Where to Invest in 2011

Last week I offered my prognosis of things to come in 2011. This week I’ll discuss where to invest now to take advantage of opportunities or avoid pitfalls in the year ahead.

Stocks. The stars appear to be aligned for double-digit returns in the stock market over the next twelve months. Retirees seeking cash flow and more conservative investors should consider investments in blue chip dividend-paying stocks. Companies such as AT&T, Southern Company, McDonalds, Con Edison, Royal Dutch Shell, Kimberly Clark and Paychex offer robust dividends while you wait for stock prices to move up. Make sure that you have a minimum of twenty different companies that are spread between a minimum of six different industry sectors.

An approach requiring less effort would be to invest in a basket of dividend-paying stocks using an Exchange Traded Fund (ETF). Two to consider are iShares Dow Jones Select Dividend Fund (symbol DVY) or Vanguard Dividend ETF (symbol VIG).

U.S. small cap stocks should also excel as America bounces out of the recession. Because these smaller companies are also more volatile, buy big baskets of stocks through mutual funds or ETFs. For low fees, consider Vanguard Small Cap Index Fund (NAESX) and iShares Russell 2000 Index ETF (IWM).

Emerging market stocks are another category that I expect to perform well this year. Many of these countries managed to side-step the financial crisis that hit the U.S. and Europe. Your best bet is to invest using mutual funds or ETFs. Two to consider are Vanguard Emerging Index Fund (VEIEX) and iShares MSCI Emerging Index ETF (EEM).

Bonds. The bull market in bonds appears to have run its course. Now’s the time to become more cautious. I expect short-term interest rates to remain relatively flat this year while longer term rates move up. To protect yourself from falling bond prices, consider shortening your maturities to five years or less. One excellent choice is Vanguard Short-Term Investment Grade (VFSTX). It has low fees, average maturity of its holdings of less than three years and currently yields just over three percent.

There is a lot of concern about the tax free bond market. Some states like Illinois and California and many municipalities are in deep financial trouble where their financial obligations (pension funding, etc) far outpace their revenues. Solutions include federal or state bailouts, extreme cost cutting measures or bankruptcy. Review any municipal bonds or bond funds you own and make sure they are of very high quality. One fund to consider is Vanguard Limited Term Tax Free (VMLTX).

Inflation. Inflation has been benign for years. In fact, for the past two years Social Security recipients have not received a cost-of-living increase. That should begin to change this year although I do not expect for inflation to significantly ramp up for eighteen to twenty-four months. Conservative investors who want to build some inflation protection into their portfolio should consider TIPS bonds. As inflation rises, the principal value of these bonds rises also. You can learn more or buy them directly from the U.S. Treasury at www.treasurydirect.gov. You could also buy a basket of TIPs bonds using an ETF such as the iShares TIPs (TIP).

Next week, I’ll discuss investments in real estate, gold, and commodities. Be sure to seek advice from your own professional advisor before acting on these suggestions.

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