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Investment Strategies Amid Downgrades, Downturns and Slowdowns

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10/01/2011 - Investors are being forced to cope with what many perceive as unprecedented circumstances in the economic and political environment. At the same time that the U.S. economic recovery appears to be slowing, one independent agency downgraded its rating on debt issued by the U.S. Treasury. Confidence that government policymakers can do anything significant to help improve the environment is low.

These and other concerns are contributing to a sense of unease for many investors. How should the major events occurring in the global environment affect your personal portfolio strategy? Here are five realities to give you an appropriate perspective on the challenges that lie ahead:

#1 The downgrade may be justified, but might have been premature.

Standard & Poor's shifted the nation's credit rating from AAA to AA+. Part of their rationale appeared to center around concerns that a dysfunctional political environment will prevent budget issues from being resolved in an effective manner. However, history is filled with examples of how American politicians have forged deals to resolve crises. It may not be fair to discount the potential that policymakers will come to agreement not just on budget issues, but other legislation designed to give the economy a boost.

#2 The economy is being tested, but a repeat of 2008 is not inevitable.

Recent memory can have a significant impact on investor behavior. The financial crisis that put the global economy on the brink in the fall of 2008 (and contributed to a 50 percent+ drop in the value of the S&P 500 stock index) remains etched in most of our memories. Fears have been raised that we may be facing a similar situation this year spurred on in part by the problems many governments (Greece, Ireland and Spain to name a few) are facing with their own debt issues. But it is not a foregone conclusion that we're headed for the same result as three years ago. Circumstances are different today. For instance, many of the economic problems in the last downturn were related to the housing market bubble and excessive consumer debt. Today, housing prices are dramatically lower and consumers have begun to wind down their debt. There are other challenges facing the economy today, but a "double-dip" recession in the U.S. is far from certain.

#3 Good news is often hidden.

In periods like these when troubling news leads the headlines, investors are often surprised when markets perform well. This is due to the fact that some market observers are looking beyond the headlines to see other trends that are favorable. The same is true in today's environment. Corporate profits remain strong and companies in the U.S. and elsewhere generally have solid balance sheets. Emerging markets are growing robustly and will likely help spur ongoing economic activity in other parts of the world, including the U.S. Prices for gasoline have moderated in recent weeks, boosting consumer purchasing power. Even in difficult times, seeds of future prosperity are planted.

#4 Stocks may offer more attractive value than bonds.

Many individuals have been pulling money out of the stock market and investing in bonds (or bond funds). Yet with interest rates on U.S. Treasury securities near their historic lows there appears to be limited upside. Worse yet, bonds paying extremely low interest rates can be risky for investors. If interest rates begin to rise, bondholders could be in for a negative surprise. That's because bond prices decline when interest rates rise. Stock values, meanwhile, remain well below the peak they reached in the fall of 2007 before the dramatic, 50 percent downturn occurred. At that time, the S&P 500 Index topped out at 1,565. Today the S&P 500 is 20 percent to 25 percent below that all-time peak. This indicates that upside potential remains over the long run, though the market will likely continue to suffer through ups and downs along the way.

#5 Market gyrations should not overtake your investment strategy.

Are you a long-term investor? Most everybody should be, at least with a portion of his or her portfolio. Even if you are retired or close to it, you may need to invest some of your money in stocks to help meet increasing income needs over the course of what could be a long retirement. If you are uneasy with your current asset mix, it is worthwhile to review your holdings and determine if there is a more appropriate solution for your circumstances. Keep well diversified, and avoid putting too much of your money into a single asset or asset class to limit the risk of a dramatic change in its price. Don't let today's headlines overwhelm your investment decision process.

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