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7 ways your money will never be the same

3:06 AM
7 ways your money will never be the same
A lot has changed since the recession began, including the roles stocks and bonds play in investors' portfolios. For starters, get used to more cash, catastrophes and regulation.

There's nothing like a honking stock market rally to prompt us to declare the end of a financial emergency. But whether or not the economy and the financial markets are really out of the woods, it's clear that the way we approach investing has changed forever.

Here are seven ways your money will never be the same.

1. Stocks are no longer king

As share prices keep rising, blogs and investor chat rooms crackle with rancorous shouting matches between folks who say the gains are justified and those who deride the charge in the Dow Jones Industrial Average ($INDU) from 6,500 past 10,000 as a "sucker's rally."

But the rally is legit because, at 6,500, stocks were priced for a disaster that never occurred and because many sectors of the economy have improved noticeably since the darkest days of the crisis.

But the wild ride of the past two years holds deep, long-term significance. It undermines the doctrine that a well-diversified basket of stocks will trounce bonds, or a mix of stocks and bonds, over long periods. This principle is rooted in the notion that stocks are riskier than fixed-income investments and so will reward you with higher returns over the long term.

Alas, that is no longer a given. Why? Weak hands have replaced the strong hands of loyal, committed stockholders. It's never been easier to trade enormous baskets of stocks indiscriminately at the drop of a news story, a rumor or some official's comment going viral on the Internet.

This shoot-first-ask-questions-later mentality weakens the ties between share prices and any precise evaluation of an actual business's future earnings and dividends. And because most of us despair at losing money more than we rejoice in making it, we will look harder at investments that pay reliable income and, presumably, protect us against inflation, deflation, currency-rate fluctuations, credit crunches and all the other complications that can cause stock prices to plunge.

2. Diversification has changed dramatically

Once, you could fight a down market with counterweights like real-estate investment trusts, high-dividend stocks and foreign stocks. In 2000 and 2001, for instance, many small-company value funds and overseas stock funds made money even as the large-capitalization U.S. stock indexes tanked. During the 2007-09 bear market, virtually every asset class save Treasury bonds fell in unison. As a result, many experts have declared diversification a failure.

I disagree. Diversification isn't obsolete. We just have to do it differently from now on. Instead of using a small-company value fund to shadow a large-cap index fund -- such as one that tracks the Standard & Poor's 500 Index ($INX) -- we'll want to own foreign-currency funds, international bonds, commodities funds, water, timberland, global real estate and anything else that is reasonably liquid and can be purchased without obscenely high fees. Wide-ranging mutual funds such as Pimco Global Multi-Asset (PGMDX) -- the brainchild of Mohamed El-Erian, Pimco's co-chief investment officer -- will sprout.

3. Cash is never trash

Forget that cash, in the form of money market funds and bank savings accounts, pays next to nothing. Yields will nudge higher once the Federal Reserve lets go of its free-money policy. But even if that enables you to collect just 2%, never again should you equate cash with garbage.

Having cash on hand allows you to swoop in and pick up bargains that an often irrational stock market creates. Plus, cash can ease the burdens in other parts of your financial life. If your cellar floods or a tree falls on your house or you have high medical co-payments, you may have several thousand dollars' worth of unexpected obligations. A large cash cushion helps you avoid running up big credit card bills or incurring penalties for tapping your retirement accounts early. Plus, you can use your cash to jump on the deep retailing discounts that will probably be common for years.

4. Regulators will be more visible

More oversight is coming, and it will go beyond executive pay and fixing bank balance sheets. After Congress finishes dealing with health care, it will establish a financial-protection agency for consumers, increase regulation on private-equity investors and hedge funds, and generally try to discourage the financial industry (in the U.S., anyway) from concocting inscrutable, high-risk stuff. There's an excellent chance that future Madoffs and Enrons won't be able to dodge the law for so long.
But tighter regulation won't stop market plunges. Markets often dive because they first rise to extreme heights. And they do so because investors let emotions control their decisions. That won't change. Besides, what if the next mega-fraud originates in Russia or China or Brazil, beyond the reach of newly strengthened U.S. regulators?

5. Catastrophes won't wait 100 years

Some people have likened the recent disaster to a 100-year flood, suggesting that we are unlikely to suffer another event so serious for a century. The problem with this 100-year cliché is that it's never been true. And now it is utterly implausible.
An authoritative new book about the history of financial follies, "This Time Is Different," by Carmen Reinhart and Kenneth Rogoff, recounts how bank failures, stock market crashes and government defaults have been with us for generations. With the ratio of all debt in the world to the global gross domestic product higher than it's been for most of our lifetimes, Reinhart and Rogoff are not optimistic that we'll be in the clear for long. Unpayable debts are almost always the spark when some stock market, currency or entire economy burns.
To these fundamental economic problems, throw in the fuel of the explosion of technology. Market-moving information can now spread worldwide and sow financial panic in a proverbial New York minute.

6. Commodities will be more important

Gold isn't the only tangible asset that has racked up big gains in 2009. Cocoa, coffee, copper and frozen pork bellies, to name a few others, are also in rollicking rallies. The breadth of the advance reinforces the idea that investors will want to make more room in their portfolios for stuff as well as securities, regardless of whether they're trying to reduce risk or are angling for big gains.
It's not that commodity prices are predictable. They can react to the weather, world politics and currency exchange rates. But because it's become a lot easier to invest in commodities, it's a good bet that they will play an ever-larger role in savings programs.
Exchange-traded funds such as PowerShares DB Agriculture (DBA, news, msgs) make corn and soybeans easy to own and disown. PowerShares DB Commodity Index Tracking Fund (DBC, news, msgs) tracks 14 commodities. Watch for more ETF offerings and price competition in the field. That will put commodities as much into the mainstream as real-estate investment trusts and foreign stocks are.

7. Bonds will be less volatile

This sounds like doubletalk, given that rising interest rates cut the value of existing bonds by making new, higher-yielding bonds more desirable. And rates look to have only one way to go, which is up. Clearly, holding a long-maturity Treasury bond that pays less than 4% is a dicey proposition.

But bonds do a better job of funneling cash to you and me than do stocks, REITs, bank accounts or just about anything else. More and more individuals are buying bonds directly, encouraged by a growing number of bond offerings from online brokerages and a growing availability of information. The Municipal Securities Rulemaking Board, an agency you've probably never heard of, has an exhaustive free database of tax-exempt bond offerings that includes information that, until now, was hard even for pros to locate.

Another reason for the growing popularity of bonds is that aging investors find risk distasteful. The price of a bond can swing widely, but unless its issuer defaults, you can always hold a bond until it matures, knowing that you'll get your principal back. Think of all the stockholders who can only imagine being made whole.

This article was reported by Jeffrey R. Kosnett for Kiplinger's Personal Finance Magazine.

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