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Economic Shifts Bring New Pitfalls And Prizes

Prepare yourself for a bumpy ride. As the new year dawned, most economists still expected the United States to avoid a recession in 2008. But then the stock market began a persistent downward slide, housing news kept getting worse, and America’s economic woes seemed to spread around the globe. Add in the unpredictability of the presidential election and you have an equation that almost guarantees a turbulent year for investors.

Consider these recent developments.

  • The housing market remains in a tailspin. Faced with sluggish sales, many prospective sellers have been forced to slash their prices or take their homes off the market. With the current glut of homes, most experts don’t expect much improvement before 2009.
  • The subprime mortgage crisis hasn’t abated, and major financial institutions continue to write down bad debt. Some estimates put the total cost at $100 billion or higher.
  • The price of oil cracked the $100-a-barrel threshold, and prices at the pump could soar to $4 a gallon or more during the summer months.
  • In 2007, the dollar suffered through its worst year since 2003, falling by about 9% against other major currencies. Low interest rates, a credit crunch and related economic worries have kept foreign investors at bay.
  • The Dow Jones Industrial Average set a record last year, but then suffered two of its biggest-ever daily point drops and slipped below 12,000 during January.

It’s impossible to know what the next months will bring. Steep interest rate cuts and a possible economic stimulus package may eventually get the economy out of its doldrums, and investment markets could bottom out and begin a comeback. But it’s equally possible that it will just be an extremely tough year.

What’s an investor to do? These seven ideas could help keep you moving toward your financial goals.

1. Diversify, diversify, diversify.Now is not the time for big bets on asset classes or sectors that seem promising. Making sure your portfolio includes a broad mix of investments reduces the risk you’ll be devastated by a downturn in one or more areas.

2. Review your asset allocation.Even if you started out with a diversified portfolio, the recent market turmoil may have pushed it out of balance. For example, emerging markets have been outperforming other stocks, and what was once a relatively small allocation to these investments may have grown to account for a much larger share of your overall holdings. You could need to sell some of those stocks or funds to reduce risk and get back to your original portfolio weightings.

3. Investigate refinancing your mortgage.Don’t be scared off by the mortgage crisis if you qualify for a lower rate through a reputable lender. You could use some of your savings to accelerate payments and pay off your new loan ahead of schedule.

4. Shore up your cash reserve.If you squirrel away enough cash, you’ll be able to weather an economic storm or pounce when a good financial opportunity arises. Normally you should set aside enough to last from three to six months, but a larger cushion may make sense if you’re in business for yourself or feel your job is vulnerable.

5. Prepare your bonds for uncertain times.Questions about the economy, interest rates, and inflation could mean a volatile year for fixed-income investments. Creating a bond ladder, a strategy in which you buy bonds with different maturities and reinvest at prevailing rates when short-term holdings mature, will help you minimize risks, but will may not be ideal while interest rates remain low. Instead, favoring short-term bonds will give you better upside, as long-term bonds are more volatile and are more affected by inflation. Be sure to examine current bond holdings for hidden risks like mortgage-backed securities, bonds issued by shaky financial institutions, or paper that has been or is more likely to be downgraded. Even money market instruments may now exhibit some new risks.

6. Consider joining the gold rush.In late 2007, gold prices reached their highest level since the gold boom of 1980, and many experts expect a further rise. Investors typically turn to gold as a hedge against a weak dollar and rising inflation, but until recently, buying bullion or gold coins meant also having to shell out storage and transportation fees. Now, exchange-traded funds2 enable you to own gold without the hassle. Keep in mind that the price of gold can be extremely volatile and has already appreciated significantly. Therefore, it is a good idea to limit your gold investment to a small percentage of your portfolio and try to get in on a price dip. Diversified commodity funds are a less-risky alternative to buying gold directly.

7. Maximize tax benefits.This may be a year when some market losses are inevitable, but you can use them to help keep your tax bill in check. Capital gains and losses cancel each other out for tax purposes, and if you lose more than you gain you can use the excess to offset up to $3,000 of ordinary income in 2008.

We’re ready to help you with these and many other strategies that could turn a bad year to your advantage. If you’re nervous about market news and the economic outlook and wonder whether you’re on track to reach your financial goals, please give us a call.

 


 

This article was written by a professional financial journalist for Legend Financial Advisors, Inc.® and is not intended as legal or investment advice.

 




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