Thoughts for 2010

After a bad end to 2008 and an equally poor start to 2009, the stock market has rallied more than 60 percent since its March low. So, what are investors to think in the New Year? Every wealth management professional has their own feeling on where the economy is headed, when inflation will make a comeback and which market sectors will lead the way in 2010.

I have my own personal thoughts. I believe the economic outlook will continue to improve. Employment numbers and personal income will also get better although it will take time. Eventually, the Federal Reserve will begin to raise interest rates to guard against inflation. I think the markets will continue to be volatile. Cost cutting has helped fuel the market’s rise over the past nine months, but strong top line growth is necessary going forward to continue the market’s rise. If we don’t get that in the first quarter, more volatility is on the way.

Those are my opinions. My advice to investors is to think holistically about your portfolio. In other words, you don’t own stocks in a vacuum. You own them in the context of your overall portfolio. Take a look at your collection of stocks and/or mutual funds and examine how they interact. If they all move in the same direction, your portfolio is not as diversified as it should be. That is true for all of your asset classes, not just stocks.

Successful investing in 2010, and every year, is not about finding the hot stock or the hot fund. Nor is it about trying to time when to get in or out of the market. Instead, it is about developing an asset allocation strategy that meets your risk tolerance, time horizon and individual goals. You won’t get that with a cookie cutter strategy off the shelf, or in simply focusing on the percentage that you invest in stocks. I believe in customization and developing plans to meet clients’ unique needs and goals.

As for where the economy is headed or if we’re due for a market correction, my advice is to focus on what you can control. You can’t control the markets and you can’t control the risk unique to individual companies. That is why I believe it’s better to buy a basket of securities rather than an individual stock. You can create a portfolio with the same objectives and similar returns over time with significantly less risk.

To some extent, you can control your expenses, taxes, asset allocation and asset location. Generally, look for investment products with low expense ratios. Over time, high expenses can eat into your returns.

In the mid- to long-run, taxes will likely rise. If you look at the current deficits the federal government is running and the growing cost of funding government programs such as Social Security and Medicare, taxes must eventually go up. If the economy strengthens in 2010, the Obama administration may let the Bush tax cuts expire, pushing the highest tax brackets back up to 39.6 percent in 2011 and the capital gains rate to 20% percent. If the economy doesn’t improve, perhaps the tax rates will be modified. But, in the long run, it is likely that federal tax rates will be higher for all of us.

This makes asset location all the more important. Put your tax-efficient investments, such as large cap stocks, in taxable accounts, and inefficient tax investments such as high yield bonds in tax advantaged accounts like IRAs and 401(k)s.

As a safeguard against inflation, consider including TIPS in your tax-advantaged accounts. These notes, issued by the government, offer a fixed interest rate (recently they had a 3.000% interest rate for a 10-year note), but unlike standard Treasuries, the principal is adjusted to reflect inflation. So during a year in which inflation hovers around 2%, your principal would be adjusted upward by that amount, giving you additional return. TIPS can also be a useful way to diversify a portfolio, since they have little to no correlation with stocks or corporate bonds.

Finally, continue to keep an eye on your asset allocation as the market moves in 2010, whether up or down. Rebalancing when appropriate is a critical step to ensuring your portfolio stays on track to meet your long-term needs.