3. Trade stocks in a taxable account
We're all drawn to retirement accounts such as 401(k)s and IRAs because of the tax breaks.But they come with lots of strings, which include the inability to sell stocks short -- that is, borrowing them from the broker and selling them now in the expectation you can buy them back more cheaply in the future. You can effectively skirt this rule with inverse ETFs, designed to go up when markets go down. But to short directly you need a taxable brokerage account.
Even if you don't want to employ techniques like shorting or buying on margin, taxable brokerage accounts are the best possible home for investments that deliver returns as capital appreciation rather than dividends and interest. The gain you get when a stock goes from $5 to $10 is a capital gain, and capital gains are taxed at a much lower rate than income. The new president, Barack Obama, has vowed to raise the capital-gains rate, but it will continue to be lower than the income rate.
4. Use bonds in your 401(k)
Your 401(k), meanwhile, is the ideal place to own income investments, such as bonds, because you don't pay taxes annually, just upon withdrawal.A lot of investors ignore them, but income investments are among the most attractive out there right now. Stocks have delivered negative returns over the past 10 years. The average broad bond-market mutual fund has earned 4% each year.
In 2008, for example, the best-performing nonbear market fund was Vanguard Extended Duration Treasury Index I (VEDTX). It owns about 50 U.S. Treasury bonds with an average maturity of 24.5 years. It soared 55.5% as global investors, frightened of everything else, joined in a "flight to quality."
Nearly any 401(k) offers a government-bond option. It might not be that particular Vanguard fund -- it has a $5 million minimum outside 401(k)s, so few could qualify if their company plan didn't offer it -- and it might not offer such a long maturity. But you could probably come close.
Truth is, though, that you can do better than close in a brokerage account these days. You could buy iShares Barclays 20+ Year Treasury (TLT, news, msgs), an ETF that shot up 33.9% last year.
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Even better, you could instead buy ProShares UltraShort 20+ Year Treasury (TBT, news, msgs). This is designed to rise twice as fast as the benchmark Treasurys decline. Having surged in that flight to quality, Treasurys are yielding a minuscule 2.9%. That is less than enough to cover an investor's taxes and inflation risk over the next two decades. Prices will have to come down to bring the yield up, and TBT will rise.
The Treasury's popularity was responsible for a surprising reversal in the decline of the U.S. dollar in 2008; you need dollars to buy Treasurys. If Treasurys become less popular -- and Congress wants to flood the market with an additional $825 billion of them in coming months -- the dollar could weaken as well. That's good for foreign stocks. It's also good for PowerShares DB US Dollar Index Bearish (UDN, news, msgs). And for ProShares Ultra Euro (ULE, news, msgs), which shot up 21.8% in December.
5. Put a premium on flexibility
And that brings me to the fifth rule: Be flexible.The dollar's rebound was not the only surprise of 2008. Oil prices soared but then collapsed. Global stocks fell apart.
And something will certainly happen in 2009 that nobody expects at this moment -- and which will profoundly hurt some investments and help others.
It's possible you will not be able to grasp that opportunity if all you have is your 401(k), particularly if you check it just a few times a year.
You will be able to seize it, however, in an IRA or some other brokerage account.
To seize that moment you will have to be unafraid to defy the conventional buy-and-hold wisdom. And that is hard; investing by its nature is a long-term enterprise. Retirement may be years away.
Buy and hold does work if you're a pension fund manager. Your time horizon is unlimited; you can buy assets -- timberland, for example -- that might not pay off for more than 100 years. Your liabilities are predictable, and you have more than enough cash flow to ride out storms, even if they last years.
A 401(k) isn't like that. Life is short. Markets are unpredictable. Cash flow could be exactly what you don't have at the very moment you need it.
A 401(k) simply can't be your principal retirement vehicle. You need a small fleet of vehicles, at least some of which are capable of capturing fleeting opportunities. You need to be an investor, not just a saver.
At the time of publication, Tim Middleton didn't own any fund mentioned in this article.
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