A Game Plan for the New Year

12/30/2009 9:40 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, editor of Forbes/Lehmann Income Securities Investor, recommends an asset allocation for income-oriented investors in 2010.

This may be the first year end in some time in which you have some positive decisions to make regarding your investment portfolio, i.e., taking profits.

While I am not advocating selling your winners just to use some of your loss carry-forwards, it is a good time to rebalance your portfolio. Following an effective diversification strategy means periodic rebalancing to the [most prudent] allocation.

For the coming year, I am recommending an allocation as follows:

Investment Grade Bonds/Preferreds: 30%
Energy Trusts/Partnerships: 20%
Convertibles and Closed End Funds: 20%
Gold/Platinum ETFs: 15%
Cash: 15%

The allocation to investment-grade bonds and preferred [stocks] should be equally weighed between fixed-rate and adjustable-rate securities. In the adjustable rate, look for those yielding about 5%, but trading at 80% or less of their par value.

These securities normally trade near par, but are lower because of the financial crisis and because they are tied to an index [that] is currently well below the floor rate of the security (often about 3%). Once inflation kicks in, the capital gain more than makes up for the lower current yield.

Convertible and closed-end funds provide you with income as well as a participation in a stock market recovery. They can also serve a dual purpose in your efforts at diversification if you buy energy or commodity-based companies or funds.

We can all see gold setting new records daily, and this has held back many investors. There is no obvious entry point here other than yesterday, so you should build up a position in these metals over time. Yes, there may be pullbacks, but the inflation outlook argues for a long-term position in precious metals.

The recommended cash allocation is high, because there is presently a lot of uncertainty, and that means opportunities. My diversification strategy argues that there is no clear path, so cover all the bases. There are, though, a number of areas not represented here [that] could prove opportune in the coming months. Also, special situations come up throughout the year, and it is better to pursue these without having to sell a position.

The areas to avoid for new buys are junk bonds, almost all real estate investment trusts, long-term US Treasury bonds, all municipal bonds, and all mortgage-backed securities.

Although junk bonds have been hot this year, a default wave of these securities is still very likely. As for long-term, investment-grade bonds, they are yielding in the 3% - 4% area, which leaves little room for price improvement, but miles of room for price erosion as inflation heats up. Sell those trading at prices over their par value and a low yield to maturity.

Yields on preferred securities rose in November while everything else was falling. There is no clear reason for this, so look on it as a buying opportunity.

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