Where (and How) to Invest 2012

Many investors wonder where to invest now but they do not consider how to invest - the basics of investing. Where to invest in 2012 is not just a strategic decision of how to choose the best funds but most importantly one of asset allocation.

Asset Allocation Beats Investment Selection

Consider this: If you choose the best stock mutual funds for the year, you could still have lower returns than the person who chooses an average bond mutual fund. How so? If stocks as a whole have a terrible year and bonds as a whole have a great year, your gift for selecting stock funds is relatively useless because mediocre bonds beat even the best stocks. This point underscores the value of asset allocation. Selecting investments is important but asset allocation has a greater overall impact on the total return of your investment portfolio.
How to invest in 2012, as in any given year, depends primarily upon your risk tolerance and investment objectives. For example, if stocks appear to be a great place to invest, a conservative investor with only a few years until retirement should not have a high exposure (allocation) to stocks, regardless of the short-term outlook for the economy and stock market.

Cash in 2012: Inflation Wins

When considering which asset class (stocks, bonds or cash) has the best odds of performing well in 2012, a process of elimination may be the best route to take. An investor would have to be incredibly pessimistic to think that cash will be the best performer. With interest rates near zero, it's hard to state a case for cash unless your number one concern now is with safety. However, even an average rate of inflation (around 3%) would make your hard-earned cash worth less in one year than it is worth today. On the other hand, if you believe the US and world economies will improve in 2012, interest rates will likely rise and therefore savings rates and money market yields for cash will improve.

Bonds in 2012: Taking the Middle Road

The prospects for bonds in 2012 also look pretty dim. If you are pessimistic about 2012, bonds may be a good bet for you. Bonds, like cash, are also sensitive to interest rates, except with different outcomes. When interest rates are rising, reflecting a growing economy, bond prices tend to fall and therefore bond mutual funds will not be the best bet for 2012. Perhaps the best idea for bonds in 2012 is to take the middle road and use an Intermediate-term bond fund. Short-term bond funds may perform more like cash and do little or nothing in 2012, whereas long-term bond funds will suffer the most if economic conditions are positive and interest rates are rising.

Stocks in 2012: Cautiously Optimistic

This leaves us with stocks. A higher allocation to stocks, in relation to cash and bonds, in 2012 is basically a bet that the worst of the European debt crisis is mostly behind us and that the US and world economies, and therefore corporate profits, can grow in 2012. This is a challenging consideration because the unknowns are too large to factor and uncertainty is the greatest enemy of stock prices. Making decisions about stocks more difficult in 2012, most economists give the prospects for entering recession a 50% chance, which also means 50% chance for a growing economy; you can see things as half empty or half full. Therefore, the prudent bet may be a cautiously optimistic balance.

Consider reducing exposure to the riskiest stock mutual fund categories, such as Foreign stock and small-cap stock, and increase exposure to relatively lower risk areas, such as large-cap index funds, dividend stock funds or defensive sector index funds and ETFs, such as Health, Consumer Staples and Utilities. In summary, stocks could put in a positive year for 2012, as long as there are no surprises and the 4th year of an incumbent presidential term holds true that stocks can do well.
Still undecided? The bottom line is that investment decisions should always lead with risk tolerance and investment objective considerations and follow with simple portfolio structures, such as Core and Satellite. Guessing the short-term direction of economic and stock market conditions (market timing) is foolish but there is no question that smart, strategic and sound can all combine as descriptions of one portfolio.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.

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