CHECKLIST Investing Dos and Don'ts for This (and Every) Market Cycle

Mark Twain wrote, “History doesn’t repeat itself, but it does rhyme.” With the recent extraordinary events that have rattled the markets and investors, it pays to heed historical precedent and apply (often forgotten) lessons to the current economic cycle. These dos and don’ts should help investors navigate the currently volatile market.

DO maintain balance (and keep perspective). Too often, investors mistakenly assume they should be either "all in" or "out entirely" of equities based on negativity or euphoria expressed in the markets or by the media. Usually, this results in selling low and buying high. A balanced portfolio will have a foot in each equity camp: large cap, small cap, growth, value, domestic, and foreign developed and developing markets. Pegging your portfolio (and perhaps your peace of mind) to any single index such as the S&P 500 will invariably focus you too much on that particular category.

DON’T seek wealth from the markets. A guiding principle of wealth management is to recognize that true wealth is created through personal diligence, thrift and expertise. Consequently, investment management should emphasize preservation. (Wealth managers should follow the physician’s adage to "first, do no harm.") A portfolio may still be allocated aggressively, but attention must be paid to risk–adjusted return and ongoing due diligence.

DO harvest tax losses. In particularly volatile markets like today’s, it makes sense to take stock of any capital losses early in the year. Realizing them can provide additional tax maneuverability later, particularly if allocation rebalancing is necessary or the market significantly recovers.

DON’T ignore tax efficiency. Seek tax-efficient investment vehicles for your taxable accounts (municipal bonds, index funds) and keep managed, high-turnover mutual funds in your qualified retirement plans and IRAs. Even incremental tax savings can add significantly to your overall longer-term returns.

DON’T ignore inflation. Unfortunately, we can do little personally to combat the effects of inflation. Sure, you can dump the SUV for a hybrid, but you will still be paying much more for cereal, beer, meat and any product derived from basic materials or transported using fossil fuels.

While the financial sector meltdown has rattled equity markets, the credit crunch is not the entire story. Markets are generally leading economic indicators of higher future prices being "baked into" lowered growth expectations. Consider "satellite" (that is, noncore) asset classes as a component in your overall allocation. Some satellite classes offer the benefit of either direct ownership of assets rising in price (for example, commodities), or direct exposure to non-U.S. currencies whose value is at an advantage to the dollar.

Diversified commodity funds and diversified non-U.S. bond funds, which are generally denominated in local currencies, are two such vehicles. These asset classes (particularly commodities) are not for the novice or the faint of heart. Satellite investments should be held in professionally managed investments like mutual funds and generally make up no more than 5% to 7% of a portfolio.

DON’T believe the hype. The media are rife with "experts" predicting with unbridled confidence everything from the month and year the housing market will "bottom," to the unemployment rate for 2008. In fairness, that’s what they get paid to do.

It is often observed but rarely heeded that once a consensus emerges, it’s a good bet to do the opposite. Warren Buffett, George Soros and virtually every politician commenting on the market or the economy have an ax to grind—and an interest in being interviewed about it. But when it comes to investing, "recession" is purely a matter of semantics. Recessions are always "officially" identified well after the markets (again, the leading economic indicators) have moved on to the next chapter.

—By John P. Maher, a financial consultant at CCR Wealth Management LLC in Boston. He can be reached at jmaher@ccrwealth.com.