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Year Beginning Pitfalls

- Alan Lavine and Gail Liberman

A word to the wise: Stay well-diversified in stocks, bonds, cash and other investments, like precious metals and real estate.

Why? You can't go by rosy beginning-of-the-year prognostications by Wall Street. They want you to invest. If enough of you do, stocks will go up and they make money. Supply and demand drives the stock market. Sure the economy seems to be improving. But if we have a terrorist attack or higher inflation and interest rates, Wall Street will change its tune. Unless you are willing to speculate, make sure you limit your enthusiasm for these investments:

  • Sector funds. These funds invest in the stocks of just one industry such as technology or chemicals. Your fortunes rise and fall with the earnings in that industry. Bad news can send stocks tumbling. Currently, analysts call for the hardware, computer chip, and information technology and construction industries to perform well this year. If you invest in sector funds or buy stocks in these industries, you had better be prepared for a bumpy road.

  • High-yield bond funds. These funds, which invest in lower credit-rated issuers, registered double-digit returns last year. High-yield bonds, also known as "junk bonds," track the performance of the stock market more than the bond market. So if stocks do poorly and the economy sags, expect these bonds to decline.

  • Gimmick funds, such as "bear market funds" or "rising rate funds." These are funds that perform well respectively when the stock market declines or when interest rates rise. If you get in and out of these funds at the wrong time, you could lose your shirt. If your financial adviser uses these funds, you had better make sure that he or she has a good system.

  • Focus funds. These funds invest in just 25 or fewer stocks. That compares with close to 100 stocks in the average stock fund. You are not well-diversified in focus funds. If the fund manager's stock picking is off, you lose.

  • Stock funds that guarantee your principal. You should not lose money in these funds. But they are high cost and deliver low returns when the stock market performs well. You would be better off owning a balanced fund that owns both stocks and bonds.


    Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

    To read more columns, please visit the column archive.

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