much in a bear market scenario as equity funds but, in a bull market, you don’t get nearly the upside potential.

The article goes on to make other moronic statements like “this analysis shows that asset-allocation funds deliver what they promise — lower risk, no switching and real returns for the investor.”

Suuuure; and I have some subprime loans I’d like to sell you for top dollar…

Let me make it clear again: The biggest danger to your portfolio is the re-occurrence of another bear market and not whether you are in the best performing fund during a bull market. If you can avoid the bear by being safely on the sidelines, your investment returns will beat just about any equity mutual fund, index or stock that was held to oblivion.

After the markets meandered for most of the day, I liquidated 2 positions that had dropped off their highs by -7.5% as announced yesterday.

Of course, I had no idea that my trades were so influential that they confused Wall Street traders and promptly ignited a strong rebound rally during the last hour. While all major indexes closed higher, it was clearly a party of one, as the Dow was the king of the Street for today.

If this feels like a roller coaster to you, you are not alone. Increased volatility may stay with us for a while and is an indication that the market is in a shakeout mode. That simply means that future direction is uncertain and a break either way can occur at anytime.

For tomorrow, none of my other sell stops have been triggered, so I will watch and wait.

With the flood of ETFS being brought to the market, there was bound to be a new product following along as a new alternative to ETFs to confuse investors even more.

Such an animal did arrive and it is called Exchange Traded Notes, or ETNs for short. I’ve been hard pressed to find information on it, but Kiplinger had an article called “Exchange-Traded Notes: The Next Big Thing?”

According to them, here’s the difference between ETFs and ETNs:

“Both ETNs and ETFs act like low-cost index funds. Their differences are under the hood. An ETF consists of a portfolio of securities (or sometimes a cache of gold or silver bullion), and owning a share gives you claim to a small portion of that portfolio. With ETNs, however, there is no portfolio. You get what is, in essence, a bond issued by the ETN’s creator, Barclays. The ETN promises to repay the amount of your investment plus (or minus) the return of the index that the ETN tracks, less a management fee.”

The benefit to some seems to be in the way distributions are handled:

“ETNs don’t pay cash distributions. Instead, the value of dividends, interest and investment gains is lumped into the funds’ total return. So you won’t face any taxes until you sell your shares. And even then, any gains on shares held more than a year should be taxed at 15%, according to a legal opinion Barclays obtained.”

So, if you are looking for monthly income, this would not be a good choice. The bottom-line is that this product is new and needs to prove itself over time. At this point, I don’t have an opinion either way, but simply wanted you to be aware that ETNs exist.

Right in the middle of a continuation rally from yesterday, news about the subprime virus having infected another institution, took the legs right out from under a strong up move and turned it into another down day.

The trigger was American Home Mortgage’s admission that it was unable to borrow or raise money, which pushed its stock down some 90%. All major indexes suffered and our sell stop points have now been brought back into play again.

Only a few of our holdings have dropped to around -7.5% off their highs. I’ll follow the same rule I talked about yesterday in that I will watch market activity tomorrow for a couple of hours. If the markets are trending higher, I will wait another day before executing my stops.

If the trend is lower, I will sell the affected holdings tomorrow.

Reader Nitin sent me an article from BusinessWeek called “Five Reasons to Sell, Sell, Sell.”

It lists five of the biggest threats to the current stock market rally, which include:

1. Earnings

5. Shiny happy investors

All of these are items which I’ve discussed in various posts and comments, and every one them has the ability to derail the current bull market. Some have actually contributed to last week’s sharp pullback. If you are a casual reader of these types of articles, you may be prompted to liquidate your entire portfolio, and possibly watch the major indexes resume their upward march for another 6 months.

And that is the problem with these stories. They may be correct in outlining all of the culprits that will always affect markets to the downside, but that does not mean such an event is imminent.

This is why I continuously harp on the fact that these stories have no value when it comes to actually making a decision regarding your investments. At the risk of sounding like a used car salesman (no offense), stick to watching the major trend and follow your trailing sell stop points. Those are real numbers you can use to improve your decision making process.

As I mentioned last Friday, those funds/ETFs that had barely triggered my sell stop points were slated to be sold today. This plan was subject to confirming further market direction to the downside at today’s opening, to make sure we would not expose ourselves to a potential whipsaw.

So far so good! The markets rebounded nicely and pushed our holdings back below the 7% sell stop level. I will wait with any liquidation until the sell points have been clearly pierced to the downside before taking further action. It is too early to tell whether today’s rebound was just a dead-cat-bounce or the beginning of another leg in the bull market.