Ask any number of investors what they want out of a particular stock, bond, or mutual fund and you’re likely to get the same answer: low anxiety and high returns. But all too often, big investment rewards come with immense risks, and these days, great nervousness. There is a solution, however. To find the proverbial sweet spot–substantial profits with bearable volatility–today’s investors need to spread their bets, and do it shrewdly. What follows is a collection of investments that can help to minimize the chance of losses while maximizing your portfolio’s earnings.
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The emerging markets of the world are natural places to look for growth. As more citizens of China, India, Russia, Brazil, and elsewhere continue to attain a middle-class standard of living, economic growth in these countries will soar. In 2009, for instance, while the U.S. struggled to get out of a recession, the Asian Development Bank reported that the region’s economy proved to be more resilient than expected in its response to the global financial crisis. The bank projected economic growth at a 3.9% pace for 2009 and 6.4% in 2010. This compares to the Federal Reserve’s U.S. forecasts of a contraction of -1% to -1.5% for 2009 and growth of 2.1% to 3.3% for 2010.
With such growth also possible in other developing markets around the world, participating investors are likely to prosper. Sure enough, Morningstar reports that emerging markets stock funds returned 10.51% per year for the past 10 years, through the third quarter of 2009, among the best of all mutual fund categories. By contrast, U.S. domestic stock funds returned a scant 2.46% a year. There is however, one catch. Emerging markets stock funds are volatile. In the crash year of 2008, this sector lost nearly 55% of its value, a far steeper loss than U.S. stock funds suffered.
So, how can you pocket profits while reducing risks? Mix your emerging markets stock funds with funds that hold bonds issued by emerging markets governments and companies. Over the past decade, emerging markets bond funds have posted annualized returns of 10.74%, slightly higher than their cousin stock funds. Emerging markets bond funds certainly have risks (they lost almost 25% in 1998 and nearly 18% in 2008) but they have not been nearly as volatile as the stock funds. “Ideally, you should hold both emerging markets stock funds and bond funds,†says Tom Idzorek, chief investment officer and director of research and product development at Chicago-based Ibbotson Associates, a Morningstar company.
“If you have an emerging markets stock fund and a bond fund, you are likely to have a smoother ride, long-term, than if you have only one type of fund.†However, he warns that investors shouldn’t load up on emerging markets stocks or bonds, expecting the high returns of recent years. “Perhaps 10% or even 5% of a diversified portfolio should be in the emerging markets,†he says.
Top-Performing Emerging Markets Bonds Funds*
Dividend-Producing Stocks
If only 5%-10% of your portfolio is allocated to emerging markets, you probably should hold stocks from the U.S. and other developed nations as well. In order to minimize exposure to a freefall like the one we all experienced in 2008, you might want to include dividend-paying stocks. “Look for companies that have enough net income to easily cover the interest on their debt and the dividends they pay to shareholders,†says Eugene Profit, who heads Profit Investment Management (No. 15 on the BE Asset Managers list with $900 million in assets under management). “Those companies have strong fundamentals so they are likely to hold up well in any type of economy.â€
What’s more, current law calls for stock dividends to be taxed no higher than 15%, through 2010. (Bond interest, on the other hand, may be taxed as high as 35%.) Among Profit’s current holdings, he is especially upbeat on these dividend-paying stocks:
Verizon (VZ): This telecom giant, the largest wireless carrier in the U.S., now has a dividend yield over 6%. “The
company may get the rights to sell [Apple’s] iPhone in the next year or two,†Profit says. “In the meantime, the high dividend means investors are being well-paid to wait for news that might boost its stock price.â€General Electric (GE): This company has been included in the financial sector because of its GE Capital subsidiary. As a result, its stock price has suffered in the credit crisis. “GE really is an industrial company, not a bank,†says Profit. “It is well-positioned to increase earnings as the economy recovers.†Meanwhile, it offers a well-covered 5% dividend yield.
United Parcel Service (UPS): Profit puts the current dividend yield at 3.25%, which is as high or higher than you’d get from most bank accounts or Treasury bonds. “In addition,†Profit says, “UPS has the highest profit margins of any major company in the transportation industry. So investors might see its stock price move up when the economy improves.â€
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Home Depot (HD): The home improvement retailer has a current yield of 3.40%. “Shelves look empty at Home Depot these days as homeowners launch do-it-yourself projects and hire contractors, either to help sell their homes or make them more comfortable because they’ll be there for awhile. Also, management is making an effort to be more customer-friendly,†says Profit of the company whose current dividend yield is around 3.4%.
Johnson & Johnson (JNJ): The healthcare company has a current yield of 3.2%. Profit admits that healthcare stocks have been up-and-down with all the talk of federal healthcare reform. “Once that’s resolved,†he says, “the basic fundamentals will emerge: an aging nation and an aging world mean more demand for healthcare.â€
Overall, Profit suggests mixing high-dividend stocks with growth-oriented issues that pay little or no dividends. If you are getting an overall 2% to 3% yield from the stocks in your portfolio, you might have current income, upside potential, and downside protection if stocks slump again.
Wealth For Life Principles
1. I Will Live Within My Means
2. I Will Maximize My Income Potential Through Education and Training
3. I Will Effectively Manage My Budget, Credit, Debt, and Tax Obligations
4. I Will Save At Least 10% of My Income
5. I Will Use Homeownership as a Foundation For Building Wealth
6. I Will Devise An Investment Plan For My Retirement Needs And Childrens’ Education
7. I Will Ensure That My Entire Family Adheres To Sensible Money Management Principles
8. I Will Support the Creation and Growth of Minority-Owned Businesses
9. I Will Guarantee My Wealth Is Passed On To Future Generations Through Proper Insurance And Estate Planning
10. I Will Strengthen My Community Through Philanthropy