First of all, I am not a professional stock picker. I am an independent investor who never studied business and never knew what he was doing in the stock market – except saying to myself, “I’m not paying some broker to do this for me and charge me on the front end, the back end, and every in and out in between.

Back to my story.

I used to think there were two options for my IRA: mutual funds and individual stocks. Bonds were out of the question. One of my friends told me, “Just say no to bonds.” And I figured bonds were for people 65 and over who had “retired” from trying to make enough money to retire.

I tried mutual funds for several years, and from 1994 – 2000 I did well. Looking back, it was a no lose environment. You could throw darts at the charts and hit winners. Janus, T. Rowe Price, Mutual Series – it didn’t matter!

But along the way, addiction set in. Those 20 – 30% profits were not enough. I got caught up in the exuberance of technology. I craved the highflying funds that were amped up on tech stocks. Well, around 2001, things went south and I lost big time.

Along the way, I had ventured into individual stocks. I reasoned,  “Stocks can go up 5% in one day. That’s more than a lot of mutual funds accomplish in a year. This is a no brainer.” I paid for the price for that, too. Clearly I did not have the genetic makeup to do well in the stock market.

Eventually, I came out of denial. It was time for recovery. No, I didn’t go to Betty Ford. I went to the sidelines. I dried out. Went into cash and some of the most boring big companies I could find. I thought dividends were better than nothing, so I tried parking in places like Procter & Gamble, AT&T, Boeing – you know the names. That was a step in my recovery. Then I had a financial awakening.

Around 2007 I learned about ETFs. “Wait. These are just index funds with a fancy name. I don’t have any trouble falling asleep. No Ambien in my medicine cabinet. Why would I go the route of index funds and commit my IRA to years of sloth and boredom?”

Then I learned about asset allocation, spreading my money around to various asset classes and periodically rebalancing. I found out about the law of compound returns and that it works if you stop trying to beat the market — lower fees and fewer mistakes! Is this really how it’s done?

I learned more about the ups and downs of ETFs – how owning a basket of stocks made sense. After all, market movements make money for managers, not individual stocks. That was an awakening for me. And I learned how markets moved in opposite directions. So if US stocks were on the outs, other indexes would probably be moving up.

So I tried this new approach, cautiously at first.  Just a few ETFs. Although I had never fretted over my IRA at 3 am, I noticed that I was not so preoccupied with my IRA. “Mad Money” was less interesting than the Lakers’ game. The Wall Street Journal was still interesting, but I was not reading the financial pages first. I wasn’t checking my portfolio two or three times a day.

Okay. My name is Miller and I’m a stockaholic.

I still own a few large stocks. I admit it –– I am not fully recovered. I still have a stash of McDonalds, Apple and a couple of other anonymous stocks.

But on the bright side, I am 90% in ETFs. I have US stocks: small, medium and large. Bonds: short, intermediate and long. Europe (bad for the moment), Asia, Canada. TIPS (which performed remarkably well last year) emerging markets, REITS, global real estate, gold and energy. I am diversified big time, with allocations appropriate for my risk tolerance, age and when I will retire.

I feel very comfortable with this arrangement. I don’t worry about the market. When I do check my portfolio, the “reds” are offset by “greens.” When one market is having a bad day, invariably the bonds or other markets pick up the slack. I’ve given up stocks for ETFs and gotten back my sanity.

There is one conspiracy however, worthy of your attention: Those on Wall Street don’t want you to know that their industry is a sham. For Wall Street, the hypnotic malaise they cast over the unknowing investor is nothing less than an $11 trillion dollar shell game. Their gambit makes the baccarat table at the Bellagio look like the neighborhood lemonade stand.

And like any good shell game, they keep the pea moving so you never really understand what just happened. Hideous mutual funds vanish into thin air leaving only winners so that fund companies can claim their funds are leaping tall indexes in a single bound. High fees slip out the back-end of your account while you lie in bed asleep at night, thinking they got your back. And how about that reporting? It’s so convoluted you would have to be a Nobel Laureate in economics to even know what you made—or lost—after fees and taxes in any given year. Did you know that it practically took an act of Congress to force 401(k) providers to tell employees in plain language how much they are paying in fees?

Speaking of Nobel Laureates, fortunately there are a few that have been paying attention: Harry M. Markowitz, Merton H. Miller, William F. Sharpe, and Nobel candidate Eugene Fama, not to mention other notable luminaries such Princeton professor and author Burton Malkiel, John Bogle the founder of Vanguard, and William Bernstein, the acerbic author and truth teller. If you haven’t yet familiarized yourselves with their findings, the time has come to do so. They’ve blown Wall Street’s cover in reams of research. Never mind that they conclusively demonstrate that low-cost indexing beats active management by a long shot, or that the buy, hold, and rebalance style of investing trumps the vein-popping practices of Jim Cramer and crew.

Worse yet, the good guys’ PR campaign is weak. While they stutter in the corner, Wall Street is rolling out eloquent waves of hypnotic media, which roll over us as in a tsunami of minute-long TV ads, billboard artistry, and heart-grabbing radio spots. Each makes you want to pull out your hanky, pick up the phone, and call your mom to say you love her.

Who cares about facts when Smith Barney speaks? Why not talk to Chuck? He sure seems like a nice guy. His name is Chuck. Have you ever met a mean Chuck? Or what about the TD Ameritrade guy, Sam Waterston. He played stalwart Jack McCoy on the NBC series “Law & Order.” He sure cracked the code there, so he’ll be the guy I can trust for my retirement, right?

Yes, Charles Schwab, TD Ameritrade, and others are excellent brokers. For a fair, low price you can have excellent trade execution and fulfillment, as well as receive tremendous customer service and online reporting. But watch your pocket if you go to these firms for investment advice. Chances are they will roll out the four-color glossy print, full-court press, and slip you right into some mutual funds from their supermarket that drip, drip, drip away your hard earned savings in high fees and underperformance.

Conspiracy theories are for the birds. Ours, however, isn’t one of them.  Facts are for the discerning. When it comes to Wall Street, the facts have been revealed by the best economic minds in the world. Are you listening?

In 1989 the first ETF—Index Participation Shares—came to the rescue. This S&P 500 proxy traded on the American Stock Exchange but was quickly gunned down by the Chicago Mercantile Exchange who quickly perceived the threat. It wasn’t until 1993 that the real gunslinger rode into town and changed the order of the fund industry forever.

The Good ETFs. In 1993, SPDR S&P 500 (symbol SPY) was launched on the New York Stock Exchange. Known as SPDRs or “Spiders,” the fund became the largest ETF in the world. In just over 15 years, there are now close to 1000 ETFs with more than $1 trillion in assets and growing at a breakneck pace close to 30 percent year-over-year.

But just when ETFs were winning the day, the ETF industry drifted from its sound mooring after the SEC approved a redefinition of the term “index” in 2003. Before then, ETFs were limited to holding baskets of stocks that tracked broad market indices such as the S&P 500 or MSCI EAFE for foreign developed country markets. After 2003, the SEC allowed ETF providers to create any set of guiding rules to form newfangled “indices.” This changed the definition of an index and allowed the Wall Street crowd to run wild creating the latest, greatest “index” de jour, cluttering the universe of good ETFs with a never-ending wave of convoluted, bad, and in some cases, downright ugly ETFs.

When trying to make sense of the world of ETFs, there are five simple principles that will guide you to the good and away from the bad and ugly:

• Index construction. Evaluate each ETF for the quality of the index it tracks and how well the provider replicates the given index’s performance over a long period of time. A bad index means a bad ETF.
• Low management fees. Be sure that you are paying rational management fees for the asset class under consideration. In general, the lower your fee the more you stand to make over time.
• High volumes. Quality ETFs often average billions of dollars in net assets where daily volume runs very high. This affords sufficient volume and liquidity so that the bid/ask spreads are narrow.
• Low turnover. More turnover means more taxable income. Look for turnover to be very low, about 10 percent for equity ETFs. Turnover is generally greater for bond ETFs because bonds mature and need to be continually replaced.
• Quality sponsors. Look to Vanguard, iShares, SPDRs, and Schwab ETFs for quality funds. These four firms account for close to 90 percent of all ETF assets and are highly regarded in the industry. Since Vanguard is a not-for-profit institution with the lowest fees in the industry, they tend to keep the other ETF providers “honest.”

The bad and the ugly ETFs. With new indexes popping up daily, the original “purity” of ETFs as suitable building blocks for asset allocation has been polluted. One of the most extreme examples of this is an ETF released in 2007 (now closed) by FocusShares, which developed an index of mid- and large-sized companies consisting of casinos, producers of beer and malt liquors, distillers, vintners, as well as cigarette manufacturers, and called it a “sin” index. Below is a list of potentially bad and ugly ETF categories to watch out for:

• Leveraged ETFs. While ProShares launched the first leveraged ETFs, a subsequent wave of leveraged products have followed. Strangely, these leveraged products have been known to sometimes severely miss the index over the long haul. Because daily returns are compounded, the returns of leveraged ETFs over periods longer than one day will likely differ in amount. And leverage is dangerous. Take for instance Direxion Daily Financial Bear 3X Shares (symbol FAZ), which plunged 95 percent, earning it the ignominious title of worst performing ETF in 2009.
• Actively-managed ETFs. It has been said that “if you can’t beat ‘em, join ‘em.” Well this seems to be the case with many active money managers that are now moving their practices from the mutual fund industry over to the ETF space. ETFs with a portfolio manager face the same challenges that mutual funds face—high fees and poor long-term performance records.
• Commodity ETFs. These hold futures contracts. Avoid ETFs that buy future contracts to achieve commodity exposure. Futures-based funds can fail to track their target index and are vulnerable to problems such as contango and backwardation. It is best to avoid such ETFs and stick with commodity ETFs that actually hold the underlying assets.

For you investment geeks who want a more comprehensive discussion on how we’ve used this to pick the ETFs for our MarketRiders portfolios, click here. When it comes to ETFs, invest in the good and avoid the bad and ugly. As tempting as the newfangled ETFs can be, the details reveal serious investment risks. By sticking with the five principles to finding good ETFs you can invest with confidence knowing that you have kept the bandit out of your portfolio.

The tax basics. First, some tax basics for all types of funds. When you make a profit, you have to pay the government in the form of the capital gains tax. Capital gains rates differ depending on whether the asset is held less or more than a year, creating short- or long-terms gains. These tax rates vary depending on an investor’s income level, but generally, federal tax rates under the Bush-era tax plan can be as high as 15 percent for long-term and 35 percent for short-term capital gains. State taxes also apply.

Most ETFs also generate dividends, which are taxed. By meeting a specific set of holding criteria, long-term ETF investors will predominantly enjoy qualified dividend tax rates up to 15 percent with the exception of funds that track real estate investment trusts (REITs), which are unfortunately taxed as ordinary income. While both ETFs and mutual funds can generate capital gains, the tax implications of each are significantly different.

How mutual fund taxes work. Imagine that everyone in your neighborhood filed a joint tax return. What if your neighbor, Joe, happened to sell his business and you were required to pay a portion of his tax? Not acceptable, you would say.

Unfortunately, that is how mutual fund investing works. If one investor in the fund sells his position, the fund manager must sell underlying stock to give that investor his money back. That underlying stock may have a very low tax basis because it was added to the fund years before you ever invested. As a participant in the fund, you get hit with a portion of the tax consequence of the other person’s sale.

This mutual fund tax bomb grows daily and will eventually explode when rebalancing and redemptions force these low cost-basis shares to be traded. There have been instances where a mutual fund manager has held an underlying equity for years, accruing significant capital gains, only to eventually sell and foist a portion of the tax burden onto the new shareholder who just entered the fund.

That’s why looking at a mutual fund’s published performance is an inadequate measure for an investment decision. And unfortunately, there’s little visibility of the size of the boat anchor the fund is dragging in the form of excess taxes.

How ETF taxes work. ETFs are like mutual funds in that investors buy a broad range of underlying equities in one purchase, but they differ in that they are traded like a stock throughout the trading day. Capital gains taxes must be paid on ETF profits as well, but with a significant twist.

Although quite technical, simply put, ETF shares are created through an intermediary, a type of middleman that stands between the individual investor and the ETF provider. The ETF provider engages in “in-kind” transactions, trading baskets of securities for very large blocks of shares with the middleman.

As individual investors buy and sell shares of an ETF, a super-computer enabled arbitrage happens between the ETF provider and the middleman in the blink of an eye. Your shares are combined with the shares of other buyers and sellers that are traded for the underlying equities with the fund itself. In this way, individual investors never directly buy underlying taxable shares. This method allows the ETF provider to manage the tax bill for investors. In fact, this methodology is so effective that it is rare for an ETF to generate any taxable income at all.

Additionally, the cost basis of the underlying equities within the ETF is constantly being reset upward and at arms length from the individual investor. The result is wonderful. The ETF behaves like an individual equity in terms of taxes, but enjoys the diversification of a mutual fund–the best of both worlds.

For these reasons, ETFs are growing. In 2008, Morningstar conducted a survey on capital gains distributions for ETFs across 27 broad-based indexes over 5-, 10- and 15-year time horizons. The study showed only two ETFs made capital gain distributions over the past five years while just one ETF made distributions over the past 10 years.

As an example of their lower capital gains structure, iShares compared its ETFs with actively managed mutual funds in multiple categories over 10 years (2000 through 2009). The iShares Russell 1000 Growth Index Fund (IWF) had a capital gains rate of zero percent compared with 2 percent for the average, actively managed U.S. large-cap, open-end growth fund over that period. The iShares Russell 1000 Value Index Fund (IWD) also had a capital gains rate of zero percent compared with 2.9 percent for the average, actively-managed, open-end U.S. large-value fund over the decade.

Dumping your old mutual funds in favor of the more sophisticated and tax-efficient architecture of ETFs is like tossing out the old Motorola flip phone in favor of a new, 4G smartphone. The technology is simply better. Along with low fees and reliable performance, tax efficiency is another reason to get on the ETF bandwagon. You will be glad you made the change.

Owning real estate has its own set of risks and benefits. A property that is well-located and leased gives you debt-like cash flow with the opportunity for appreciation like stocks. Leased buildings are valued based upon the stability of cash flow from rents and the cost to replace the building. Real estate also protects you against inflation, as its value tends to move closely with the costs required to replace it-think land, bricks, concrete, steel, labor, and fixtures. These costs rise with inflation, and landlords raise rents over time if inflation grows.

Most investors, however, don’t want to buy a building. Fortunately, it’s easy to own real estate without ever fixing a toilet, or worrying about a roof caving in during a winter storm. You can get a well-diversified real estate portfolio by owning real estate in the form of real estate investment trusts (REITs). These are unique public securities because they pay no taxes and pass through 90 percent of their income to investors in dividends. From 1970-2009, public REITs returned an average of 9.1 percent per year. That means money invested in REITs doubled every eight years!

That doesn’t mean real estate won’t have ups and downs. REITs tend to trade in large swings between the fair value of the real estate held in the REIT to the stock price-from a 20 percent discount to a 20 percent premium. As you can see from the green box on this chart, between 2000 and 2009 REITs have been up or down by more than 35 percent. But while the stocks may swing, you can sleep at night knowing that you own hard, rent-paying assets.

The best way to own REITs is through an exchange traded fund (ETF) because the costs are low and you’d be hard-pressed to find an active fund manager with the expertise to consistently pick REITs over many years that will beat a REIT index. In fact, owning REITs through a mutual fund can cost you almost 50 percent of the yearly dividend you should receive, in manager fees. Therefore, instead of paying high fees, just buy an ETF that holds all of the REITs that matter. We recommend two SPDR Dow Jones ETFs in all of our portfolios to get REIT exposure: The SPDR Dow Jones REIT ETF (RWR) which indexes U.S. real estate and the SPDR Dow Jones International Real Estate ETF (RWX), which indexes international real estate.

For an annual fee of only 0.25 percent, RWR allows you to own the largest 81 REITs in the United States, including the largest American malls through Simon Malls, self-storage units at Public Storage Group, apartments, office buildings, and strip centers. Last year, investors received dividends of 3.61 percent.

For a fee of only 0.59 percent, RWX allows you to own a piece of companies like the Westfield Group in Australia with shopping centers worldwide and apartments and hotels held outside of the United States by Mitsui Fodusan. RWX paid a dividend of 3.46 percent last year.

Not all real estate assets serve the same purpose. Your personal residence should not be considered part of a proper real estate allocation because it is one highly concentrated holding largely for personal consumption. Owning raw land, real estate development projects, and hotels are not considered part of this asset class. These investments’ value relies upon the operating expertise of the principals, not the fundamentals of the real estate itself.

But owning REITs using an ETF gives you global exposure for a low cost and adds diversity to your portfolio. That’s why we  make sure you have them among your retirement assets.

Just because these countries like Brazil, India, Russia and China may be growing at record levels, stock prices don’t necessarily rise because their economies and governments are “emerging.” Shareholders benefit when companies grow after-tax profits. Governments of these countries might have onerous tax rates, state-sponsored price controls, securities laws that are not evolved or enforced, corruption, or risk of wars and violence, to mention a few common risks. All of these elements make these economies and their stock prices highly volatile.

Until a few years ago, the everyday investor had limited access to emerging markets, and when there was an alternative, he paid eight to 10 times more in fees than institutional and wealthy investors. Exchange-traded funds (ETFs) have truly democratized international investing. In the last six years, high-priced mutual funds averaging 1.5 percent in annual fees, like Morgan Stanley Emerging Markets (MGEMX), Lazard Emerging Markets (LZEMX), or T. Rowe Price Emerging Markets (PRMSX), have been challenged by superior, low-cost ETFs.

We recommend a single ETF for emerging market stocks: the Vanguard Emerging Markets ETF (symbol VWO).  If you owned $10,000 of VWO, you would own a piece of 833 stocks in more than 20 countries and for only $27 per year (a 0.27 percent expense ratio). Vanguard trades, rebalances, and maintains this basket of stocks. You won’t have to figure out whether China will do better than Russia, or whether you should be investing in Mexico or Thailand. You won’t have to decide whether Petroleo Brasileiro is better than China Mobile or Samsung-or pay an arm and a leg to an investment pro to figure this out. With VWO, you’ll own them all.

If you want some of your emerging market allocation to include specific countries or even continents, there are more specific ETFs. For country and region ETFs, iShares offers, for example: EWZ (Brazil), FXI (China), EWY (South Korea), or even all of Latin America (ILF). Expenses for these ETFs range from 0.5 percent to 0.8 percent in fees and are the equivalent of buying the S&P 500 for these countries. Some of our members for example, may use VWO for 80 percent of their emerging markets allocation and then pick two countries and put 5 percent in each of these.  They use the “I Want To Build It” path on the portfolio engine for doing this.

Investors who are new to ETF investing might have trouble making sense of out of all the hype and excitement. Don’t be fooled-most ETFs are irrelevant. In fact, many highly specialized ETFs are dangerous for most investors for a variety of reasons and appropriate for only the most active traders.  Read the NY Times article below to better understand why.

Even with more than 1,000 available ETFs, just 80 of them account for 80 percent of all money invested in ETFs and the top 20 account for 50 percent of all capital invested in ETFs. Generally, stick with well-known, easy-to-understand products. For example, those that are composed of very liquid securities to avoid hidden trading costs that accompany some smaller funds.

Our members tend not to be active traders. We just want a common-sense, low-cost, globally diversified portfolio for retirement.  For this purpose, there are only 20 or so ETFs that we use at MarketRiders to gain exposure to most asset classes.

The MarketRiders investment strategy is based upon research that show returns are predominantly determined by where your money is invested (your asset allocation).  Therefore, investors need a solid allocation plan for all the different types of available investments like US stocks, bonds, real estate, and foreign stocks.

Once you decide upon your allocations (our service helps you with this), ETFs are the building blocks to implement your plan.  ETFs are an amazing financial innovation because they give all investors access to the investment strategies of the most sophisticated investors.  They are made possible because of super computing technology that enables the instant building and adjustment of baskets of securities for very low fees.

Many ask us: “how is — ETF performing?” The question arises from what we call a “performance” mentality from years of conditioning from Wall Street.  If you have an ETF that mimics the S&P 500, then why ask how it did?  Just look at how the S&P 500 did.

We recommend ETFs that are the best “index” for a particular asset class.  In evaluating ETFs, we ask:  if we look back 20 years from today, will this particular ETF accurately capture the performance, after tax, of its index? Nearly all of our recommended portfolios include a Vanguard Emerging Markets ETF (VWO) that was up over 76% in 2009.  We aren’t geniuses for having recommended it.  It was up because the 28 emerging market economies (Brazil, Russia, India, China etc.) were up almost exactly 76% last year.  VWO did a good job mirroring this performance.

For MarketRiders we only require 20 ETFs to make our recommendations.  The ones we recommend, you can hold and rebalance for a very long period of time and achieve the best after tax returns.  Here are a few articles to dramatically increase your understanding of ETFs in 10 minutes or less.

Wall Street Journal:  How to Choose an Exchange-Traded Fund

Morningstar:  ETF Solutions

Index Universe:  What is the ETF Creation and Redemption Mechanism?

1.  Sign up for a MarketRiders 30 day Free Trial.  There is a “sign-up” link on the top right of www.marketriders.com.

2.  You will be asked to create your first portfolio and you’ll have 2 options:  “Build It For Me” and “Let Me Build It.”  Choose “Let Me Build It.”

3.  In Step 1 of 5, you’ll see a list of templates that you can use in a pull-down menu.  The CNBC model portfolios are listed in these templates.  Select the portfolio that you’d like to use.

4.  In Steps 2 and 3 of 5, you’ll be able to alter the asset allocations and ETFs in the CNBC portfolios.   If you don’t want to change anything in the CNBC portfolios, click “Next” at these steps and go to Step 4 of 5.

5.  In Step 4 of 5, name your portfolio and enter the amount you want to invest so MarketRiders can calculate the number of shares you need to purchase of each ETF and email you a list.

6.  Once you’ve purchased the ETFs, enter the costs into MarketRiders and you’ll receive an email notification when the actual allocations stray from the CNBC targets so you can then rebalance portfolio.  On the dashboard, you can “Change Alert Settings” to make these alerts more or less frequent.

Read more about the CNBC portfolios here:

www.cnbc.com/id/34726386

A few other noteworthy tips that surfaced recently are highlighted below.  I hope they are of interest to you.

* Economist and “Sunday Morning” Commentator Ben Stein stopped by “The Early Show” Thursday to discuss advice from his new book, “The Little Book of Bulletproof Investing.” Stein explained how to maximize your income while protecting your savings from financial calamities.  Interested to learn more, read the complete story:

* Mr. Madoff spends free time in the prison library on the weekends and often watches movies, including “Lethal Weapon,” according to the former inmate. He said he chatted with the admitted Ponzi schemer on Saturdays in the library and asked for financial advice: “He gave me ideas on my index funds.”  Mr. Madoff advised him to diversify, saying he should invest in funds that track the S&P 500 index of stocks “where my money would be on all the stocks instead of putting my eggs into one basket,” the former inmate said.  The source might be questionable but the advice is good.

* Lastly, TIPS-short for Treasury Inflation-Protected Securities-offer investors the closest thing Uncle Sam has to a sure bet these days. These bonds have the full backing of the U.S. government and provide investors with returns that will keep pace with future rates of inflation, as measured by the U.S. Consumer Price Index. You can buy them directly from the government, but it’s easier-and a better investment decision in many cases-to buy low-fee ETFs that hold TIPS. Read more.

So when it comes to investing in any type of fund, be it index mutual funds, exchange traded funds (ETFs) or mutual funds, investors need to be their own advocate.  Do your homework to understand your true costs as no two funds are exactly alike.  ’Americans save trillions of dollars for college education and retirement by investing it with funds managed by industry and giants like the Vanguard Group and Fidelity Investments.’

If you are new to the game, beginners should brush up on Investing 101 basics. There are a lot of choices. Make the smartest choice for YOU.  Just remember, time is your friend.  Money spent on fees today, compounded over time, is money that could be sitting in your retirement account. Do your homework, you will thank yourself later!