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In January, I discussed my
predictions for how you should invest in 2004. This article
updates those recommendations in light of recent events.
Read on to know how to protect your money.
Several trends have occurred over the last 4 months that
could play a significant role in the performance of the
stock and bond markets for the remainder of 2004. These
events include the situation in Iraq, the Presidential
election here in the US and the increased likelihood of the
Federal Reserve raising interest rates. I will explain each
of these and then look at their effect on stock and bond
investments.
The handover of power from the Coalition Provisional
Authority is set to occur on June 30th—little more than 60
days away. There are serious questions about who will take
authority and the impact it will have on the success of
democracy in Iraq. This uncertainty will impact the
financial markets in the U.S.
Back in the U.S., the outcome of the 2004 Presidential
election is far from certain. Senator Kerry is proposing
significant changes to the way corporations are taxed, the
repeal of the dividend and capital gain tax cut and the
repeal of the tax cut on those earning $200,000 or more.
There is concern among investors that, if elected, these
changes would impact corporate profits and investors’
interest in stocks.
At the same time, the economy continues to recover resulting
in the increasing likelihood that the Federal Reserve will
raise interest rates sooner than expected. One major impact
of rising interest rates is on what is called the ‘carry
trade’.
The ‘carry trade’ takes place when financial institutions
such as banks and brokerage firms borrow money at a low rate
and invest that money at a higher rate. For instance, for
quite some time these institutions have been able to borrow
money at about 1.25% and reinvest it in 10 year Treasury
Notes at about 4%, pocketing the difference. This has
resulted in substantial profits for these companies.
Rising interest rates will cause these institutions to
unwind these positions by selling the bonds they have
invested in. The effect of this selling will be to drive
down bond prices and increase bond yields.
How does this affect you and what should you do about it?
That depends on whether you are invested in stocks or bonds.
Many of you may own mutual funds or closed-end funds that
invest in Government Guaranteed, investment grade corporate
or high-yield bonds. If you own any of these you will have
seen their value decline over the last few weeks.
If you have not done so already, you may want to reduce the
portion of money you have invested in bonds. For some of my
private wealth management clients I am further reducing
their bond allocation because of the risk of loss in these
investments.
For those that own stocks or mutual funds that invest in
stocks, the returns on equities this year may not be as high
as you thought while their volatility may increase. For
instance, my firm is still anticipating an 8% return from
equities for all of 2004. It’s possible that won’t be
achieved.
If you are retired or near retirement then you will want to
keep an eye on your stock-oriented investments. This is not
the time to throw your investments in the drawer and forget
about them. If you are uncomfortable with your investments
declining in value, determine the level at which you would
take action to prevent additional loss. If that level is
reached, sell the investment and wait for conditions to
improve.
Regardless of whether you own stock or bond oriented
investments, you should reduce your short-term expectations.
And don’t panic. These are short-term events that should
straighten themselves out over the next 6-12 months.
Lastly, many investors are taking the drastic step of
locking their money in Equity-Indexed Annuities for 10-15
years because they fear additional losses. Don’t make a
long-term investment decision based on short-term
events—especially when you won’t have the ability to change
your mind without losing a significant portion of your
investment through surrender charges.
For advice on how you should invest your money feel free to
give me a call.
Mr. Voudrie is a Certified Financial Planner, a nationally
syndicated columnist and the President of Legacy Planning
Group, Inc., a Private Wealth Management firm in Johnson
City, TN. He can be reached by calling 1-877-827-1463
toll-free, by email at jeff@guardingyourwealth.com or by
going to www.guardingyourwealth.com.
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