Invest in stocks to overcome rising inflation
The best defense against the threat of inflation isn’t Treasury inflation-protected securities (TIPS). It’s not gold, either. For long-term investors, the ultimate hedge is stocks. Consider this: The consumer price index has risen tenfold since January 1947. Over the same period, Standard & Poor’s 500-stock index climbed about 80-fold.
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To give things a more recent spin, we pitted the CPI against a portfolio of 60% domestic stocks and 40% international stocks. Over the ten-year period from 2002 through 2011, the CPI climbed 2.4% annualized, but our 60-40 stock portfolio returned 3.6% a year (and that includes the wipeout year of 2008).
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Should you be worried about inflation? Near term, no. Like most analysts, we expect inflation to clock in at 2% in 2012 and possibly into 2013. But longer term, many experts see the inflation rate rising.
Ignore dubious tipsters
Insiders. A friend tells you the company he works for is about to get a takeover bid. Don’t rush out to buy the stock. There’s a good chance you could be accused of insider trading.
Brother-in-law. He may be smart, but that doesn’t necessarily mean his advice is going to pan out. Do you really want to jeopardize your relationship with him -- and your sister -- over a few bucks?
The herd. When was the last time following the herd helped you score decent money? Internet stocks? Real estate? Adhering to groupthink is always baaaaaa-d news for your investments.
Cold callers. Often found in boiler rooms, they ring you up out of the blue and try to sell you whatever it is they’re promoting that day. Cold callers care little about you and care mostly about their commissions.
Talking heads. Of course the potash analyst appearing on CNBC thinks potash stocks are a steal now. Just as real estate agents always say it’s a good time to buy a house. Don’t invest on the basis of a sound bite.
Sell losing investments to cut taxes
Turn your investment losers into winners by using them to cut your tax bill. You’ll have to sell your investment to do so, and the assets must not have been held in a tax-deferred account, such as an IRA.
If you’ve got losses that qualify, you can use them to offset any capital gains you pocketed that year. You’ll need to match up your long-term capital gains—on investments held for more than one year—with long-term losses, and match up short-term gains (held for one year or less) with short-term losses.
Do your losses exceed your gains? Use the excess to write off up to $3,000 of ordinary income. If you still have leftover losses, you can carry them forward to offset capital gains and up to $3,000 of ordinary income in future years.
Make the most of low-cost ETFs
Exchange-traded funds, created to let investors easily track a market index, have become increasingly complex. Here are four rules for making the most of ETFs:
Pick the right index. Most ETFs track an index, so your first call is to pick the index you want to replicate, be it one that follows, say, big U.S. stocks, the health care sector or foreign bonds.
Keep costs low, part I. If two or more funds track the same index, use the ETF with the lowest expense ratio.
Keep costs low, part II. Use an online broker that lets you trade certain ETFs without charging commissions.
Use limit orders when buying and selling. ETFs can be volatile. It’s best to place an order establishing the price at which you’re willing to buy or sell.
Give your portfolio an annual checkup
First, take its pulse. The market had a rough ride in 2011 -- how did your portfolio do? Compare the returns of your stocks, bonds and funds with an appropriate benchmark, such as Standard & Poor’s 500-stock index or a general bond index. Which investments beat their benchmarks, and which lagged?
Screen for serious illnesses. Examine the laggards to figure out why they’ve underperformed and whether it’s time to sell. Does the fund have a new manager? Or did the fund’s investment strategy change? Likewise, for a declining stock: Has the outlook for its sector deteriorated? Have you lost confidence in the company’s managers?
Practice preventive medicine. Make sure your allocation matches your goals and your time horizon. Put your emergency money in cash-type investments, such as Treasury bills and money-market deposit accounts. Stash your medium- term money -- cash you’ll need in three to five years -- in bonds and fixed-income instruments that mature when you need it. Invest for long-term goals -- ten or more years away -- in a diversified basket of stocks or stock funds.
Check the bill. Calculate what you paid in fees the previous year, such as brokerage commissions, asset-based money-management fees, miscellaneous charges and mutual fund expenses (estimate by multiplying each fund’s expense ratio by the amount you have in it). The sum may shock you. Cut costs by moving to cheaper funds, using a discount broker or negotiating a better rate with your adviser.
Know when to sell a stock
Picking a winner is one thing. Knowing when to sell it is another. The pros sometimes set target “sell” prices for the stocks they buy; when the share price hits the target, they unload their shares (doing so takes the emotion out of selling, so they say). Of course, fundamental problems are cause for pulling the trigger, too. Use the following checklist as a starting point to figure out whether it’s time to bail on your shares in a particular company:
The company’s got a major product with strong head winds. (Examples: Eastman Kodak and its camera film, Research in Motion and the BlackBerry)
The outlook for the company or its industry has deteriorated significantly. (Examples: bank stocks, newspaper stocks)
Management has left, or you’ve lost confidence in it. (Examples: Olympus, Avon, Hewlett-Packard)
The company’s earnings outlook has been chopped for several consecutive quarters. (Examples: Barnes & Noble, Best Buy)
Keep mutual fund fees low
Investors can’t control the markets, but they can control the amount they pay in fees. The less you pay, the more you pocket. Even small differences can have a huge impact over time.
Consider two otherwise identical index funds that track Standard & Poor’s 500-stock index -- one offered by Vanguard (symbol VFIAX), the other by Dreyfus (PEOPX). The Vanguard fund charges 0.06% a year; Dreyfus charges 0.50%. If the S&P 500 earns a total return of 8%, Vanguard clients take home 7.94%, and Dreyfus investors get 7.5%. Over the course of a single year, that’s not a big deal. But if your $10,000 is left invested for 30 years at that return, you’d have $117,304 in the Vanguard fund but only $101,907 in the Dreyfus product. The more you invest and the longer your money is working, the more the fee differential matters.
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