The ongoing turmoil in world markets has made for a herky-jerky ride this year. What did you learn?
While most professional money managers expect stomach-churning volatility to continue, there's no reason why you can't still position your portfolio for safety, income or growth. Here are some mistakes to avoid:
1. Staying Out of the Market.
Sure, the market this year was crazier than selling snowballs to Inuits. But by staying out - and pretending you knew when to come back in - you missed plenty of profit opportunities. The Select Sector Utilities SPDR ETF , for example, offers a nearly 4 percent yield and has returned about 16 percent year to date through December 7.
The FTSE NAREIT Residential Index ETF, which samples real estate securities throughout the U.S., is up about 9 percent year to date with a 3 percent yield. The greater lesson is not that these funds did well - I'm not predicting they will do well in 2012 - but that diversification offers returns in a number of places. The "all in or all out" approach will deprive you of profits and you just can't know where they will come from.
2. Ignoring Inflation.
While the current U.S. Consumer Price Index is running at slightly more than a 3 percent annual rate of increase, inflation has never really gone away. Just look at your medical expenses. Annual premiums for employer-provided health care plans rose 9 percent this year, according to the Kaiser Family Foundation. That's three times the rate of general consumer inflation and more than four times the rate of wage increases. With inflation, everything is relative. If your essential expenses are outpacing your wage growth, you're falling behind.
While there's little you can do to get a raise in a sour economy, you can protect your portfolio with Treasury Inflation-Protected Securities or I bonds, both of which pay a premium based on the government's cost-of-living index increase.
3. Not Having an Investment Policy Statement.
If you are constantly watching the headlines and business TV shows, you're not paying attention to your real bottom line. An investment policy statement puts in writing your goals, risk tolerance and portfolio allocation. Do you want to retire at 60? Are you saving for college? Are you living on a fixed income? Each kind of objective requires a different allocation. And I'm not just talking about just stocks and bonds. There's a whole range of alternative investments from public real estate investment trusts to commodity funds that can enhance your returns. So if you haven't crafted a personalized investment policy statement, now's the time to do it. Here's some guidance: link.reuters.com/dah55s.
4. Trying to Time the Market.
Did you get out of gold when it turned south earlier this year? How about European stocks and bonds? It's much more sensible to determine how much of your portfolio should be in different asset classes based on your age, vocation and risk tolerance (see investment policy statement above). If you need to preserve capital, maybe you need to build a portfolio of individual bonds and hold them to maturity. Searching for income? Create a portfolio of dividend-paying stocks and buy on a monthly basis while reinvesting your dividend payments in new shares.
Will next year bring more bad news from Washington and Europe? What about China and the developing world?
You can count on market hiccups. Volatility is now the rule rather than the exception. Yet any strategy that's predicated on actively dodging bullets is doomed to fail because you're competing with light-speed robo-traders. It's more important to have a working knowledge of market and credit risk to understand how much money you can lose.
Make your mission to hedge risk in the coming year. How do you offset bond market risk? Do you have a way of protecting your stock positions? Are you overconcentrated in U.S. or European stocks? Now's the time to face the truth and make adjustments.
The author is a Reuters columnist. The opinions expressed are his own.
(Editing by Jilian Mincer and Beth Gladstone)