However, you should always keep in mind that not all exchange traded funds are created equal. For example, there are a lot of ETFs that have been created to tap into popular, but risky, themes and fads. So you need to be very selective with your ETF holdings.

Exchange traded funds are set up to mirror the performance of a stock-market index or sub-index. They hold a more or less fixed selection of securities that represent the holdings that go into the calculation of the index or sub-index. ETFs trade on stock exchanges, just like stocks. Investors can buy them on margin or sell them short.

For example, a member of Pat McKeough’s Inner Circle recently asked us about Global X Silver Miners ETF (symbol SIL on New York). The fund tracks the Solactive Global Silver Miners Index, which includes between 20 and 40 international companies that mine, refine or explore for silver (see below for more on this ETF’s holdings).

Use caution when investing in silver

Silver prices tend to rise along with gold prices. That’s because when gold prices soar, as they have lately, investors see silver as less of an industrial commodity and more as a precious metal. Sometimes known as “poor man’s gold,” silver attracts a lot of interest as gold prices reach levels that seem too expensive for the average investor.

"Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds": In this new special report, Pat McKeough and his team of investment professionals show you which funds could make you exceptional profits over the next year. You learn how Pat and his team rate the funds they select, how to choose the right funds to help you weather a market slump, and much more. Click here to learn how you can get started right away.

Conservative investors should be careful when making silver investments, as they would be with any volatile commodity investment. Further, silver should only make up a modest part of the resources segment of your portfolio.

This exchange traded fund offers a convenient way to hold silver-mining stocks

If you want to invest in silver, we think the best way to do it is through silver-mining stocks. We recommend staying away from silver bullion, certificates representing an interest in bullion, and other silver bullion alternatives, such as so-called “junk silver” coins (these are common coins with no numismatic value that trade strictly on their silver content).

Commodity investments like these do not generate income. Instead, they come with a continuing cash drain for management, insurance and so on.

You can hold silver stocks directly, through mutual funds, or through exchange traded funds like Global X Silver Miners ETF, which we recently analyzed for a member of Pat McKeough’s Inner Circle.

Global X Silver Miners ETF began trading on April 19, 2010.

Canadian-based companies make up 58% Global X Silver Miners ETF’s holdings, but it also includes companies based in Mexico (24%), the U.S. (10%), Peru (4%) and Russia (4%). The fund’s MER is 0.65%.

The ETF’s top-ten holdings are Silver Wheaton Corp. at 13.9%; Pan American Silver, 12.3%; Fresnillo plc, 11.2%; Industrias Penoles SAB de CV, 10.3%; Silvercorp Minerals, 5.2%; Coeur d’Alene Mines, 5.0%; Hecla Mining, 4.9%; Silver Standard Resources, 4.8%; Gammon Gold, 4.6%; and Polimetall OAO, 4.0%.

If you have investment-related questions, or if you’d like to ask us about stocks or other types of investments you’re considering buying (or selling), you should join our Inner Circle service. Click here to learn more.

How asset allocation funds work

Asset allocation funds are mutual funds that can shift their portfolio allocations between stocks, bonds and cash in order to capitalize on perceived investment opportunities in any one of those classes.

For example, if the managers feel that the bond market is depressed and poised for an upswing, they may overweight the portfolio in fixed-income investments for a few months to take advantage of the change.

Some managers use judgment calls to choose between stocks, bonds and cash, while many use a so-called “black box” — a computer program that makes trading decisions based on a preselected set of rules for interpreting financial statistics. Computer modelling makes this investment approach sound scientific, but it is just as likely to detract from a portfolio’s long-term return as it is to add to it.

Holding bonds — through asset allocation funds or otherwise — will likely hurt your long-term returns

The performance of bonds is inversely related to the rise and fall of interest rates; when rates fall, bond prices go up.

"Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds": In this new special report, Pat McKeough and his team of investment professionals show you which funds could make you exceptional profits over the next year. You learn how Pat and his team rate the funds they select, how to choose the right funds to help you weather a market slump, and much more. Click here to learn how you can get started right away.

With interest rates now at historic lows, bonds can’t go a lot higher than they are. In fact, it seems more likely that rates will hold steady or rise slightly in the short term, and move higher in the long run. That means asset allocation mutual funds would only earn interest income on their bonds; instead of capital gains, their bond holdings could produce capital losses.

Our long-term strategy puts you in a better position to profit than asset allocation funds

Instead of asset allocation mutual funds, we think you would be far better off investing in well-established, high-quality dividend-paying stocks. If you want to hold these stocks in a mutual fund, you could choose from the funds we recommend in our special report, “Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds.”

Moreover, you can eliminate market-timing risk by spreading your money out across most, if not all, of the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; and Utilities). This way, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or changes in investor opinion.

You also increase your chances of stumbling upon a market superstar — a stock that does two to three (or more) times better than the market average.

Here’s an alternative to an all-stocks portfolio

If you are reluctant to hold a 100%-stocks portfolio — and many people are — then one alternative to consider is to keep a portion of your investment funds in relatively short-term fixed-return investments, with maturity dates of a few months to no more than two to three years in the future.

These fixed-return investments will lose value when interest rates rise, but not enough to make a serious dent in their value. You can hold them till maturity, then get your money back and reinvest.

In “Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds,” we show you which mutual funds could make you exceptional profits over the next year. You get our in-depth analysis of each fund, plus our latest strategies for maximizing your mutual-fund profits, weathering a market slump and more. Click here to learn how you can get started right away.

That’s because the country borders on North Korea, with its nuclear weapons and seemingly unstable leader. Certainly, North Korea’s unpredictability is a continuing drawback to investing in South Korea. However, the North Korean leader’s bluster has so far stopped short of any serious risk to the south.

As well, South Korea’s economy, which is Asia’s fourth largest, grew 5.9% in the fourth quarter of 2009. That’s the highest rate since 2007. Moreover, the World Bank’s 2010 ease of doing business survey recently ranked South Korea 19th, just behind Sweden and ahead of Germany and France. (Brazil, by comparison, ranked 129th and India 133rd.)

The country’s exports to China are also rising. That’s helping offset lower exports to the U.S. and Europe. China is now South Korea’s biggest export market. To top it off, South Korea is home to some of the world’s most successful multinational corporations, including Samsung Electronics, Hyundai Motor Co. and LG Electronics.

Use exchange-traded funds to tap into South Korean profits

Exchange-traded funds (ETFs) can be good choices for the part of your portfolio that you devote to investing in foreign countries, including South Korea.

That’s because directly investing in foreign markets can be complicated and risky, and high-quality ETFs let you make overseas investments with greater safety.

ETFs mirror the performance of a stock-market index or sub-index. They hold a more-or-less fixed selection of securities that are chosen to represent the holdings that go into the calculation of the index or sub-index.

Exchange-traded funds trade on stock exchanges, just like stocks. Investors can buy them on margin or sell them short. The best ETFs offer well-diversified, tax-efficient portfolios with exceptionally low management fees. They are also very liquid.

In a just-published issue of Canadian Wealth Advisor, we give you our special analysis of five ETFs that may be appropriate for the part of your portfolio you devote to international investing. One of these funds is the IShares MSCI South Korea Index Fund (symbol EWY on New York).

"Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds": In this new special report, Pat McKeough and his team of investment professionals show you which funds could make you exceptional profits over the next year. You learn how Pat and his team rate the funds they select, how to choose the right funds to help you weather a market slump, and much more. Click here to learn how you can get started right away.

A low-cost way to hold the biggest South Korean companies

IShares MSCI South Korea Index Fund aims to track the MSCI Korea Index. The index aims to capture 85% of the total market capitalization of the South Korean stock market. The other 15% is unavailable for investment, partly due to limitations on foreign ownership.

The fund’s top holdings are Samsung Electronics, 18.0%; Posco (steel), 7.6%; Hyundai Motor Co., 3.9%; Shinhan Financial, 3.7%; KB Financial Group, 3.5%; LG Electronics, 2.2%; Samsung Electronics preferred shares, 2.2%; LG Chemical, 2.2%; Hynix Semiconductor, 2.2%; and Korea Electric Power, 2.1%.

The fund’s industry breakdown is as follows: Information Technology, 28.5%; Financials, 16.0%; Industrials, 14.9%; Materials, 14.0%; Consumer Discretionary, 12.0%; Consumer Staples, 5.0%; Telecommunication Services, 3.4%; Energy, 2.4%; Utilities, 2.4%; and Health Care, 0.5%.

iShares MSCI South Korea Index Fund was launched on May 9, 2000. The ETF has an expense ratio of 0.65%.

You can get our full analysis of five top exchange-traded funds for international investing, including our latest buy/sell/hold advice in the current issue of Canadian Wealth Advisor. What’s more, you can get this issue absolutely free. Click here to learn how.

Exchange traded funds are set up to mirror the performance of a stock-market index or sub-index. They hold a more-or-less fixed selection of securities that represent the holdings that go into the calculation of the index or sub-index.

Exchange traded funds trade on stock exchanges, just like stocks. Investors can buy them on margin or sell them short. We recommend a number of carefully selected exchange-traded funds in our Canadian Wealth Advisor newsletter.

Avoid losses: Be wary of theme-based exchange traded funds

It’s important to note that not all ETFs are created equal. For example, there are a lot of ETFs that have been created to tap into popular, but risky, themes and fads. So you need to be very selective with your ETF holdings.

An Inner Circle member recently asked us about an ETF that’s tied to a risky theme (“alternative energy” in this case). To give you a sense of the risks involved in this type of investment, we’d like to share our member’s question, along with our response. We hope you enjoy and profit from it.

Q: Hello Pat. I am currently holding the following in my RRSP account: Market Vectors Nuclear Energy ETF. What do you think about this exchange-traded fund? Thank you for your advice.

A: Market Vectors Nuclear Energy ETF, $22.80, symbol NLR on New York (Shares outstanding: 7.4 million; Market cap: $167.2 million), aims to track the performance of the DAXglobal Nuclear Energy Index. The index includes 24 companies in the nuclear-energy industry. These firms are located in a number of countries.

"Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds": In this new special report, Pat McKeough and his team of investment professionals show you which funds could make you exceptional profits over the next year. You learn how Pat and his team rate the funds they select, how to choose the right funds to help you weather a market slump, and much more. Click here to learn how you can get started right away.

To be included in the index, a company must be publicly traded, have a market cap over $150 million U.S. and meet certain minimum trading requirements. The index is divided into seven different areas of the nuclear industry: uranium mining (36.6%), nuclear generation (26.0%), plant infrastructure (22.5%), uranium storage (4.5%), nuclear conglomerates (4.4%), uranium enrichment (3.5%) and nuclear fuel transport (2.5%).

The index’s top 10 holdings are Mitsubishi Heavy Industries (8.5%), Constellation Energy Group (8.2%), Electricite de France (7.7%), Exelon Corp. (7.5%), Cameco (7.4%), Uranium One (5.2%), JGC Corp. (4.6%), Paladin Energy (4.3%), Areva SA (4.1%) and Uranium Participation Corp. (4.1%).

Market Vectors Nuclear Energy ETF first sold units to the public for $50 each, and began trading on New York in August 2007. The fund holds 24 stocks. It has an expense ratio of 0.61%.

Nuclear power’s long-term outlook is positive. That’s because global electricity demand is growing in the face of heightened concern about power generated using conventional fuels. Oil, for example, is a non-renewable resource. Coal is also non-renewable, and releases large amounts of pollutants when it is burned.

Technological advances in both uranium mining and nuclear-reactor construction have improved nuclear power’s safety record, addressed a number of environmental concerns and increased efficiency. As a result, there is growing acceptance that nuclear energy is a necessary part of a “green” energy solution.

Nuclear industry faces unique risks

Despite these advantages, the nuclear industry faces a number of short-term problems, including lower uranium prices, delays in building costly new nuclear plants, the weak global economy and ongoing problems in credit markets. All of these problems will likely hold back Market Vectors Nuclear Energy ETF.

We don’t recommend Market Vectors Nuclear Energy ETF.

If you have investment questions, or if you’d like to ask us about stocks or other types of investments you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.

ETFs are set up to mirror the performance of a stock-market index or sub-index. They hold a more-or-less fixed selection of securities that represent the holdings that go into the calculation of the index or sub-index.

ETFs trade on stock exchanges, just like stocks. Investors can buy them on margin or sell them short. The best ETFs offer well diversified, tax-efficient portfolios with exceptionally low management fees.

Exchange-traded funds have certain drawbacks

It’s important to note that not all ETFs are created equal. For example, there are a lot of ETFs that have been created to tap into popular, but risky, themes and fads, so you need to be very selective with your ETF holdings.

Moreover, ETFs tend to load you up on the hottest, most popular stocks or sectors as they rise. That’s because, as they rise, these stocks or sectors make up a rising proportion of the index.

The Resources sector provides an example. Many Resources stocks have made significant gains with the economic recovery, and this sector now makes up roughly 47% of the Toronto Stock Exchange.

However, over the next year or even two, resource prices are likely to be highly erratic as the economy continues to struggle to get back to normal. That’s why we believe that it’s better to be under-represented in Resources, rather than sit through a slump with too much committed to this volatile sector. Aggressive investors may want to commit up to 25% or 30% of their portfolios to Resources (provided they diversify widely within the sector), however a 47% weighting in Resources is far too high, even for highly aggressive investors.

Stick to our ETF recommendations

We recommend a small selection of exchange-traded funds in our Canadian Wealth Advisor newsletter. In our latest issue, we’ve published our analysis of 6 exchange-traded funds that track the major North American stock exchanges, including our clear buy/sell/hold advice. See below for our latest analysis of one of these funds: iShares CDN LargeCap 60 Index Fund (symbol XIU on Toronto).

"Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds": In this new special report, Pat McKeough and his team of investment professionals show you which funds could make you exceptional profits over the next year. You learn how Pat and his team rate the funds they select, how to choose the right funds to help you weather a market slump, and much more. Click here to learn how you can get started right away.

IShares CDN LargeCap 60 Index Fund: An easy way to buy some of Canada’s top stocks

iShares CDN LargeCap 60 Index Fund (symbol XIU on Toronto) is a good, low-fee way to buy the top stocks and income trusts on the Toronto Stock Exchange. The units are made up of stocks that represent the S&P/TSX 60 Index, which consists of the 60 largest, most heavily traded stocks on the exchange. Expenses are just 0.17% of assets.

Most of the stocks in the index are high-quality companies. However, as it must ensure that all sectors are represented, the index holds a few we wouldn’t include, such as Yellow Pages Income Fund.

The index’s top holdings are: Royal Bank, 8.1%; TD Bank, 5.8%; Bank of Nova Scotia, 4.9%; Suncor Energy, 4.8%; Barrick Gold, 3.9%; Canadian Natural Resources, 3.9%; Research in Motion, 3.7%; Potash Corp., 3.4%; Manulife, 3.4%; Bank of Montreal, 3.1%; Goldcorp, 2.9%; CIBC, 2.7%; CN Railway, 2.6%; and EnCana, 2.6%.

For our latest buy/sell/hold advice on IShares CDN LargeCap 60 Index fund and 21 other safety-conscious investments, be sure to consult the latest Canadian Wealth Advisor newsletter. Best of all, you can get this issue absolutely free. Click here to learn how.

(One of the best ways for investors to tap into Chinese growth is through low-fee exchange-traded funds. The iShares FTSE/Xinhua China 25 Index Fund is one example of an exchange traded fund that focuses on China. You can get our very latest buy/sell/hold advice on this fund in the latest issue of Canadian Wealth Advisor. See below for further details. )

Political instability still a danger to foreign investors in China

Even though China offers lots of growth potential, there are still risks involved in investing directly in Chinese stocks. One of the biggest risks is politics. China’s periodic leadership struggles can bring positive or negative changes for foreign investors. Inside China, there is unrest in rural areas, because farm workers are not joining fully in the growing prosperity in the cities. This unrest could spread to the unemployed and under-employed in China’s cities, destabilizing the political and social environment.

"Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds": In this new special report, Pat McKeough and his team of investment professionals show you which funds could make you exceptional profits over the next year. You learn how Pat and his team rate the funds they select, how to choose the right funds to help you weather a market slump, and much more. Click here to learn how you can get started right away.

As well, China is still in the early stages of establishing the rule of law, in which property rights are respected. Corporate governance is in its infancy, and control of corruption is sporadic. The political climate can change quickly in countries that do not have a tradition of the rule of law. When changes occur, you can bet that foreign investors will suffer more than the locals.

Exchange traded funds offer a low-cost, convenient way to access emerging markets

In light of these risks, we continue to recommend that you use caution when directly investing in emerging markets like China. We also think that low-fee exchange traded funds are one of the best ways for most investors to take advantage of the fast growth that these markets offer.

Exchange-traded funds mirror the performance of a stock-market index or sub-index. They hold a more-or-less fixed selection of securities that are chosen to represent the holdings that go into the calculation of the index or sub-index.

These funds trade on stock exchanges, just like stocks. Investors can buy them on margin or sell them short.

Here’s our latest analysis of a Chinese exchange-traded fund with strong growth potential

We’ve updated our buy/sell/hold advice on the iShares FTSE/Xinhua China 25 Index Fund in the latest Canadian Wealth Advisor.

The exchange-traded fund aims to track the FTSE/Xinhua China 25 Index, which is made up of the 25 largest and most liquid Chinese stocks. All of the stocks in the index trade on the Hong Kong exchange. Some also trade as American Depositary Receipts on the New York Stock Exchange.

The $7.6-billion fund’s top holdings are China Mobile, 10.4%; China Construction Bank, 9.5%; Industrial & Commercial Bank of China, 8.4%; China Life Insurance, 7.0%; Bank of China, 6.2%; China Merchants Bank, 4.2%; CNOOC Ltd., 4.2%; Ping An Insurance Group, 4.0%; China Petroleum & Chemical, 3.9%; and China Telecom, 3.9%.

The fund’s holdings give it the following industry breakdown: Financials (46.6%), Telecommunications (18.0%), Oil and Gas (12.0%), Basic Materials (11.1%), Industrials (8.8%), Utilities (1.9%) and Consumer Services (1.6%).

iShares FTSE/Xinhua China 25 Index Fund was launched on October 5, 2004. It trades at a 0.8% discount to its net asset value. The ETF has a 0.73% expense ratio. The dividend yield is 1.2%.

You can get our latest buy/sell/hold advice on iShares FTSE/Xinhua China 25 Index Fund in the latest Canadian Wealth Advisor newsletter. Click here to learn how you can get one month free when you subscribe today.

The $15.7-billion fund’s top holdings are Microsoft, IBM, Apple Inc., Cisco Systems, Wal-Mart Stores, Google Inc., Hewlett-Packard, Oracle Corp., Philip Morris International and PepsiCo.

Vanguard Growth ETF is broken down by economic segment as follows: Information Technologies (36.1%), Health Care (13.8%), Consumer Staples (11.3%), Consumer Discretionary (11.8%), Industrials (8.0%), Energy (7.5%), Financials (5.9%), Materials (4.5%), Telecommunication Services (0.8%) and Utilities (0.3%).

Vanguard Growth ETF is a buy.

The fund’s MER is 0.50%. iShares Dividend Index Fund has a 3.7% yield.

Top holdings are CIBC, 7.3%; Bank of Montreal, 6.3%; Manitoba Tel, 5.7%; National Bank, 5.5%; TD Bank, 5.3%; IGM Financial, 4.5%; Royal Bank, 4.4%; Bank of Nova Scotia, 4.3%; Telus, 4.2%; Sun Life, 3.6%; Power Financial, 3.4%; and TransCanada Corp., 3.4%.

iShares Dividend Index Fund is a buy.

Vanguard, which went into business in 1975, offers low-fee index mutual funds. Generally speaking, Canadians can’t buy units of mutual funds that are registered in the U.S. because they aren’t registered with provincial securities commissions. For that matter, some Canadian funds aren’t available in all provinces.

Canadians can, however, buy Vanguard exchange-traded funds (ETFs) that are listed on U.S. stock exchanges. We don’t recommend all of the Vanguard index funds, but here are two that we do see as low-fee buys:

VANGUARD EMERGING MARKETS ETF $38.72 (New York symbol VWO; buy or sell through brokers) aims to track the MSCI Emerging Markets Index, which is made up of common stocks of companies located in emerging markets around the world. The fund has an MER of 0.27%.

The fund’s top holdings are China Mobile (China: wireless), Gazprom (Russia: gas utility), Samsung Electronics (South Korea: electronics), Teva Pharmaceutical Industries, America Movil SA de CV (Latin America: wireless), Petroleo Brasileiro SA (Brazil: oil and gas), China Construction Bank, Vale SA (Brazil: mining) and Industrial and Commercial Bank of China.

The $32.7-billion Vanguard Emerging Markets ETF’s largest holdings by country are: China (17.8%), Brazil (17.0%), South Korea (12.8%), Taiwan (11.3%), India (7.6%), South Africa (6.9%), Russia (6.5%), Mexico (4.4%), Israel (2.8%), Malaysia (2.7%), Indonesia (1.9%), Turkey (1.5%), Chile (1.5%), Thailand (1.4%), Poland (1.3%), Hungary (0.6%), Philippines (0.5%), Peru (0.5%), Czech Republic (0.4%), Colombia (0.3%) and Egypt (0.2%).

Vanguard Emerging Markets ETF is a buy for aggressive investors.

VANGUARD GROWTH ETF $51.35 (New York symbol VUG; buy or sell through brokers) aims to track the MSCI U.S. Prime Market Growth Index, a broadly diversified index that mainly consists of stocks of large U.S. companies. The fund has an MER of just 0.15%.

The $15.7-billion fund’s top holdings are Microsoft, IBM, Apple Inc., Cisco Systems, Wal-Mart Stores, Google Inc., Hewlett-Packard, Oracle Corp., Philip Morris International and PepsiCo.

Vanguard Growth ETF is broken down by economic segment as follows: Information Technologies (36.1%), Health Care (13.8%), Consumer Staples (11.3%), Consumer Discretionary (11.8%), Industrials (8.0%), Energy (7.5%), Financials (5.9%), Materials (4.5%), Telecommunication Services (0.8%) and Utilities (0.3%).

Vanguard Growth ETF is a buy.

TD Science & Technology’s top holdings include Microsoft, IBM, Apple, Google, Cisco Systems, Samsung Electronics, McAfee Inc., Qualcomm, Palm, Autodesk, Juniper Networks, Canon, Hewlett-Packard and Accenture. The fund’s MER is 2.68%.

The $92.6-million fund rose 49.5% (in Canadian dollars) over the last year. The Nasdaq index gained 19.4% (also in Canadian funds) in the same period. However, over the last 10 years, the fund has lost 10.6% annually, compared to a loss of 7.4% annually for the Nasdaq index.

Science and technology is a volatile area, and the fund could suffer significantly in a market downturn.

TD Science & Technology Fund is a hold, but for aggressive investors only.