One of the best ways to make money in ETFs is to not lose money. I know it sounds obvious, but I can assure you that many people don’t get this key point. So if I can help you do that, then I count it as a success. And today I’ll talk about an ETF category I think you should avoid in 2012: Japan.

What’s Wrong with Japan?

I’ve been to Japan many times. I love the country and the people. Yet I have to tell you that now is not the time to invest in Japanese stock ETFs. Yes, I know the Nikkei Dow looks oversold, but it’s looked that way for years. As I’ve explained before, calling a bottom is tough. And I don’t think Japan is there yet. Here are six reasons why:

#1 — Strong Yen

The yen was very strong in 2011 … which is bad news because it makes Japan’s exports relatively more expensive. And exports are a BIG part of the national economy for Japan.

The authorities are well aware of this, of course, but there isn’t much they can do about it. The Bank of Japan intervened multiple times last year. In every case, the impact of their actions was gone within a few days.

#2 — European Recession

A huge chunk of Japanese exports go to Europe. As you’ve surely noticed, the euro zone is having a few problems. A severe recession — or at best a few years of low growth — seem likely for 2012 and beyond.

If Europeans have no money to spend, their demand for imports (from Japan and elsewhere) is going to plummet. This is another bad sign for Japan.

#3 — Hungry Competitors

Japan reached economic success by beating the developed countries in cheap, efficient manufacturing. Now they have competitors: Taiwan, South Korea, Brazil, India … and of course China.

The challenge for Japan is that all these other countries can do the very same things that put Japan on the map. And in some cases, they can do it better. Nations like Brazil have other advantages, too, like better access to natural resources and geographical proximity to key markets.

#4 — Aging Population

Japan is, on average, one of the oldest nations on the planet. Furthermore, the relatively small number of young adults has a very low birth rate.

The resulting imbalance is making it harder and harder for Japanese industry to keep growing. Older workers hang on to their jobs for dear life while younger people have no way to gain skills. We’re seeing a similar pattern here in the U.S., but in Japan it’s a much bigger problem.

#5 — Massive Government Debt

Japan’s national debt is projected to surpass 1 quadrillion yen in 2012. A big cause is the population imbalance noted above. All those older people require heavy spending on health care and pensions.

To stay afloat, Japan will almost certainly need to raise taxes on both individuals and businesses. And higher taxes won’t make it any easier to create economic growth.

#6 — Political Instability

Japan’s parliamentary government used to work pretty well. Now it’s turning almost as dysfunctional as Italy and Greece.

Consider this: Japan has had six different prime ministers since 2006. The current occupant, Yoshihiko Noda, took office in September 2011 and is already under fire.

The real problem isn’t the government; it’s the voters and their unrealistic expectations. Changing leadership is just a symptom.

Japan-Heavy ETFs to Avoid

Japan may well have short-term rallies in 2012, but I still think the best opportunities will be elsewhere. Here are some ETFs with heavy Japan exposure:

  • WisdomTree Japan Small Cap Dividend (DFJ)
  • WisdomTree Japan Hedged Equity (DXJ)
  • iShares MSCI Japan (EWJ)
  • iShares S&P/Topix Japan 150 (ITF)
  • SPDR Russell/Nomura Japan (JPP)
  • SPDR Russell MidCap Japan (JSC)
  • iShares MSCI Japan Small Cap (SCJ)
  • db-X MSCI Japan Currency-Hedged Equity (DBJP)
  • MAXIS Nikkei 225 Index Fund (NKY)
  • Vanguard MSCI Pacific ETF (VPL) (62% allocation to Japan)

If any of these are in your portfolio, I suggest you look for a chance to get out as soon as possible.

There is an ETF that is designed to go up as Japanese stocks fall. ProShares UltraShort MSCI Japan (EWV) is a 2x leveraged inverse fund. However, I don’t recommend EWV as a long-term investment. It is a short-term trading instrument. (See Three Overlooked Risks of Inverse ETFs to learn more.)

So what do you do with the cash you aren’t investing in Japan?

Good news: You have plenty of opportunities elsewhere. I’ll be telling you about some of them in my Money and Markets columns as the year unfolds. And if you’d like more specific recommendations on what to buy and sell, click here and check out my International ETF Trader service.