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Five Resolutions for Investors

Jason Stipp

Jason Stipp: I'm Jason Stipp from Morningstar, and welcome to the Friday Five.

In case you haven’t started your New Year's resolution making yet, Morningstar markets editor Jeremy Glaser is joining me today with a short list to get you going. Thanks for being here, Jeremy.

Jeremy Glaser: Happy New Year, Jason.

Stipp: So what do you have for the Friday Five this week?

Glaser: This week we are going to take a look at some resolutions like ignoring political rhetoric, carefully checking your asset allocation, avoiding Facebook, being careful with alternatives, and finally, don't stretch for yield.

Stipp: So that first one, ignoring political rhetoric, sounds a little bit easier said than done. Why is this important for investors?

Glaser: It certainly is. I realize that with the incredible amount of information that’s going to come out over the course of this presidential campaign for the next year, it's difficult to completely close your ears and just not listen to it and stay focused on your long-term goals. But I think it's important to do that.

We are going to hear so many different proposals from so many different candidates on the Republican side, from whoever eventually emerges as the nominee, and from President Obama during the campaign. There is just going to be a lot of information about different plans they want to enact. How they want change the tax code. How they want to change different incentives. But the truth is that a lot of these probably won't happen. We won't actually know what anyone is capable of doing until after the election.

And trying to adjust your portfolio during the year based on "well the dividend tax rate may go up a little bit here, may go down a little bit here, capital gains tax is going to change here" is an absolutely impossible task.

And instead of trying to worry about staying ahead of any potential tax changes, waiting until these tax changes look a little bit more concrete, and then making those concrete changes to portfolio, I think is a much more prudent path. And I think it’s a good idea to kind of close your ears a a little bit to that rhetoric that’s going to be coming from both sides of the aisle.

Stipp: Resolution number two: Carefully examine your asset allocation. What things might you find when you crack open your portfolio, and why should you resolve to make sure that it's in line with your plans?

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Glaser: Asset allocation is probably the single most important decision that investors make. Obviously the investments that are inside the particular stock fund that you buy or particular bond fund that you invest in are going to have a big impact, but more than anything, it's how many stocks do you have, how many bonds do you have, and in what proportion to each other.

I think that there is a temptation as a lot of people approach retirement and maybe see that their balances aren't quite as big as they thought they were, to be more aggressive, to try to put a lot more in stocks and try to take a lot more risks. But I think we've seen over time that that just doesn't necessary work. Over the short term, we've seen that risky assets are just that, incredibly risky. With the amount of volatility that we've seen recently in the market in 2011, I think we're going to see a repeat of that in 2012, you could find that a swath of those risky assets will be moving pretty aggressively.

So I think you need to sit back and really think about how much risk you're willing to take, and exactly when you're going to need that money. And if you really can't stomach that risk right now, you might want to think about moving the asset allocation more into fixed income, more into cash or other more stable items--that might be prudent for you.

And if you find that you do have a shortfall, you might have to look at other things such as working a little bit longer, taking a part-time job in retirement. Think about other ways to change your life to make that work versus taking on a lot more risk, which is something that you might regret just a few years down the road.

Stipp: So certainly expect more volatility for the coming year.

Jeremy, the third one, I noticed that on your Facebook page, you haven't "liked" the Facebook company IPO, and you're not recommending that investors like it either. Why is that?

Glaser: This is going to be big news next year. Facebook is going to be one of the largest tech IPOs that we've ever seen. The hype around it is going to be almost unimaginable. We are already starting to hear it, and they haven't even filed their S-1 yet, and chances are the valuation is going to be absolutely in the nosebleed section if it prices anywhere close to some of the other recent tech IPOs, which obviously haven't performed very well, but priced pretty well when they came to market.

Facebook is a great company. They have a huge network. Presumably they're going to post results in their S-1 where they could have great profitability. They might have good growth prospects, but you can't just assume that that's worth any price. I think investors should be incredibly skeptical of getting into this IPO. They're going public because it's an opportune time for them, not because it's an opportune time for you as the investor. There might be entry points further down the road. I don't think it's a terrible company or anything, but chances are that when S-1 comes out, and we hear more about it, the Facebook IPO is going to be one to avoid for the next year.

Stipp: Another area where you are suggesting investors think twice before jumping in is the alternative space. This has been a very hot space of the investing market over the last couple of years. Why should investors carefully consider alternatives?

Glaser: We've heard a lot about alternatives--all sorts. Everything from long-short funds, to much arbitrage funds where you buy companies that are about to get an M&A deal completed, to commodities, to holding gold in future contracts, or holding gold or other commodities in the physical form. And all these alternatives have really, as you said, gained a lot of popularity. But many of them don't have a very long-term track record of how they are going to work in individual investor portfolios. There's often a lot of academic research that shows they could be beneficial to various portfolios, that they can increase your return without introducing a lot of risk. Some of them have been run in hedge funds for a while with some success.

But I think until we see a long-term track record about how these different items are really going to make your portfolio a lot better and really give you a lot more return, I think investors should wade in with caution. It's not to say you shouldn't use alternatives. I think that there is a case to be made for making a small portion of your portfolio available to try some of these alternative strategies and to get a feel for them. But allocating a huge part of your portfolio at this time still seems like a risky bet.

Stipp: So certainly something to tiptoe in.

Another area where investors have had some difficulty is the yield area. So I know we have fixed-income alternatives for example. One of the reasons people are looking at these is because it's cloudy for fixed income, and investors are not getting a paid a lot of money to [hold fixed income] right now. So, what's the resolution for yield investors and income investors?

Glaser: Don't reach for yield.

We've seen yields be at these historically low rates for a couple of years now. The idea of going back to a 3% rate on short-term money seems like an incredible deal now, even though only a few years ago you would have thought that was somewhat of a paltry yield. And it seems like yields are going to stay low for a while. The Federal Reserve is quite committed to keeping rates low, to keeping monetary policy extremely easy, and we are probably not going to see an incredible increase in interest rates anytime soon.

But that doesn't mean that you should just start taking on a huge amount of risk in order to get that extra yield out of your portfolio. You are probably going to be moving into asset classes and moving into different assets that might not be exactly what you are looking for. If you are trying to create income in retirement, you probably don't want something that the price could fluctuate a huge amount, and you could end up losing a lot of your principal and losing a lot of your capital.

I think investors should really focus on that total return. If you can find a great dividend-paying stock that has a solid yield, but also has the potential for stock appreciation, you might be able to eke out a decent return over time, even if it's not coming completely from that dividend yield. I think trying to reach could leave investors unhappy in 2012.

Stipp: Well, Jeremy, I'll resolve to meet you here every Friday for another great year of Friday Fives. Thanks for joining me this week.

Glaser: Thanks, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.