Two Basic Investing Rules and How They Apply to the Current Economic Situation

Disclosure: I hold a small position in an ING bond fund (IDBOX). I’m also not a professional investor. Please don’t take my word for anything you do with your money.

I started looking at investment about six months ago when I realized I would soon achieve my goal of eliminating credit card debt. It is a bewildering world, and back in August I wrote a 2 part series about investing in a recessionary economy (and part II). This post is in a similar theme. Here’s a few basic rules I follow when deciding how to invest:

1. Don’t Buy After a Rally

First off, I never buy an asset (stocks, mutual funds, real estate) when the price has increased. There is no hard and fast rule on how much it has to have increased for me to avoid it, but basically if it’s being hyped by the media or talked about by people, I stay away.

You might miss some really strong growths in specific stocks by not buying in a rally, but it’s also possible that you’ll buy in near the top and only see the value decline substantially. It’s too much of a game for me. I haven’t bought in to tech stocks like Google and Apple for the same reason.

2. Don’t Sell After a Slump

In the same vein, don’t sell when the price drops. A lot of people see a stock’s value going down and sell hoping to avoid losses, but in effect they are locking in price decline that has already happened. Here again it seems like it’s just as likely that you will sell when the value reaches the bottom and so won’t benefit from following gains.

The Current Economic Climate

These rules can be hard to follow though. As fears of inflation (the fed cuts rates again, though read Global Economic Trends for an argument of why inflation is not related to federal interest rates as much as production capacity) mount and the dollar loses it’s value, a lot of people are shifting to gold and silver or foreign markets with their investments. But where do those of us stuck in dollar based investments turn?

I could shift out of dollars into gold or other commodities, but doing so would violate rule #1 given the meteoric rise in the price of gold

In fact, any shift out of US dollars now that dollars have declined heavily would be violating rule #2. Yet I have real fears that the economy is going to be in a substantially worse position in the coming year or more and I suspect that the value of the dollar is only going to decline further.

And if inflation is really occurring at much higher rates than reported, then the situation is worse because inflation is just eating whatever returns my investments are earning and then some.

So the real question is whether it’s better to stay in stocks, risking financial loss when the inevitable burst happens, stay in bonds with low earnings being eaten by inflation, or violate rules #1 and #2 by selling off dollars and buying something relatively more expensive in the hopes that a foreign asset or commodity won’t decline?

About a month ago I shifted my meager investments from a tech mutual fund (IDTOX) to a bond fund (IDBOX). This protects from a coming stock decline, but not from a further decline in the dollar. It’s sort of a middle position in which I’ll lose some value either way:

If stocks decline, the economy worsens and the value of the dollar further declines, I’ll lose value due to inflation

If the value of the dollar recovers, then I won’t be left with commodities I purchased at their peak.

Still, fear is a powerful emotion. If ING Direct Investment had a commodities fund, I’d be hard pressed not to violate my rules and shift into commodities to whether out the storm.

Of course, the value of my investments at the moment are only roughly $500, so it wouldn’t be a disaster in any situation.

I’d be interested in hearing from any readers who have investments or are facing similar decisions. You can flip the situation around to consider debt as well. If the fed is spurring inflation in an effort to stave off financial crisis, it makes no sense to pay more than the minimum on student loans that were consolidated at 3.5% interest (if you were lucky and graduated in 2002).