Source: Hulbert’s Financial Digest

At the same time, over that same ten-year period, there have been three GIANT bubbles, one in DOT COM stocks in 1999-2000, another in real estate between 2002 and 2006 and another in clean energy in 2007. If you had a strategy to actually capitalize on these run-ups, you would be doing fantastic right now – well above the dismal market average over the last ten years. If you didn’t, as most people didn’t, then you watched the gains and losses gyrate like a rollercoaster in your portfolio without any clue as to what was happening – until recently when the most dramatic downturn in 80 years rattled you to the core.

NASDAQ’s BOOM PERIOD (1998-2000): OVER 200% GAINS

REAL ESTATE’s BOOM PERIOD (2002-2007): OVER 100% GAINS

CLEAN ENERGY’s BOOM PERIOD (2007): APPROXIMATELY 60% GAINS

The Problem with Mutual Funds

Mutual funds in general are old products that don’t allow you to capitalize on industry, sector, size or style gains because they are full of everything and the kitchen sink. Many are invested in some of the worst dying industries on Wall Street – like tobacco companies and corporations that have debt obligations equal to more than ten or even twenty times the value of the company. General Motors’ liabilities total almost $192 billion, while the company’s value on Wall Street is a measly $3.5 billion.

My warnings on General Motors as a “faded” Blue Chip began as early as 2004, at the same time when I was applauding Google as the greatest IPO of all time (something that came to fruition when Google became the first company to go from IPO to over $100 billion market capitalization in under two years). You can view these articles firsthand in vol. 1, issue 50, vol. 3, issue 8 and vol. 1, issue 48, respectively, in the NataliePace.com online magazine archives.

Modern Portfolio theory and ETFs, with proper diversification and asset allocation, offer a strategy that allows you to capitalize on the gains of a particular industry, size, style or index, while keeping an appropriate portion of your nest egg safe. Most people think they don’t have a choice and have to take what the 401 (k) provider gives them. That would be like thinking that the local fruit stand is the only option for food – untrue!

Just as the car made travel easier than riding in a horse-drawn carriage and planes made international travel easier than going by boat, Modern Portfolio Theory and Exchange Traded Funds are relatively new innovations that allow the investor greater security, higher gains with much less effort! The problem is that many Certified Financial Planners and brokerages with old school ways were not offering this way to you because they weren’t paid to sell them to you. They were paid to sell mutual funds, which offer a much higher commission structure to the CFP. The online, discount brokerages are leading the charge for ETFs, however, and with a few minutes of your time, I’ll explain how and why.

Here’s how the strategy of Modern Portfolio Theory (plus ETFs) works:

1. Invest in emerging products, energy and technology, not dying industries
2. Invest in wisdom, not the old way of doing things
3. Diversify and rebalance with a wealth blueprint that is appropriate to your age, instead of blind faith, buy and hold whatever my broker says
4. Know what you own instead of holding a big basket of everything, including companies you despise

It’s easier than you think, faster than you can imagine and more effective than any other strategy on Wall Street for Main Street investors…

1. Invest in emerging products, energy and technology, not dying industries

Bill and Nilo Bolden used the following pie chart which I drew on a napkin to recession proof their portfolio and to date have lost nothing. Here’s why and how.

During a recession, which I began warning of in February of 2008, you want to overweight into safety. This is not market timing; it is rebalancing. Bill is 55. Therefore overweighting an additional 20% into safety for the pending market downturn meant that 75% of his portfolio had to be in T-Bills. (Note that Bill then had 75% of his nest egg safe, not just the 50% outlined in the above pie chart for 50-year-olds during more normal market circumstances.)

Why T-bills and not money markets? We knew money markets were risky and they were losing money! It was easy for Bill to see that T-bills returning 2% was better than money markets at -2% return, which was available right on the first page of his 401(k) plan!

There are always industries, products and companies that are emerging and others that are suffering. A great financial news organization, like NataliePace.com, earns our reputation by keeping you informed. What are the track records of the pundits you are listening to on television?

Industry diversification

The remaining 25% of Bill and Nilo’s nest egg should have gone into small, medium and large caps, value, growth, clean energy, international, biotechnology and gold, however, the mutual funds offered by the 401(k) provider didn’t allow for that kind of diversification. Therefore, Bill and Nilo put EVERYTHING into T-bills while Nilo shopped for a provider that did offer ETFs and industry diversification.

By doing the right thing – demanding good products and not simply doing what was easier by selecting the only products that were offered to her – Nilo hasn’t lost a dime to date during the horrible Wall Street meltdown of September and October 2008. Many of Nilo’s colleagues followed her example and have lost nothing as well. Nilo’s bosses didn’t believe Nilo’s plan was better than the one that their financial advisors were telling them to do, and have lost hundreds of thousands of dollars as a result. You can bet they are listening to her now.

Avoid Dying Industries

General Motors (value: $3.5 billion) and Ford Motor Company (value: $4.9 billion) today, combined, are worth less than one-tenth of Toyota Motors (value: $112 billion). In 2004, when Toyota won Motor Trend’s Car of the Year with its Prius and Ford and GM were still invested in SUVs and Hummers, the companies were about equal in value. While GM and Ford have lost 87% and 83% of their stock market value since 2004, respectively, over the same period of time, Google launched the most successful IPO of all time and is currently one of the biggest corporations on Wall Street. There are Blue Chips that are fading and others that are becoming the new staples of the U.S. economy.

The Dow Jones Industrial Average Components (30 companies) in 2007 included General Motors, Philip Morris Tobacco Company, Home Depot, Morgan Stanley and other corporations that were poised to implode under massive debt obligations and declining sales, customers and/or profits. In 2006, AIG was a top component of the Dow. Fannie Mae was one of the most popular mutual fund holdings in early 2007. These were the same companies that investors were blindly taking ownership in and relying upon for their futures. (Meanwhile, NataliePace.com readers were warned to trim Fannie, Philip Morris, GM, etc. out of the mutual funds beginning in 2003 and 2004).

So, how do you have the stability of blue chips (large cap companies) without the exposure to the faded blue chips?

2. Invest in wisdom, not the old way of doing things
Nilo Bolden is shopping for a new 401(k) provider with products that allow all of the employees at her company to diversify and have proper asset allocation. The investors who attend my Get Rich and Enrich Retreat have learned how to create their own basket of blue chips when they couldn’t find an existing product with the companies they believed would make a strong foundation for their portfolio. Where there is demand, there will be products! Demand better products. Communicate with the ETF providers and let them know what you want.

Check the ETF providers’ websites to find the diversification you need to have a healthy nest egg, and when you don’t find the products you want to see there, email them! Barclay’s Global Investors (Barclay’s Bank) owns iShares.com. PowerShares, WisdomTree and Wilderhill are all ETF providers. Also, check AMEX for more listings.

3. Diversify and rebalance with a wealth blueprint that is appropriate to your age, instead of blind faith, buy and hold whatever my broker says strategies
So, why not just stay all in on T-bills? The Beauty of Rebalancing.
So, why not just stay all in on T-Bills, if that worked so well for Bill and Nilo in 2008? As the charts on real estate, NASDAQ and clean energy above illustrate, there were great gains to be enjoyed by investing in emerging technologies and companies. If an investor were rebalancing twice a year, then s/he could capture the gains of the small caps (NASDAQ stocks in 2000), capture the gains of real estate in 2006 (REITs, which is an industry I’ve not included in the diversification strategy this year), capture the gains of clean energy in 2007 all while rebalancing back to the desired exposure outlined in the pie chart and keeping enough safe, appropriate to your age. In this way, the nest egg grows without additional risk – always keeping a percent equal to a person’s age in safer, yielding products, like Treasury bills. (Money markets, bonds — not bond funds — and CDs are safer investments as well, although these options are not desirable this year.)

Brokerages, 401(k) providers and CFPs
You’ll need to find 401(k) providers and brokerages that have switched to the ETF product offerings. Period. The old way was mutual funds with a basket of everything in the kitchen sink. That plan doesn’t work today and it won’t work tomorrow either because there is no way of identifying which industry/sector or style has experienced gains or losses.

The easiest way to tell if your broker is a salesperson or a Modern Portfolio Theory person is to ask the question, “Was I properly diversified to begin with?” Did you lose more than 25%? If you did lose more than 25% and determine that you weren’t properly diversified, it is time to find a better financial partner and 401(k) provider.

When interviewing for new partners, the second question should be, “How are you paid?” New brokerages that encourage their associates to take a balanced view for their clients pay them on assets under management, not commission on how many mutual funds they sell you. I have an article on my home page that gives you ten questions to ask when searching for your perfect financial life partner, called “How to Pick a Broker.” Interview your CFP as if your life depends upon it because your lifestyle does.

Annuities

Please read what FINRA.org has to say about annuities. They have four articles on the FINRA.org website. In general, annuities are pushed hard by salespeople and are not necessarily the best strategy. Your 401 (k), IRA, health savings plan, college fund, etc., should protect you better than annuities from taxes, from lawsuits and debt collectors and position you for a better upside. So, the idea that annuities are safer is not necessarily the case, especially when the upsides of gains and safety of the well-planned nest egg, and the tax advantages and protections offered for the IRAs, health savings plans and 401 (k)s are considered.

Additionally, the “guaranteed” returns of your annuity are only as good as the corporation underlying the promise. With all of the broken pension promises and bankrupt legacy corporations on Wall Street, investors would be wise to place their faith in a healthier system. (Annuities are part of the old way.)

Rebalancing

After you have interviewed and found the perfect Certified Financial life partner, plan on meeting with her at least twice a year to rebalance. In today’s recessionary environment, meet at the end of October to make sure that you have your investments balanced according to the pie chart. That way you have the potential for earning some gains, while also supporting the companies, products, goods and services you wish to be an owner and a consumer in and of. (Those companies need to be healthy enough to make the stuff you need to live, and your ownership in them helps that.)

Meet again at the end of January to rebalance the portfolio, overweighting any gains you may have made during the Santa Rally (if there is one) into the safer portion of your pie. 2009 is predicted to be another hard year in real estate and the stock market. So, overweight back into safety, keeping a percent equal to your age, plus 10-20%, safe in Treasury bills. Money markets, CDs and bonds will be good safe investments again in the future, but for now, just stick with Treasury Bills.

The balance between ownership in the companies of the future and safety during a recession is critically important, as too many wounded investors are now discovering. Rebalancing twice a year, in October and late January, allows you to do that.

4. Know what you own instead of holding a big basket of everything, including companies you despise
Investing in the future is as simple as investing in the products, goods and services that you need to live and to enjoy your life. How many of you still use turn tables for your music or want to drive a gas-guzzler around? Quite simply, there are better products available and great companies making them.

The person who smashed your nest egg to begin with by not employing Modern Portfolio Theory, by not having investments in strategic, emerging industries, by overinvesting in dying industries and by ignoring sound recessionary strategies is not the person who can resurrect and rebuild your Buy My Own Island fund.

So, if you want to have a very healthy nest egg like Bill and Nilo Bolden, you have to start with opening your eyes very wide, trusting in the sound theories outlined in this article and leaning into the wave of the future, instead of allowing yourself to be swept downstream. The challenges of Wall Street and Main Street are not over yet. Act now to be in the best position possible and to be a beneficial part of the re-emergence of the U.S. economy.

And do your friends a favor as well. If this article makes sense to you, please forward it to at least a dozen friends whom you would like to see prosper as well. Many of these strategies are outlined in my new book, Put Your Money Where Your Heart Is. This book is available now for pre-order on your favorite bookseller, like Amazon.com or Barnes and Noble.

If you are a NataliePace.com subscriber who read my “Recession Proof Your Portfolio” article and employed those strategies and today are enjoying the beautiful protection these strategies provide, please email me right away. We’d love your testimonial and to hear your story!