Yes, we know. Investing is a hot, even uncomfortable topic these days. You can't avoid the bad financial news—it seems that wherever you look there are signs that the economy is getting worse. We're definitely in a recession, but that doesn't mean you ought to stop paying attention to your portfolio.
If anything, now is the time to pay even more attention, to re-assess your investment objectives and to review your financial advisor's ability to guide you through this difficult environment. You need to consider what your "appetite for risk" is. Your neighbor, or your brother-in-law's best friend has a different need and risk profile than you do. It doesn't make much sense to try to compare notes with someone who doesn't share your economic situation and goals.
General guidelines for investing during a tough economy:
You should consider keeping any cash that you'll need within the next 6–18 months in a very short-term instrument, such as short-term CDs.
Determine your appetite for risk. If you don't have a stomach for a 20-40% drop in the markets, then your portfolio should not be invested aggressively—you should not have much exposure in the emerging markets. You need to match your appetite for risk with your portfolio return expectations. For example, if you aren't comfortable with anything more than a 5% market decline, you should have a minimal allocation to stocks—say 25% as an overall asset allocation strategy.
After you have set aside funds for the short-term and determined your appetite for risk, you can focus on your long-term investments—the one's that should provide you with better returns than what you're receiving from your cash investment.
- Use your taxable (non-retirement) account for long-term investing strategies—buy and hold.
- Use your retirement account for short term investing strategies (there is no taxation on any gains you incur in retirement accounts, until you liquidate the account).
- Consider liquidating any capital gain property, because the provision for the 15% capital gains tax is set to expire and unlikely to renew. You may want to talk to your tax advisor about your options and the financial consequences.
- Consolidate as many accounts (including prior employers' 401K plans) that can be rolled over into an IRA. You'll have a better handle on your retirement accounts, and it will be more cost efficient.
- If you are in a higher tax bracket, consider using tax-exempt state securities, even for your money-market funds. That income will be federal and state income—tax-free.
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- Roth IRA Conversion—tax law changes in 2010 will allow taxpayers to convert a traditional or rollover IRA to a Roth IRA regardless of their income level. Additionally, any tax owed upon conversion can be paid over a two year period.
- Take your gains—if you've participated in the recent run up in the financial markets, then take some off the table and offset against losses that you may have incurred during the financial meltdown.