Year-End Financial Pondering

Tomorrow is the last day of 2008. Regarding investments tomorrow and in early 2009, what is wise to do?

Of immediate concern is to remember that your taxes can count $3,000 of capital loss beyond any capital gains as a tax deduction. If your 2008 capital loss is not yet $3,000 more than any capital gains, it is probably smart to sell a bit more depreciated stock before the new year arrives.

Regarding early 2009, I've been collecting advice. During my holiday vacation I've talked with a few family members about investing during this recession. None are professional investors, but all are well-read and understand the math. Here is their advice, salted with links to articles I have found with similar opinions. None of it is innovative, but common-sense sound advice is worth repeating.

• Have a mortgage and think about gold. The U.S. will probably see more inflation during the next decade. Inflation makes it cheaper to pay off debt. Although too much debt is unhealthy, anyone without a mortgage is asking inflation to hit them harder than necessary. Investing in gold is similarly attractive.

• Have liquidity. During December the market was volatile but fairly stable as investors are waiting to see how our new president will act once in office. His cabinet appointments have been well received, curing the market drop caused by fears immediately after his election. But for now both psychological and economic factors might cause a further market drop in the first quarter of 2009. If you are risk-averse then the percentage of your wealth in cash should be higher than usual; if you do not mind risk then still an extra large portion of your investments should be liquid enough to reallocate quickly.

• Don't Flee the Stock Market. Unless your time horizon is short (because you are about to retire, send a child to college, etc.) the market is down so do the first half of "Buy low, sell high". Even if the market drops during 2009, many years from now those who bought during 2009 will be happy. Recovery comes in bigger one-day bursts than drops do with good days tending to cluster at the start of the recovery. Don't be too risk-averse.

• Flee Troubled Sectors. The saying "Buy low, sell high" is not quite accurate. It should really be "buy undervalued, sell overvalued", which translates into the investment advice of "buy low Price/Earnings Ratio, sell high Price/Earnings Ratio". In a recession certain sectors of the economy see a drop in earnings, which means a jump in their companies' Price/Earnings Ratios. Currently it appears that the sectors of Banking, Retail, and Real Estate are facing systemic issues that will trouble them with continued losses of earnings. Shift away from these and move carefully to emphasize Health, Infrastructure, and Energy in companies where the P/E ratio is low enough and the companies are resilient enough. Certain commodities are also comparatively sound.