Make money in 2010: Your investments

After this year's monster rally, smaller gains probably lie ahead.

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By Janice Revell, Money Magazine senior writer

Picks to start the new year
With so many risks remaining in the economy, stick with high-quality stock and bond funds, like the ones below.
Fund Ticker 1-year return 5-year return
FMI Large Cap FMIHX 18.3% 6.3%
Jensen J JENSX 9.6% 2.4%
T.Rowe Price New Era PRNEX 30.3 6.3
FPA New Income FPNIX 4.7% 4.1%
iShares Barclays TIPS Bond TIP 11.3% 4.8%
Templeton Global Bond TPINX 24.8% 10.6%
Source:NOTE: Five-year returns are annualized. SOURCE: Morningstar
CDs & Money Market
MMA 0.39%
$10K MMA 0.35%
6 month CD 0.37%
1 yr CD 0.70%
5 yr CD 1.38%

Find personalized rates:
 

Rates provided by Bankrate.com.

(Money Magazine) -- With the market up more than 60% since March, you're probably feeling a lot better about your portfolio lately than you did a year ago. The worry for 2010: Will the runup run out of steam?

Even though stocks are still well below their 2007 peak, they can no longer be considered cheap, with the price/earnings ratio for companies in the Standard & Poor's 500 now nearly 20% higher than its long-term average.

"In order for the market to keep delivering gains in 2010, companies need to start showing some real, sustainable earnings growth," says Tom Forester, manager of the Forester Value Fund.

The good news is that those profits will probably materialize. Analysts look for operating earnings for S&P 500 companies to rise 27% from recession-battered levels, fueled primarily by improving economic growth overseas and a further weakening of the U.S. dollar (that makes our goods cheaper abroad and boosts exports).

So even if P/E ratios fall to historic levels, stocks still have room to move modestly higher, says Sam Stovall, chief investment strategist at Standard & Poor's Equity Research. How modestly? Say goodbye to double digits and get used to returns closer to 6% annually for the foreseeable future.

Over the short-term, the path to that 6% may not be smooth, given the risks the economy still faces. But you'll be hard-pressed to do better elsewhere. "The easy money has already been made in the bond market too," says Carl Kaufman, manager of the Osterweis Strategic Income fund. Most analysts now expect low- to mid-single-digit returns for both high-quality and "junk-rated" issues in 2010, and a skimpier 2% to 3% for Treasuries at best.

Wild card: To fill the void created by the slowdown in consumer spending, U.S. companies must rely more on exports to fuel profits. If growth stalls overseas, corporate earnings and stock prices here will also suffer.

What to watch: Keep an eye on the yield curve. A widening gap between the yields on 10-year and two-year Treasuries signals growth in the economy and corporate profits.

The action plan

Stocks: Rebalance your portfolio -- now. Sharp market moves can quickly throw your asset allocation out of whack. That's why back in March, with stocks down 57% in 18 months, Money advised moving swiftly to rebalance your portfolio to its normal stock-bond mix and maybe boosting your stock weighting by five percentage points.

Given the market's white-hot performance since, your portfolio is likely off -kilter again -- only this time, you probably have too little in bonds. Rebalance again now to get back to your original mix and consider raising your bond commitment by five to 10 points. Get there by directing all new investments into fixed-income securities or by shifting money out of stocks and into bonds until you're at the allocation you want.

Stocks: Favor the big guns. Also weigh shifts within the stock portion of your portfolio to reflect changes in market conditions. For instance, small-cap stocks with little (or no) earnings have been the big winners in this year's rally, making blue chips look cheap by comparison.

"As the recovery matures, the best performers will be high-quality companies with lots of cash, sustainable earnings, and the clout to take market share," says David Spika, chief investment officer of Westwood Holdings. A good option for beefing up on big-caps: FMI Large Cap (FMIHX) on the Money 70 list of recommended funds.

Stocks: Think globally. Next year business spending is expected to hold up better than consumer spending, especially in overseas markets. Goldman Sachs's chief U.S. strategist David Kostin thinks energy, technology, and materials companies should see particularly robust growth, since they generate at least half their revenue from foreign markets. Jensen (JENSX) and T. Rowe Price New Era (PRNEX) are Money 70 funds with big bets on these sectors.

Bonds: Stay short and focused on quality. To shield yourself from the twin risks of default and rising rates, stick with highly rated bonds that mature in five years or less. A smart choice: FPA New Income (FPNIX), which has a mix of top-rated corporates and munis. And don't limit your foreign exposure to stocks; it makes sense to be looking abroad when it comes to some of your bondholdings as well. A solid choice: Templeton Global Bond (TPINX).

Bonds: Hedge against inflation. Subpar growth should keep a lid on prices next year. But inflation could reignite quickly after that, given the big money the government is pumping into the economy. Treasury Inflation-Protected Securities, which adjust your principal to keep up with rising prices, protect you against this threat. Buy them via a fund like iShares Barclays TIPS Bond (TIP).

Make money in 2010: The economy

Make money in 2010: Your job

Make money in 2010: Your savings and credit

Make money in 2010: Your home To top of page

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