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Ways to hedge your investing bets if stocks tank this year
By Alan Lavine/On Investing
Sunday, January 11, 2004
Will this year's stock market do as well as last year's?
It's a presidential election year. Historically, that's been good news for stocks.
But just in case things go sour due to a terrorist attack, rising interest rates or a sudden slowdown in the economy, it's a good idea to hedge your bets.
Here are a few ways to limit your losses and let your profits run:
Own both stocks and bonds. Bonds typically do well when stocks are in a bear market or if we have a recession.
For example, if you kept 40 percent in bonds and 60 percent in stocks, research by Ibbotson Associates, Chicago, shows that you will experience an investment loss about one of every four years.
However, your average loss will be 8 percent.
By contrast, if you kept 100 percent in stocks, your average loss will be more than 10 percent.
Invest in ``bear-market'' stock funds. These funds do well when the stock market drops.
Companies that offer no-load, bear-market mutual funds include Pro Funds and the Rydex Group.
If you're using a market timing investment system, you can move all or part of your money out of stocks and into bear-market funds when the indicators you're following say the stock market will decline.
The drawback: Your call had better be right!
Additionally, you could owe taxes on your trades if the money you moved isn't in a tax-deferred retirement savings accounts.
Invest in low-risk stock funds. These funds own large blue-chip stocks that pay dividends. The dividends help cushion the blow of stock losses.
Consider insured investments. You can invest in variable annuities that come with what are called ``living-benefit'' and ``death-benefit'' guarantees.
Variable annuities are contracts with insurance companies that let you invest in mutual funds tax deferred.
When you retire, you can opt to receive periodic income for life. Or, you can cash out your annuity and pay taxes on your profits.
These investments often come with two guarantees.
The death-benefit guarantee promises that when you kick the bucket, your heirs will receive the principal or market value of the annuity, whichever is greater.
For an added fee averaging about one-third of one percent, you also can opt for living-benefit guarantees, which vary according to the insurance company.
Such a guarantee might protect your mutual fund investments against losses if you hold the investment for, say, more than 10 years.
Other living-benefit guarantees promise to pay you a guaranteed income when you retire - no matter how your investment performs.
Of course, even without added guarantees, you typically pay more than 2 percent in annual fees for variable annuities.
So it's important to ask yourself whether the higher fees are worth the added insurance protection you're getting.
The most valuable commodity I know of is information