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Don't expect the economy to "get back on track." It's a new track, folks, and here's how to navigate it.
There's a whiff of economic recovery in the air, and investors have been feeling frisky as of late. Just another bout of irrational exuberance, you ask, to be followed by another bust? One thing that's certain, however, is that the Great Recession, the credit crisis and the past year's meltdown in financial markets will change how you handle your finances. In many ways, your money will never be the same.
1. Investments: Less risk In the old days -- before 2008, that is -- an aggressive portfolio had 80% or more of its assets in stocks. No matter how well you're doing now or how well you or others think stocks will do in the years ahead, investors are so shell-shocked from their bear-market losses that it will be a long time before they will be confident enough to justify that high a proportion of stocks within their total portfolio. The new normal for an aggressive investor, for example, may be just 60% or 70% in stocks, and someone who accepts only moderate risks may be comfortable with 40% or 50%. That may not be the right way to go -- barring a catastrophe, we think stocks will outpace bonds, and handily at times -- over the next ten to 20 years. But that's the reality when a generation of investors takes such a shellacking.
2. Markets: Greater volatility Daily, hourly and even minute-to-minute swings will continue to be wild and sometimes vicious. Experts blame the heightened volatility on the ceaseless flow of information, or misinformation, which encourages misguided trading. One blatant example: On April 19 a crank posted a Web "newscast" claiming that he had possession of a leaked government report saying that 16 of the country's top 19 banks would be exposed as dead when the Treasury Department released the results of its stress tests a few days later. Standard & Poor's 500-stock index promptly fell 4.3% the next day, even though Treasury discredited both the post and the source. Enormous volumes in trading-oriented products, particularly exchange-traded funds, exacerbate the volatility. That's especially true early and late in the trading day. How to cope? Keep your eye on the long-term prize and don't get caught up in day-to-day, or minute-to-minute nuttiness. Plus, "Don't trade in the first or the last hour, or you'll get whipsawed," says Tim Kober, of Cedar Financial Advisors in Portland, O
3. Diversification: More choices The recent market unpleasantness tarnished the concept of diversification; nothing worked well save cash and Treasury securities. So much for the traditional advice to keep fairly equal holdings in various stock categories -- such as growth and value, small-company and large-company, foreign and domestic -- and to own different kinds of bonds, including super-safe Treasuries, municipals, corporates and so on. The new plan is to add a variety of investments, some of which might be considered highly risky, that really have a chance to zig when the ordinary stuff zags. That could mean putting a greater amount of your money into such things as gold, foreign currencies, real estate, energy and other commodities (see Low-Risk Commodities Investing). "Defense is not just diversification by allocation. It also means keeping defensive funds in the mix," says investment adviser Dennis Stearns, of Greensboro, N.C. For instance, you may want to look into a fund such as Pimco Unconstrained Bond (symbol PUBDX). Launched in June 2008 by the pre-eminent bond manager in the U.S., the fund invests in any part of the bond market without any sector limitation. Year-to-date through June 2, the fund gained 5.7%. In the same vein, you'll see a push to introduce new products aimed at immunizing you from wrongheaded forecasting or missed trading signals. The new buzzword will be "buckets," or places where you store built-up savings to shield them from untimely losses. Some examples: annuities and insurance polices designed to lock in gains; easy-to-purchase packages of laddered certificates of deposit; and, in general, more passive-type investments with guaranteed floors and plenty of liquidity.
4. Dividends: No guarantees The association between constant dividends and financial health is broken. Companies that paid dividends continually for many years were considered the strongest. Those that raised them the longest were really regarded as solid. But the recession and other developments showed that there are few safe havens nowadays. General Electric, Pfizer, Alcoa, many other industrial companies, and just about every major bank and many insurance and real estate firms cut or eliminated payouts over the past year. The new thinking: If a company is convinced it has a better use for its cash than to distribute it to shareholders, then don't necessarily punish the stock because of a dividend cut. After all, GE's stock (GE) surged 59% from February 27, when it slashed its dividend 68%, through June 3. Shares of Alcoa (AA) have skyrocketed 65% since the aluminum giant chopped its payout 82% on March 16. This doesn't mean you cannot find solid dividend payers. The key, though, is for dividend growth, not a very high yield. Consider these three serial dividend boosters as an excellent foundation for a long-term portfolio of growth stocks: Abbott Laboratories (ABT), Coca-Cola (KO) and Sysco (SYY).
5. Credit: Tougher to come by More than liar loans and other sketchy subprime credit is by the boards. Even after home prices stabilize, the 30-year fixed-rate mortgage with a substantial down payment will once again become the cornerstone of the housing industry. Partly that's because big banks under financial stress are and will remain under pressure from regulators and shareholders to tighten up. Also, local and community banks will be making a larger share of mortgages. Those institutions tend to keep loans on their books rather than buy and sell them for inclusion into mortgage securities, so they're more selective about saying yes or going easy on borrowers. Adjustable-rate loans with teaser rates will still be available. But they'll be targeted toward people who really do have the potential to earn more in the future -- think doctors during their medical residency, for example -- instead of flippers, investors, or borrowers with marginal income and credit. As for credit cards, they'll come with stiffer terms. Gone are the days when you could hop from one 2.9% offer to another. New credit-card legislation that curbs punitive late fees and interest penalties is popular with consumer advocates. But there's a flip side. Look for banks to reinstate annual credit-card fees, demand higher credit scores, and offer fewer perks to customers who use their cards frequently. In fact, a study by Synovate, a market research firm, found that U.S. households are already receiving dramatically fewer card offers in the mail. An increasing number of those offers are for fee-based cards.
6. Retirement: Getting a makeover Traditional fixed pensions are disappearing, strapped employers are ending matching contributions to 401(k) plans (at least temporarily) and many plan participants have lost one-third to one-half of their savings. As a result, the retirement system will get a makeover and more oversight. In general, the system will become more compulsory and less voluntary. For instance, the trend toward automatic enrollment in a 401(k) or equivalent plan sponsored by your employer (unless workers opt out) will accelerate. The same for efforts to get employees to increase contributions each year until they hit the legal limit. Also, instead of a lump sum being the most prevalent payout method (either to be rolled into an IRA or spent), expect more company plans to offer annuities, which will resemble the monthly-payments-for-life structure of traditional pension plans. Private managers, such as Fidelity, Vanguard and TIAA-CREF, will still handle the money and offer a range of investment choices, but fees will be lower and will be disclosed. And plan managers will try to make payouts more predictable. One possibility: Require target-date retirement funds to hold more cash as you approach retirement age.
7. Government: A visible hand President Obama has said he hopes a more stable financial system will "help speed the day that the government can get out of the way and let the private sector grow the economy." But the Federal Reserve's buying binge of Treasury securities extends Washington's influence over interest rates -- which traditionally has affected short-term overnight rates or 30-day maturities -- to as long as 30 years. And there's talk of establishing a "financial product safety commission" to vet the exotic creations of financial engineers. The idea is to foster more predictable and less risky investment markets. For a while the government did succeed in flattening the business cycle, and the U.S. experienced more than 20 years without a harsh recession. It remains to be seen whether this time around the hand will be smoother, or just heavier.