The last decade provided subpar investment performance for large cap stocks, many investors with diversified portfolios did much better. Just adding a mix of investments would have helped greatly as $1 invested in U.S. bonds would have grown to $2, in small company stocks to $1.30, over $2 in emerging market stocks, and $1 invested in gold would have appreciated to $4. Instead of hope, develop a strategy that includes portfolio diversification and rebalancing. Here are areas to consider:

U.S. large cap stocks started the decade valued at 30x earnings - twice the historical average and offered half the historical average dividend yield. Despite valuations at all time highs to begin the decade, investors were embracing stocks with wide-eyed-optimism. Today's market is much more fairly valued which provides more compelling opportunities for U.S. stocks, however not without challenges.

The biggest challenge for the U.S. economy is the enormous amount of debt on consumer and government balance sheets. Nearly one in four Americans owes more on their house than it is worth at a time when almost one in five Americans is either unemployed or underemployed. Focusing on Federal debt levels, if you combine government debt, Social Security, and Medicare liabilities you would need over $50 trillion to fully fund the U.S. government and their entitlement programs. Put another way, considering U.S. total economic output is $15 trillion it would take three years of all U.S. economic output being paid directly to the U.S. Treasury for the Federal Government to have a net worth of zero. Although a combination of Treasury borrowing and Federal Reserve money printing will likely reduce the debt burden through inflation over time, owning some international fixed income or hard assets such as gold and commodities can help reduce the risks of a country issuing too much currency. Regardless of the headwinds from excessive debts, companies and corporate profits are likely to continue to grow. With stocks valued more reasonably they will be more likely to rise along with the growth in profits. Last decade, earnings for the Standard and Poor's 500 companies grew substantially while the index shrank. Businesses are generating more profit but are worth less, providing better value for investors. With a 2% dividend yield and likely 3-4% profit growth U.S. stocks may be able to return a mid to upper single digit in the decade. While things are below the historical average, they are priced much more fairly for the decade ahead despite the challenges.

Given that a dollar borrowed is tomorrow's spending pulled forward to today, you may want to allocate investment dollars to areas with less debt. Today, these areas include countries in many of the emerging markets. India, Brazil, and China have debt levels approximately half to one third that of the U.S. and Western Europe. The lack of high debt levels in their economies coupled with historically high savings rates should allow those economies to grow at a faster pace as credit markets develop and standards of living rise. Allocating a portion of one's portfolio to international investments with some exposure to emerging markets may help to improve your results for the next decade as the lack of debt saturation in emerging economies should lead to better growth over the developed world.

The most important part of any investment strategy is that it allows you to sleep well at night. While different types of asset classes can balance out returns over time, an appropriate allocation to quality fixed income based on your goals and objectives to dull investment volatility is critical. Too many people ditched their investment strategy at inopportune times through the past decade. Taking an appropriate amount of risk will keep you in the game and well rested, knowing that your nest egg is not in jeopardy even when your strategy is out of favor. As a portfolio grows to a wider variety of investments, it is important to rebalance the mix of assets back to your targets. If you decide that 5% of your investment mix should be in emerging market stocks, be certain to trim profits out when the asset class grows and add to it when it's out of favor. Otherwise, if you allow your higher risk investments to appreciate along with the market you will accumulate a large amount of risk assets at the time the market is at its highest level. Set targets for what you want in different types of investments and rebalance to those targets.

Don't let another decade go by waiting for your old investment mix to come into favor like the leisure suit in the back of the closet. Review your current investments in light of your goals, objectives, and ability to take risk or work with your financial advisor to revamp your portfolio. If the 2000's were the uh-ohs, developing a diversified strategy that you're comfortable with will help to make certain the 2010's move you closer to your goals. 

2010-03-04 01:00:00 -0500