Stay Calm and Prosper: What to Do Now
As the old saying goes, truth is the first casualty of war. Truth is also frequently the first casualty when things head south in the financial markets, as politicians attempt to assure voters that “the fundamentals of our economy are strong” on the same day that two of the nation’s oldest financial institutions—Lehman Brothers and Merrill Lynch—collapse and the Dow Jones Industrial Average loses 500 points.
Investors who follow the news know better. The economy has lost more than 600,000 jobs since the beginning of the year—and that is by the Labor Department’s own conservative estimate—and could tip into a recession as early as this quarter. The current financial crisis, despite the federal government’s aggressive and unprecedented intervention over the past several months, could very well get worse before it gets better. Unlike politics, the world of investing is still very much a “reality-based community.” To be able to profit from changing circumstances, investors must first understand—and face—the facts driving the changes.
While the current financial crisis is almost certainly more than a run-of-the-mill downturn, there is no reason for despair—or, even worse, panic. Below, we provide some simple steps individual investors can take to protect their wealth in the current market environment, maintain their peace of mind, and position their portfolios for future gains.
Check your federal coverage
The Federal Deposit Insurance Corporation (FDIC) is the New Deal-era program that backstops cash deposits at retail banks; the Securities Investor Protection Corporation (SIPC) is a similar entity that protects securities. While the two programs are indeed similar in many ways, there are some important differences.
The FDIC protects up to $100,000 per depositor, per bank. In other words, if you have several accounts containing a combined total of more than $100,000, then the excess may not be covered in the event of a bank failure. (In recent bank failures, however, the FDIC has covered depositors up to $150,000.) If you’re unsure whether your bank is covered by the FDIC, check your bank statement or give them a call. Note also that the FDIC only covers cash—not stocks, bonds or mutual funds. For the purposes of FDIC protection, money market funds are considered securities, not cash.
The SIPC protects up to $500,000 per investor, per firm, and coverage kicks in if your brokerage fails and cash or securities are missing from your account. Note that the cash coverage tops out at $100,000. While brokerage failures are extremely rare, they are not unheard of, and SIPC participation is something that all reputable brokerages should offer. Again, if you’re unsure about whether your brokerage is covered, check your latest statement or call your broker.
If your time horizon is 5 years or more, then buy equities
If you’re a contrarian with time to ride out the current volatility, then now may be a good time to buy—but don’t try to pick an industry sector or even a region. Instead, go global. The fact is that one of the broadest measures of the global stock market—the FTSE All-World Index—is off about 30 percent since last year. Vanguard’s Global Stock Index Fund tracks this index, and iShares has recently launched a host of global ETFs, including the Global 100 Index Fund, which tracks international mega-cap companies, and the MSCI ACWI ex U.S. Index Fund, which excludes U.S. companies.
Of course, there is no way to predict the future direction of the market, but we do know from ample historical data that the trend over the long term is upward. Even if the current woes in the U.S. financial sector ripple out to the global economy, it’s unlikely that the entire world wouldn’t have regained its footing within five years.
Factor a weakening dollar into your strategy
Will all the money the Federal Reserve and Treasury Department have been pouring into the financial sector lately (not to mention the giant budget deficits the federal government has been running); it makes sense for every long-term investor to factor a potentially weakening dollar into long-range forecasts. When the government has to print more money—or lower interest rates—the dollar tends to fall against other world currencies. For many years, economists have discussed the possibility that the euro, the currency of the 15-nation eurozone, could displace the U.S. dollar as the world’s preferred reserve currency and medium of international trade. While that is still unlikely, the current financial upheaval here in the U.S. is sure to spark renewed discussion of an ascendant euro.
Gold is a traditional hedge against a weak U.S. dollar. Keep in mind, however, that the futures market for this precious metal is volatile and funds or ETFs that invest in gold miners (or gold bullion) should only make up a small fraction of overall portfolio assets. Because foreign currencies by definition rise when the dollar falls, an international bond fund or ETF that invests in a basket of foreign currencies would also serve as a good hedge against a weak greenback while minimizing some of the volatility of a gold or single-currency investment. The PowerShares DB G10 Currency Harvest Fund tracks an index of nine foreign currencies as well as the U.S. dollar. The fund’s value has declined recently because of bets against the U.S. dollar.
Don’t forget tax-loss harvesting
For investors, particularly those with investments in the U.S. financial sector, this year may be a particularly good one for tax-loss harvesting, the practice of realizing capital losses to minimize taxes. You may apply an unlimited amount of capital losses to offset your capital gains. In addition, if your capital losses exceed your capital gains, you may apply of to $3,000 of that amount against your ordinary income; additional capital losses can be carried forward into future years. For more information, consult with your investment adviser.
