How to Invest when Nothing Looks Good

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88972_BLOGJPG_20120712132600155The performance of different asset classes used to diverge. When interest rates were soaring, stocks slumped. Some didn’t care because those high interest rates were delivering CD income. Then when interest rates dropped, stocks took off.

Even when you couldn’t count on anything else, there was always that old reliable—your house. If you hung on to it for several years, you were almost guaranteed a fat profit, multiplied by the benefits of leverage.

In recent years, all that market divergence has evaporated. Interest rates are miniscule. Of course, bank accounts offer safety of your principal, but that’s little comfort if you need or want to grow your nest egg.

The stock market can be a scary as the late-night horror show. Precious metals have performed well over the last several years… but many investors obviously thought prices were too high to risk opening a new position…and we’ve seen leading ETFs like PowerShares DB Gold Fund (DGL) and SPDR Gold Trust (GLD) give ground in the last four plus months.

And… that old reliable house has let home owners (read that as investors with faulty objectives) down in a big, big way.

With a need to fund a retirement or recover from disastrous losses, how can an investor be sure history won’t repeat? Scared into immobility, some investors have resorted to keeping all their money in the low-interest bank account or even under the mattress. Not the smartest plan.

But there is a better way to invest when nothing looks good. Here are some tips to consider:

1) Keep in mind that the best investments are often made when things look blackest. Nearly every asset class except precious metals is cheaper than it was a few years ago. Even if the economic news remains grim, the huge drops in home values are unlikely to repeat because the bad news and low demand is already factored into their prices. Stocks will represent a better value as P/E ratios drop or at least revert to the norm.

2) Shop in the bargain basement. Find a recession-proof business whose share price is already beaten down because of a temporary problem, multiply it by a huge drop in the overall market, and you’ve found a large measure of safety. Similarly, the foreclosure or short sale in a recovering neighborhood gives you extra protection against any further drops in real estate prices.

3) Spread your money around. Don’t depend on any one asset class to fuel your personal recovery. Make sure you have some money in a variety of different national and international stocks, real estate investments, precious metals and fixed income instruments. Too much diversification will ensure mediocrity, but some diversification is absolutely essential insurance against the unforeseeable.

4) Keep plenty of cash on hand. Not only do you need cash for emergencies, but having a cash cushion will enable you to take advantage of the great buys that tend to pop up in a gloom-and-doom economy.

5) Don’t forget to take some losses. Some investors falsely believe that a loss doesn’t exist until they actually sell an asset. But if your assets are worth less than you paid for them, you’ve lost money whether you wish to admit it or not. This certainly doesn’t mean you should go out and panic-sell every asset that’s lost value.

You’ll want to keep most of your assets for the eventual recovery, but the IRS allows you to take up to $3,000 in capital losses every year. This can be offset against gains or used to reduce your tax bill. It’s usually foolish not to take advantage of this perk. If you still believe in your investment strategy and think your stock’s price does not reflect its true market value, sell the loser and buy back a similar stock. Keep in mind, though, that you can’t buy back the same stock for at least 30 days or you’ll run afoul of the wash sale rule.

6) Get the best rate you can on your fixed rate investments. While the difference between half a percent and a percent may not seem worth bothering with, the amounts add up over time.

7) Don’t pass up free money. If your employer offers a 401k match, make sure you take it. This free money can help make up for losses suffered during an economic downturn, yet an astonishing number of people fail to take advantage.

8) Don’t give the IRS an interest-free loan. Getting a big tax refund feels like a good thing. It isn’t. That money could have been earning interest for you and giving you extra rainy day funds instead of sitting in the coffers of the IRS.

By making sure you keep all your money working for you, keeping a reasonable amount of cash on hand and using it to buy low, and do a little prudent diversification, you can protect yourself from many of the worse dips and swoons of the economy.

Mike Casson
Executive Editor
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