The market dropped 11 per cent in 2011, capping off its worst four years on a rolling average – which is to say comparing each month with its equivalent for the past four years – since the Depression. So stick to cash, perhaps buy some government bonds since they’re on a roll, stay away from shares because enough is enough and, for a bit of a thrill, maybe buy some gold, which has been a star, and you’ll be right?

Afraid not. The best you could hope for, especially when you take tax into account, would be to tread water.
OK, so that’s better than losing money – and I know staying in cash worked a treat last year but funnily enough that’s one of the best arguments against doing it again.

Overvalued

Think of it this way. The better something does, and so the dearer it becomes, the closer it comes to the fine line of being overvalued.

Bonds are a great example. The prices of three-year maturities, for example, had been pushed so high by early 2012 that you’d only get a yield of 3.3 per cent if you bought then. Barring a global depression, they can’t fall much further and are more likely to rise at some point.

It’s the opposite for the sharemarket. Values are depressed in early 2012 and while there are bound to be more bad hair days there must be a bigger risk of missing the upturn – which can happen before you know it – than suffering even more drops.

Tricky

Instead of a wink or a nod to get back in, markets prefer to trick you by veering off the other way just to frighten you.

This is not helped by the contradiction between forward-looking share prices and backward-counting economic statistics.

So, what’s the right strategy for 2012?

Not sitting in cash, unless you know you’ll need the money in a few months or you’re saving for something for starters.

Otherwise you’ll only be watching your returns fall or, at best, stagnate.

Worse, you’ll be kicking yourself for missing better opportunities.

Mystery

Nobody knows when the sharemarket will take off again and it’s bound to be before an improvement in the economy is obvious, but there’s no denying there are good stocks out there paying amazing dividends.

If you’re getting a double-digit income from a stock and don’t need to sell it in a hurry, it shouldn’t matter if the price drops for a while.

Besides, the payouts on some blue-chip stocks are so high, with their 30 per cent tax credit from franking, that even if they cut their dividends by 20 per cent you’d still be getting a great yield.

Compare that with a 5 per cent return on a decent length term deposit – or as little as 2.7 per cent after tax.

Unattractive

“Bond rates under 4 per cent are also unattractive. Even though these fixed-interest alternatives provide capital safety, income investors should consider switching into shares for the higher yield,” Dayton Way Financial adviser,

Tony Lewis, says.

When shares pick up you can cash in the capital gain and put more into bonds and term deposits which, by then, should be paying more.

After all, brokers say the market is undervalued and so there are good buying opportunities – but then they would.

Still, unless Australia is going into a recession there’s no doubt the market is unusually cheap.

You can see that most clearly with the listed investment companies, known as LICs, which do nothing but invest in other shares, making them a bit like a managed fund.

Although many of them have been around longer than some of the companies they invest in, they’re trading for less than their share portfolios are worth. The only reason their prices have drifted down so much is because nobody can be bothered.

You need to be patient because LICs can trade at a discount to their value for a long time for no good reason.
Also undervalued are real estate investment trusts (REITs, once called LPTs) with good yields as a result of trading below the value of their properties.

The difference is their dividends aren’t franked and, rather than the indifference meted out to LICs, the market is persecuting them for having borrowed too much.

But after slashing their debt and selling unprofitable properties, REITs are coming back into favour among fund managers.

Trim the weeds

Already have shares? Then you may need to rebalance. Since some stocks would have risen or fallen by more than the overall market, consider selling the good performers and buying more of the laggards or other stocks going cheap that might have caught your eye.

Then you’re taking some profits and setting up other opportunities.

Whatever the market does it will be haphazard and erratic, so when buying it is safer to dollar-cost average, where you spend a fixed amount at regular intervals. The more the price rises the fewer shares you pick up.

That way you won’t get caught paying too much at the wrong moment.

Go west ... and east

Investing internationally is a favourite theme of fund managers who, naturally, have global funds they can offer.
Frankly, the average global share fund has left a lot to be desired over the past decade. But the stars could finally be aligning for them.

Thanks to the debt crisis, European shares, gasp, are going cheap for starters.

And Asian emerging markets have been powering on, even shrugging off the dampener of the stronger dollar on returns.

Indeed some say the dollar is way overvalued, in which case we’re getting offshore assets cheaply and, at some point when it drops, the returns in the local currency will look huge.

But whatever you do, know thyself when it comes to risk, which boils down to whether you’ll be able to sleep, and set a time horizon that you’re going to stick to.

Oh, and keep your fingers crossed.

By David Potts
(Source: http://www.afrsmartinvestor.com.au)