Making sure wild ride of 2007 won't be repeated

PERSONAL FINANCE

December 23, 2007|By EILEEN AMBROSE

This year has been a wild ride for investors.

The subprime mortgage crisis toppled CEOs and threatened the economy. Oil prices hit a record high. Gold surged to levels not seen since 1980. The dollar sank so low that New York's Fifth Avenue became the shopping destination for European bargain hunters. A roller-coaster stock market whiplashed portfolios.

Next year may be just as topsy-turvy.

That makes this a good time to review the lessons of 2007 so we don't repeat them in 2008. Among them:

Know what you own. If you can take a single lesson away from the subprime mortgage mess, this is it.

David Resler, chief economist at Nomura Securities International in New York, says many of the mortgage-related securities now underwater were created since the last recession. They had never been tested by the ups and downs of a business cycle. Credit-rating agencies miscalculated their risk. And big players on Wall Street eager to make money jumped in without looking.

"Nobody had a good understanding of just how much risk they were taking on," says David L. Straus, senior portfolio manager with Johnston Lemon Asset Management Inc. in Washington.

Personal Finance 101 tells you not to invest in anything you don't understand.

If you don't know what it is, how can you know whether to take the risk?

Volatility is normal. Investors in recent years have been lulled by the stock market's gentle rocks and gradual rise. Volatility kicked into high gear in late summer. From October to late November, the market fell 10 percent - an official correction.

What happened? The market returned to its old self. "If you look back to 1929, 80 percent of the years had an 8 percent decline or more," says Jackie Perrins, global investment specialist at JPMorgan Private Bank in Washington.

Expect volatility to continue into next year, Perrins says. Protect yourself with a diversified portfolio.

The world is flat. As of last week, U.S. stock funds were up 4.62 percent for the year, according to Morningstar Inc. International funds - up 12.64 percent.

Too many will miss out on those higher returns. "Americans are woefully underinvested internationally," says Peter Ricchiuti, assistant dean at Tulane University's business school. The typical portfolio has 5 percent invested abroad, far too little given that two-thirds of the world's securities are outside the United States, Ricchiuti says.

He recommends bumping your international holdings up to 20 percent to be properly diversified. You also can benefit from a weak U.S. dollar when investing overseas, he adds.

A house is something to live in. The hot real estate market turned homeowners into investors. Some counted on the value of houses always going up. They took advantage of low interest rates and exotic mortgages to buy more house than they could afford. Others speculated on properties with little money down. Once the market cooled, homebuyers found themselves in over their heads.

"My own personal philosophy is you buy a place to live in," says Brian C. Rogers, chairman of T. Rowe Price Group in Baltimore. "You don't buy it as an investment."

If you want to invest in real estate, buy shares in real estate investment trusts, which own and manage properties, he says.

Too much is too much. Workers still load up on their employer's stock, even after Enron. Maybe it's loyalty. Maybe it's because we feel we know our employer best. But too much of any one stock puts you at risk.

New York financial planner Gary Schatsky tried to persuadehis client early this year to sell the bulk of her employer stock, which made up a quarter of her portfolio. The stock had been going up and up and she didn't want to sell. She reluctantly agreed to sell half her shares, worth a few hundred thousand dollars.

Then the mortgage crisis hit. Her employer - Citigroup - lost billions. The CEO resigned. The stock now trades at about $30 a share. She had sold at $53.71, Schatsky says.

If you feel you must own employer stock, make sure it's no more than 10 percent of your holdings.

Don't chase performance. Investors tend to put their money on whatever investment has done well in the recent past. That had been true of value stocks, which last year rose an average of 21 percent. That's nearly double the performance of growth stocks, says John Nersesian, a managing director with Nuveen Investments.

The tables turned this year. Growth stocks rose 9.5 percent; value stocks squeaked out a 1.7 percent gain.

Holding a diversified portfolio with both growth and value stocks takes the guesswork out. Annually rebalancing your portfolio forces you to buy low and sell high.

"An investor who rebalanced at the end of last year would have been forced to take money out of value stocks that have done so well and added it to growth stocks exactly at the time it would have been most [advantageous] to do so," Nersesian says.

Questions? Comments? Want to share your own financial tips with readers? Contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

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