Tackling your investment concerns in the new year
Here’s a way to make your head explode in one hour or less: Start reading forecasts for the economy and markets in 2010 and try to decide who’s likely to be right.
Will interest rates rise? Will the recession return? Will the banking system crash again? And what kind of surprises, good or bad, might come out of left field?
Every year is a crapshoot for forecasters, but this one is as tough a call as ever because there are so many outsized uncertainties involving government, companies and consumers in the aftermath of the financial-system meltdown.
So there really is just one new-year tip that I think has true value for most investors: Focus on what you can control about your finances and admit you’re powerless over most of the rest.
Here are four issues that are likely to be on most people’s short list of concerns for 2010, and my suggestions for dealing with them:
* “I just can’t shake the feeling that Wall Street is one big con game, and I don’t want to be part of it.” You’re disgusted by the mess that bankers, brokerages, hedge funds and other big players have made of the financial system? Of course you are, and rightly so.
A recent e-mail I received from a reader: “Let’s face it, no one knows what those crooks on Wall Street are doing now.” She then declared that anyone older than 50 “better be getting themselves OUT of the market by putting their money in CDs and money market accounts, etc.”
That’s a fine idea -- if you can survive earning 2% or less on your money.
I have a suggestion: It’s OK to despise Wall Street, and it’s wise to be constantly on guard against the system’s propensity to cheat you. But it makes no sense to assume that because the system is corrupt, no individual investment (say, a stock or mutual fund) has any merit.
In this case, you’ve got to differentiate between the salesman and the product. The money-changing business has never been a bastion of righteousness. That doesn’t mean there have never been good investments.
* “I didn’t buy stocks last year, and now that they’re up so much from their lows I think it’s too late.” First, realize that if you feel this way you’re approaching the market logically: Price matters, and the surge in share prices since March means there’s more risk in the market now than there was then.
Many investors have been waiting patiently for a meaningful sell-off so they could get aboard. It hasn’t come: The Standard & Poor’s 500 index hasn’t pulled back more than 7% before buyers have moved in and the rally has resumed.
This won’t go on forever; eventually, something will trigger a classic “correction” in the market, meaning a decline of at least 10%.
Then the question will be whether would-be buyers will quickly step up, or whether a vacuum will develop, allowing stocks to go into the kind of free-fall experienced between September 2008 and last March.
Barring another financial-system catastrophe or a geopolitical nightmare (a nuclear strike?), a free fall seems unlikely. But who knows?
If you have faith that the economy will grow over the next five years, and you’d like to put more money into stocks, make a plan now: Identify stocks or funds you’d like to buy -- in your 401(k) plan, for example -- and commit to making the move when prices finally come down.
I know this sounds simple, but the lack of planning is precisely what foils most investors: They only think about what they would have done, after the fact.
* “I bought bonds last year for safety. Now I’m worried that I’ll lose money as interest rates rise.” Yes, you very well might lose money in bonds, at least on paper. But you might not need to care, depending on why you bought in the first place.
Say you pay $1,000 face value for a 10-year bond that earns a 5% rate of interest each year. In 10 years you’ll be repaid that $1,000.
But if market interest rates rise (perhaps because the economic recovery gains steam) and investors are demanding 6% yields on new 10-year bonds, no one will pay you face value for your 5% bond. Instead, they’ll demand a discount from the $1,000 maturity value.
That’s how it works: Older bonds are devalued when rates rise on new bonds.
If you don’t sell your bond, however, you don’t lose: Unless the issuer runs into financial trouble, you’ll still be collecting 5% interest each year, and
you can expect to get your $1,000 back when the bond matures.
Investors in bond mutual funds face a different situation, however. Funds don’t mature at some preset value; they don’t mature, period. Instead, you’re buying a piece of a diversified portfolio of bonds, the value of which will rise or fall depending on changes in market interest rates, among other factors.
So the daily share price of your bond fund will fluctuate. And if market interest rates rise sharply, the share price almost certainly will fall. At the same time, if rates rise the income you’re getting from the portfolio should rise, assuming the fund is buying new bonds at higher rates.
Consider what happened in 2009 with the Vanguard Intermediate-Term Treasury fund, which owns Treasury bonds maturing in three to 10 years. Market rates rose on Treasuries last year. That drove the share price of the Vanguard fund down 4.6% in 2009, to $11.09 on Thursday from $11.63 a year earlier.
But the fund’s investors still earned interest all year. That offset much of their principal decline. The net “total return” on the fund, combining principal change and interest earnings: a negative 1.7%.
Remember, though: A paper loss isn’t a real loss unless you sell. Remember, too, that high-quality bonds will always provide relative stability for a portfolio compared with what stocks can lose.
If you bought bonds for the first time last year, now is a good time to think about how much you can stand in terms of paper principal loss, if 2010 brings higher interest rates.
Would 5% be too much of a drop? What about 10%? Does the principal value of your bonds really matter to you -- or is the income what’s important?
* “I’m convinced that the government’s massive spending, and the huge sums injected into the financial system by the Federal Reserve, will mean higher inflation ahead.” If that’s your view, what do you do about it?
Maybe not much: If your investments are well diversified, you may already have significant inflation protection. Real estate could be a good hedge. So could commodities, including gold. And many stocks, too, could gain if higher inflation gives more companies pricing power over their goods or services.
Rising inflation would be hardest on fixed-rate bonds. That’s an argument for being wary about buying bonds at current relatively low yields.
Two points about inflation worries: First, recognize that higher inflation is exactly what the Fed wants, because that would be expected to accompany an improving economy.
Second, barring another financial crisis, realize that we’re probably not talking about a sudden jump in annual inflation to double-digit rates, but rather a gradual rise from current levels of about 2%.
This may be an issue more for 2011 than 2010.
