Quinn: Lessons for Hard Times

Once again, stocks plunged just when investors were starting to feel fat and happy. Once again, a recession rained down. Two things are different this time (every downturn is different in its own unhappy way). The credit squeeze makes it hard to borrow your way out of trouble, and a "new" investment—commodities—seems fit for retirement plans. Some lessons to heed:

There ' s no substitute for cash. Money you're going to need in the next couple of years—for current bills, meeting a payroll, a house closing, whatever—should sit in places where cash is safe: an insured bank account or a plain-vanilla money-market fund at a large institution that will protect the fund from loss. It doesn't matter that you're earning less than the inflation rate. This is not an investment, it's your wallet. Savers who reached for higher interest rates, in "cash-plus" funds or ultra-short bond funds, are losing money, sometimes a lot.

Diversification works. Sneerers say that diversification is overrated because all the world's stock markets have dropped together. Ignore them. Just three simple examples show why:

An undiversified investment in Standard & Poor's average of 500 leading U.S. companies earned 1.66 percent from 2000 through 2007. Money split three ways—65 percent in the S&P, 25 percent in leading international stocks, 10 percent in emerging markets—gained 4.33 percent. Reducing the S&P investment and adding 20 percent in smaller stocks raised the take to 6.34 percent—all without raising a finger. (For these data, thanks to Morningstar's Ibbotson Associates.)

Commodities can be your friend. I first wrote about commodities in 2005, and with a trembling hand. I thought they might be a bit, well, far out for the average investor. Now I think they're a good addition to an investment plan.

On fundamentals, their story lies in the voracious demand for oil, food and metals in fast-developing Asia, Africa and Latin America. Their strategic advantage lies in their "low correlation"—meaning that, when stocks zig, commodities often zag. Craig Israelsen, a professor at Brigham Young University, found that adding commodities to a diversified portfolio reduces volatility and lowers your chance of losing money, long term. Owning them makes sense, even if today's high, bubbly prices break.

Pittsburgh-based planner Robert Hapanowicz recommends the PIMCO CommodityRealReturn Strategy Fund and the exchange-traded fund GSG. (Exchange-traded funds—ETFs—are mutual funds that trade like stocks.) GSG tracks the S&P GSCI Commodity Index, which currently has a 75 percent stake in oil and gas. The Dow Jones AIG Commodities index is better diversified, says Jeffrey Ptak, head of Morningstar's ETF analysis, with only 35 percent in oil and gas. His pick: iPath DJ-AIG Commodity Index Total Return exchange-traded notes. (Warning: the notes, which are debt obligations rather than funds, carry high fees.)

Real Estate Investment Trusts are another great diversifier. REITs more than tripled in price from January 2000 to February 2007, then lost 25 percent in a hurry. They've picked up a bit in the past few weeks and currently sell at a median 12 percent discount to the estimated value of their properties, says Jason Lail of SNL Financial Research, with dividends in the 6 percent range. There's a hard road ahead for commercial real estate but, hey, you're supposed to buy stocks when they're low.

Don ' t chase the gold price. Gold is a bet against the dollar. If its price adjusts for inflation since 1980, it should eventually run to $2,000 an ounce from $930 today, says Chris Laird, editor of PrudentSquirrel.com. You'll almost certainly lose, however, if you try to buy and sell as the market churns up and down. Either make gold a permanent part of your portfolio or leave it alone. Gold stock mutual funds reflect the performance of mining companies, not gold itself. Gold bugs should consider ETFs such as StreetTracks Gold Trust or iShares Comex Gold. (Warning, from planner Steven Medland at TABR Capital Management in Orange, Calif.: gains on gold ETFs are taxed at 28 percent, not the usual 15 percent.)

Tax-free municipal bonds are paying more than taxable Treasuries. That makes them great buys. If interest rates rise, they should lose less in value than other bonds, says Mark McCray of PIMCO, specialists in fixed-income securities, while still paying a decent income.

For debtors, three little words: It's all over. Lenders want to see your cash.

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