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Mutual Funds

7 Ways Your Money Will Never Be the Same

Brace yourself for more-volatile markets, tighter credit and a revamped retirement system.

Investors have been feeling frisky of late. Just another bout of irrational exuberance, you ask, to be followed by another bust? Possibly. One thing that's certain, however, is that the Great Recession, the credit crisis and the past year's meltdown in financial markets will change how you handle your finances in the future. In many ways, your money will never be the same.

1. Investors: Less risk. In the old days -- before 2008, that is -- an aggressive portfolio had 80% or more of its assets in stocks. But most investors have been burned so badly that it will be a long time before they'll again be confident enough to justify such a high proportion of stocks within their total portfolio.

The new normal for an aggressive investor, for example, may be just 60% to 70% in stocks, and someone who accepts only moderate risk may be comfortable with 40% to 50%. That may not be the right way to go -- barring a catastrophe, we think stocks will outpace bonds over the next ten to 20 years. But that's the reality when a generation of investors takes such a shellacking.

2. Markets: Greater volatility. Daily, hourly and even minute-to-minute swings will continue to be wild and sometimes vicious. Experts blame the heightened volatility on a ceaseless flow of information -- or misinformation -- that can encourage misguided trading.

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Enormous volumes in trading-oriented products, particularly exchange-traded funds, exacerbate the volatility (see The Perils of Leverage). That's especially true early and late in the trading day.

How to cope? Keep your eye on the long-term prize. Accept the fact that day-to-day and even minute-to-minute nuttiness has become a fact of life, and don't get caught up in it. And, says Tim Kober, of Cedar Financial Advisors, in Portland, Ore., "Don't trade in the first or the last hour, or you'll get whipsawed."

3. Diversification: More choices. The recent market unpleasantness has tarnished the concept of diversification. Nothing worked last year, save cash and Treasury securities. So much for the traditional advice to keep fairly equal holdings in various stock categories -- such as growth and value, small-company and large-company, foreign and domestic -- and to own different kinds of bonds, including supersafe Treasuries, municipals, corporates and so on. The new plan is to add a variety of investments, some of which might be considered highly risky, that really do have a good chance to zig when traditional assets zag.

That could mean putting a greater amount of your money into investments such as gold, foreign currencies, real estate, energy and other commodities. "Defense is not just diversification by allocation. It also means keeping defensive funds in the mix," says investment adviser Dennis Stearns, of Greensboro, N.C.

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In the same vein, you will see a push to introduce new products aimed at immunizing you from wrongheaded forecasting or missed trading signals. The new buzzword will be buckets, or investments in which you store built-up savings to shield them from untimely losses. Some examples: annuities and insurance policies designed to lock in gains; easy-to-purchase packages of laddered certificates of deposit; and, in general, more passive types of investments with guaranteed floors and plenty of liquidity.

4. Dividends: No sure thing. There used to be an association between dividends and financial health. Companies that paid dividends consistently for many years were considered strong; even better were those that raised their payouts regularly. That's no longer the case. The recession and other developments have shown that there are few safe havens nowadays. General Electric, Pfizer, Alcoa, many other industrial companies, many insurance and real estate firms, and just about every major bank cut or eliminated dividends over the past year.

The new thinking: If a company is convinced it has a better use for its cash than distributing it to shareholders, then you shouldn't automatically punish the stock because of a dividend cut. After all, GE's stock (GE) surged 57% from February 27, when it slashed its dividend by 68%, through June 5. Shares of Alcoa (AA) have skyrocketed 85% since the aluminum giant chopped its payout by 82% on March 16.

This doesn't mean you can't find solid dividend payers. The key, though, is to focus on dividend growth rather than a very high yield. A good place to start your search for serial dividend boosters is Stocks That Pay Rising Dividends.

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5. Credit: Tougher to come by. It isn't just subprime mortgages and liar loans that have gone by the boards. Even after home prices stabilize, the 30-year fixed-rate mortgage with a substantial down payment will once again become the cornerstone of housing sales. That's partly because big banks suffering financial stress are -- and will remain -- under pressure from regulators and shareholders to tighten up. Also, local and community banks will be making a larger share of mortgage loans. Such institutions tend to keep loans on their books rather than sell them for inclusion in packages of mortgage securities, so they're more selective about saying yes to or going easy on borrowers.

Adjustable-rate loans with teaser rates will still be available. But lenders will target people who have the potential to earn more in the future -- think doctors during their medical residency, for example -- instead of flippers, investors, or borrowers with marginal income and credit.

As for credit cards, they'll come with stiffer terms. Gone are the days when you could game the system by hopping from one 2.9% offer to another. New legislation curbs punitive late fees and interest penalties, but there's a flip side. Look for banks to reinstate annual fees, demand higher credit scores and offer fewer perks to customers who use their cards frequently. In fact, a study by Synovate, a market-research firm, found that U.S. households are already receiving dramatically fewer card offers in the mail. And an increasing number of those offers are for cards that charge fees.

6. Retirement: Getting a makeover. Traditional fixed pensions are disappearing, strapped employers have stopped matching contributions to 401(k) plans (at least temporarily) and many plan participants have suffered big losses. As a result, the retirement system will get a makeover and more oversight.

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In general, the system will become more compulsory and less voluntary. For instance, the trend toward automatic enrollment in a 401(k) or similar plan will accelerate -- though you may still opt out. The same goes for efforts to get employees to boost yearly contributions until they hit the legal limit. Also, instead of a lump sum being the most prevalent payout method (either to be rolled into an IRA or spent), expect more company plans to offer annuities, which will resemble the monthly-payments-for-life structure of traditional pension plans.

Private managers, such as Fidelity, Vanguard and TIAA-CREF, will still handle the money and offer a range of investment choices, but fees will be more transparent. And asset managers will likely run their target-date retirement funds more conservatively, holding a smaller proportion of assets in stocks and a larger proportion in cash as a fund approaches its target year.

7. Government: A visible hand. President Obama has said he hopes a more stable financial system will "help speed the day that the government can get out of the way and let the private sector grow the economy." But the Federal Reserve, which has traditionally limited its influence to short-term interest rates, is now seeking to influence yields on bonds and mortgages as long as 30 years. And there's talk of establishing a "financial product safety commission" to vet the exotic creations of financial engineers.

The idea is to foster investment markets that are more predictable and less risky. For a while the government succeeded in flattening the business cycle, and the U.S. went 25 years without a harsh recession. It remains to be seen whether this time around Uncle Sam's hand will be smoother, or just heavier.