Questions to Ask as the New Year Dawns

It’s 1994. Do you know where your investment plan is?

While Wall Street is racking its collective brain trying to divine where stock prices and interest rates are heading this year, your task should be much simpler: Making sure you’re positioned for any eventuality.

That may be far less difficult than you might initially suspect. If you stop worrying about what you don’t know and just take care of the basics, investing--at least, long-term investing--becomes a fairly simple game.

In his new book, “Bogle on Mutual Funds,” John Bogle, head of mutual fund giant Vanguard Group and a longtime champion of individual investors’ rights, lists 12 commandments of investing.

The first one: “Never forget that investing is easier than it looks.”

The second: “When all else fails, fall back on simplicity.”

Whether you’re investing for the first time or looking to improve your existing portfolio’s prospects, here are some basic questions to ask yourself as the new year begins:

* Do you have a plan? Rather than lose sleep worrying whether stock and bond markets are going up or down over the next 12 months, focus on your long-term goals. You should have some kind of investment plan for the future mapped out, either on paper or in your head. If you have a plan, the market’s inevitable short-term gyrations won’t freeze you into inaction.

For example, have you thought about how much you will be able to save and invest this year, realistically? Have you nailed down which investments you might like to buy (or buy more of)?

Are you prepared to make those investments--in other words, have you done the necessary research? In the case of mutual funds, have you called the funds for applications and prospectuses so you have them on hand?

Assuming you are a long-term investor, probably the smartest thing you can do is to get on a dollar-cost-averaging plan, whereby you’re investing small amounts on a monthly basis. That way, you needn’t be concerned about market timing, and you’re never at risk of investing too much at what turns out to be a market top.

If you’re investing via your company’s 401(k) retirement savings plan, you are already dollar-cost-averaging. Increase what you save via the plan, if possible. If you don’t have a 401(k), many mutual fund companies will help you set up a regular investing plan.

* Do you know what you own? Sounds simple. Yet many people accumulate investments over time, without thinking about how their entire portfolio fits together.

Tally up your financial assets (including retirement accounts, but not including your home’s value), then calculate what percentage is invested in stocks, in bonds, in short-term accounts (CDs, money funds) and in other investments. Does the mix make sense for you?

Generally, the younger you are, the higher the percentage of your financial assets that should be invested in stocks at any given time--because stocks offer the best long-term returns. As you age, more of your portfolio should be shifted to fixed-income investments, because those securities offer more stability along with regular income.

A simple rule of thumb is to subtract your age from 100. The resulting number is the percentage of your financial assets that should be in stocks; the rest should be either in bonds, short-term accounts or other assets, or a combination of them. (Note, however, that your personal situation may dictate having more or less in stocks than what the rule of thumb would suggest.)

* How diversified are your stock investments? With the U.S. market overall near record highs, you aren’t diversified if your stock assets consist primarily of your employer’s shares, or if you own just a single “growth-stock” mutual fund.

If you’re a fund investor, many experts say you should own at least three distinctly different funds: one that invests primarily in stocks of major U.S. companies; one that invests mostly in smaller U.S. stocks, and one that invests in stocks overseas. There’s virtually no excuse not to have at least three funds; nearly every major fund company offers those options, and minimum fund investments are mostly under $2,500.

How you should allocate money among those three categories depends on how much risk you’re willing to take. Aggressive investors might split that mix in thirds; more conservative types would probably limit the small-company and international funds each to 10% or 15% of their total portfolio.

What if you’re only beginning to diversify your stock fund dollars? Do it slowly, not all at once. For example, given the surge in international stock funds last year, they are vulnerable to a short-term selloff at some point this year, many pros agree. If you buy in slowly and regularly, you’ll be assured of picking up shares during any selloff; if those markets keep rising all year, you’ll be investing all the way up.

* Do you have a hedge, should things go wrong? The U.S. bull market is 38 months old, which is aged by historical standards. Likewise, interest rates are near 20- to 30-year lows, which suggests there is as good a chance of them rising this year as falling further, especially if the economy is robust.

So let’s assume that rates move up, and that that sparks a selloff in U.S. stocks. Do you have a hedge--an investment that might rise even as stocks and bonds slide, offsetting some of your loss?

For small investors, a hedge might be as simple as having 5% of your total portfolio in gold bullion (because gold, up 17% in price last year, could continue to benefit if investors take profits in stocks and bonds and look for an alternative.)

Scott Black, money manager at Delphi Capital in Boston, likes small U.S. energy stocks as a hedge. Oil sank in price last year, but if the economy is stronger than expected this year--bad for interest rates, and possibly bad for many stocks--energy prices could get a lift. Black likes such small exploration firms as Basin Exploration ($11.375 on Nasdaq) and Wiser Oil ($17.50, New York Stock Exchange).

(Note also that many mutual fund companies offer funds that invest exclusively in natural resources companies. That’s a way to bet on higher commodity prices in a strong economy.)

David Shulman, investment strategist at Salomon Bros. in New York, says that for most investors, “the best hedge is probably just to hold more cash than normal this year.” That doesn’t mean keeping 80% of your assets in a money fund. But it may mean holding 20% cash instead of 10%. A bigger cash hedge would offset a market decline--and would assure that you have the money available to invest if stock and bond prices suddenly dive to bargain levels.

* Could you live with a worst-case scenario? There are many reasons to think that 1994 will work out just fine for Wall Street--that interest rates will rise slowly if at all, and that stock prices can advance (if fitfully) as the economy and corporate profits improve.

But what if the optimists are wrong? Could you sit through a classic bear market in stocks?

Count up the money you now have in stocks. If that sum suddenly lost 20% of its value, would it change your life? What about a 30% or 40% drop?

There have been 24 bear markets since 1897, and the average one has lasted 14.5 months and sliced 34% off the Dow Jones industrial average, from peak to trough, according to the Chartist newsletter in Seal Beach. If you couldn’t afford to see that percentage of your stock assets evaporate, then you should adjust your portfolio accordingly.

Maybe you sell some stocks and move the proceeds into cash. Maybe you don’t want to invest more in the market until prices come down again, which they almost certainly will at some point.

Maureen Tsu, a certified financial planner at Professional Financial Advisors in San Juan Capistrano, reminds her clients that investors who bought at the stock market peak in August, 1987, waited two years to break even.

“We talk to them and make sure they have at least that kind of time frame,” Tsu says.

Similarly, bond investors should ask themselves how much of their principal value they’re willing to sacrifice, should interest rates rise. Consider: A long-term Treasury bond that now yields 6.35% would lose about 10% of its value if market interest rates on new bonds rise to 7.35%.

You would still be earning your 6.35% on the older bond, regardless of what’s happening with market rates. But if you can’t stomach the idea of the bond itself being worth 10% less in price, then you should devise a plan to exit that investment well before it loses that much of its value.

Indeed, the smart investor never buys a security without first asking: “How long am I planning to hold this? And what would cause me to sell?”

A Checklist for Paranoid Investors

Is it time to sell stocks? Not yet, says market analyst Richard Eakle of Eakle Associates in Fair Haven, N.J. He has compiled a checklist of 20 indicators that tend to signal market tops. Of the 20, only two currently suggest a top is here, Eakle says. Here are 12 of his indicators (the other eight are more technical in nature).

* Does economic evidence indicate an approaching peak in the business cycle? NO

* Is inflation accelerating? NO

* Are corporate profits rising at an unsustainable rate? NO

* Are short-term interest rates on the increase? YES

* Has the Federal Reserve begun a more restrictive monetary policy? NO

* Is the stock market’s aggregate price-to-earnings ratio near that of its previous cyclical peak? NO

* Are mutual fund cash reserves nearing historic lows? NO

* Have financial stocks peaked, only to fall off during successive rallies in recent months? YES

* Have markets exhibited successive rallies to previous highs, only to retreat without making substantive additional gains? NO

* Have corporate executives (“insiders”) begun selling vs. buying their own stocks at a ratio exceeding 3 to 1? NO

* Is the number of NYSE issues trading above their 200-day moving averages nearing the historical danger level of 80%? NO

* Is private and/or professional investor sentiment markedly over-optimistic? NO

Source: Eakle Associates