As you develop your 2008 asset allocation plans, perhaps consider your exchange traded funds’ (ETFs) risk-reward characteristics over time. One way to do this is through William Sharpe’s ratio, which measures the historic risk/reward characteristic of a security. The equation is: (Total Return – Risk Free Rate)/Standard Deviation of Returns.

Jeff Pietsch for Seeking Alpha reports that looking across ETF categories with the Sharpe ratio equation, he saw two things. First, volatility increased dramatically in almost every ETF category, in some instances nearly doubling between the first and second half of the year. Second, was the dual nature of returns. Energy and metals led the pack, and financials and homebuilders brought up the caboose. Split returns like these are not traits of a healthy bull market.

When considering your 2008 portfolio of ETFs, this equation may offer a bit of guidance.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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