Extra11/24/2010 5:14 PM ET

3 new investing rules to live by

Risk is on the rise, and investors need new strategies and an activist attitude if they hope to stay in the market without getting burned. But help is available.

By MarketWatch

It's a challenging environment in which to make money -- volatility is high, and returns are sideways to low.

But that doesn't stop people from trying.

What to consider before buying a fund

Nor should it, said Andrew Lo, the chairman and chief scientific officer of AlphaSimplex Group, finance professor at MIT and director of the MIT Laboratory for Financial Engineering.

As investors proceed, they should consider the new world order of investment truths, as expressed in three basic principles.

Traditional investments are now unpredictable

"The first truth is the fact that volatility is unstable," said Lo, whose company manages funds for Natixis Funds.

"Any kind of reasonable strategy to boost returns in a low-return environment must take into account the volatility of volatility," he said. "You must manage risk on an active basis. It's more important than ever."

Lo has described the past few years as a roller-coaster ride.

Traditional investments are now unpredictable. The Standard & Poor's 500 Index ($INX) historically had volatility of 15%, but it has reached 85% in recent years.

In other words, it's possible to lose all of your money in a few days.

"I don't think it's possible that anyone can stand that kind of risk," Lo said.

Diversification is different

The second truth has to do with diversification.

In the old days, it was considered prudent to have a portfolio with 60% invested in stocks and 40% in bonds. In the old days, when stocks went up, bonds went down, and when stocks went down, bonds went up. Those asset classes were uncorrelated; that was the chief benefit, and point, of diversification.

Today, however, it's considered imprudent to have a traditional 60/40 portfolio. Because of the influx of assets into the financial industry, an increasing number of asset classes are correlated, and it has become much more difficult to find unique opportunities.

"Diversification is more difficult than ever," Lo said.

Creating a well-diversified portfolio today means allocating your assets across a wide mix of investments -- from currencies to commodities to distressed securities; going long as well as short; and doing it all dynamically.

Among the funds that fit the bill are, of course, some managed by Lo's company, including Natixis ASG Global Alternatives (GAFAX), Natixis ASG Diversifying Strategies (DSFAX) and Natixis ASG Managed Futures Strategy (AMFAX).

According to Morningstar, two funds that might be considered similar are Gateway (GATEX) and Hussman Strategic Growth (HSGFX).

Lo urges consideration of the Goldman Sachs Absolute Return Tracker (GARTX), a fund that, like Global Alternatives, is designed to deliver hedge-fund returns without the costs.

Dylan Cathers, an equities analyst with Standard & Poor's, noted that mutual funds that aren't designed to track a major stock index -- such as those mentioned above -- can provide much-needed diversification.

"There are times when you don't want your investments tracking an index," Cathers said.

You need to be an active investor

The third truth has to do with being opportunistic.

For investors who can afford to be opportunistic, and who have the background, investments in distressed situations, especially commercial real estate, could prove worthwhile.

Putting these truths into practice is more difficult than it sounds. "Investing is more complicated today," Lo said in an interview. "Investors have to spend more time getting smarter at this. You can't expect to have a good portfolio if you devote only one hour per quarter to it."

According to Lo, the need to be smarter about investing is no different than the need to become more alert about any other part of our daily lives, such as nutrition. We're more conscious about carbohydrates and cholesterol, for instance, than we were years ago. And the same must hold true for investing.

"We have to think about volatility; we have to worry about correlation," Lo said in a recent report.

Becoming smarter doesn't mean that you have to go it alone, Lo said. "Financial advisers do add value," he said.

And asset managers can be useful when it comes to helping you diversify.

This article was reported by Robert Powell for MarketWatch.

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10Comments

Newest

12/02/2010 3:39 PM

I now have just A few mutual funds.I had many til october of 07.They went down more than the market.Now I have alot more dividend paying stocks,good companies.That way if the stocks go down at least i'm getting the dividends.And at the same time buy even more stock when it's down.Its working for me.I'm now over what I was when the market started going down in 07.

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Crashnburn5590

11/29/2010 9:00 PM

I have 20 different funds in my portfolio, at 5% each. I have 2 mutual funds, two closed end funds, and 16 ETFs in my portfolio. I use Quantex Portfolio Planner to try to minimize correlation, as it calculates past correlation.

Once I have the funds selected, I try to maintain at least 5% in each fund with a positive trailing return, and no more than 5% in each fund with a negative trailing return. I also use a little bit of technical analysis to determine when I buy, and when I sell.

For instance, it looks like gold is making a head and shoulders formation, so I trimmed my excess shares a couple weeks ago. And, the trailing return is negative now. Eventually, my indicators will turn positive, and I'll bring the fund back to 5% of my portfolio. I'll have sold high, and bought low, which is the trick to successful investing

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MARVINATOR

11/29/2010 10:33 AM

Unless your on the exchange and can play profit taker or you are one on the few corps that actually rule the mkt you done have a chance anyway

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Steveo_

11/29/2010 10:15 AM

This article is nonsense. As Marty2000 mentioned, you can use the volatility to your advantage to pick up more shares on the cheap.

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mom2010

11/29/2010 5:41 AM

Christmas is coming, how you are going. Gift ready.
so what, move your mouse . " fashionsb " go...look me

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Marty2000

11/26/2010 6:13 AM

What a bunch of nonsense. Volatility has nothing to do with risk. A true "investor" should not care about short term swings in the market, except that it provides him an opportunity to pick up stocks at cheap prices on occasion.

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Janet706

11/26/2010 12:38 AM

Another genius promoting his wares. Him and his kind are the ones to be blamed for all the mess we are in. Asking to invest in his funds....what kind of returns is he targeting with that kind of expenses. I challenge hime to beat the index consistently after cost for 5 straight years.

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rayinca

11/25/2010 2:43 PM

Mutual fund outflows have now reached 29 consecutive weeks. Looks like the retail investor wants to be miles away from the rigged market. So now the banks and investment houses and their machines can trade with themselves.

Wholesale fraud has consequences ......namely, lack of credibility.

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muddler1

11/25/2010 10:43 AM

Financial engineering is what helped get us into the mess we are in today . Microsecond trades don't allow the small investor to deal with any market. Even though a lot of people took risky mortgages, this does not excuse the professionals who developed the credit default swaps and the like to take advantage of this situation. I run for cover when I hear professionals talking about new investing rules, paradigms etc, to invest by.

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MillionWater

11/25/2010 6:55 AM

Buying a fund(s) with a 5.75% load and hiring a financial adviser AND an asset manager to "add value" and to help you "diversify" are not new investing rules to live by. They are old methods for underperforming the market.

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