ETFs for Tomorrow

Investing in index funds can be all the Foolish strategy you need to build a financially rewarding portfolio. You get instant, low-cost diversification across a variety of industries, and you never have to worry about timing the market.

Making automatic contributions into an index fund gives an average investor all the benefits of dollar-cost averaging, making it easy to save regularly for the future. Warren Buffett once noted that his favorite time to sell is "never," and in that respect, index funds let you invest just like the Oracle of Omaha does.

That could explain why exchange-traded funds are now so popular. According to the Investment Company Institute, ETF assets totaled more than $507 billion of the more than $1 trillion in stock index funds as of August.

A basket of stocks
ETFs, originally modeled after index funds, are mutual funds that trade like stocks. The first batch of ETFs, SPDRs ("spiders") offered even lower expense ratios than many index funds, along with some additional tax efficiency. The ability to trade ETFs like stocks added to their popularity, although Fools should note that increased taxes and trading costs can erase any benefits from buying and holding an ETF.

As ETFs proliferated, they gradually narrowed their contents, from broad indexes to specialized slices of the market. That's been a boon to investors seeking to home in on certain areas of the market by buying a basket of related stocks. But it also concentrates the risk that accompanies such specialization, tilting a portfolio away from the diversification that makes index investing attractive.

Today, we're looking at the best performing ETFs over the past 30 days. We'll then look at the collective intelligence of the professional and novice investors at Motley Fool CAPS, and find out which funds our participants have rated as the best.

There are many exchange-traded funds to choose from, but few have been around for very long. Considering the way the market's behaving these days, it's not surprising that ETFs betting on declining stocks have prospered.

Yet while these funds have been designed to help hedge against downturns, they are new creations without track records. In fact, only ETF we highlight today has a one-year return record, and none of the rest has been around for three full years. Of course, even venerable mutual funds had to start sometime, so only time will tell if these ETFs can build as solid a track record over five- and 10-year time periods. Until then, however, investors would be wise to use caution.

An international flavor
In particular, one ETF designed to hedge against real estate did particularly well. With the Federal Reserve taking actions to help soften the economy, All-Star CAPS investorintelledgement, who has a 94.03 player rating, sees opportunities to capitalize:

[The Fed isn't] going to cure the excesses of the real estate market over the past several years. We are in this mess in part because of easy credit enabling loans to be made that should not have been for houses with unrealistically inflated values. Making mortgages a little easier to get ain't gonna solve the bad paper problem, and it may actually make it worse. It sure wouldn't help the dollar any.

The big picture here is that collectively, the USA has been borrowing cheap money like mad and mostly spending it on operations (vacations, Jacuzzis, invasions) instead of capital investments (infrastructure, education, production capacity). This unsustainable dynamic has to end sooner or later, and the industries that depend on overpriced real estate for succor will be among the first to lose their balance and are likely to fall the furthest.

Half of the nearly 200 investors rating this real estate ETF hedge are All-Stars, with 95% of them expecting it to continue outperforming the market.

A basket of opinions
Do you agree? Give your opinion over at CAPS on whether you think these ETFs will continue to outperform -- or is it time for new ones to ascend to the top of the lists?