One of the foremost economic forecasters, the Economic Cycle Research Institute, recently predicted that “a recession (defined as two consecutive quarters of negative gross domestic product) is on the way and it is unavoidable.” These economists should not be taken lightly. They correctly predicted the last three recessions and developed the methods used by the leading economic indicators. They have a “long history of measuring and predicting turning points” in the economy.

If we are headed for a recession, it may not feel much different than what we are experiencing now. Economic activity has been so weak that even if GDP drops for a quarter or two, it may not feel any different.

Europe still has not dealt with Greek’s debt problems and undercapitalized banks, and China is slowing down (three straight months of slower manufacturing activity). Probably most troubling of all is that policy makers have little in the way of tools left to address the problem. These factors may cause a deeper-than-expected recession.

History indicates that if we experience a normal recession, stocks could drop 26 percent, on average, from peak to trough. We have already dropped 19 percent from peak to trough, so we may only have a little more to go.

If you are a long-term investor, now may not be the time to run for the exits. Because if you do sell, you will have to make two correct decisions – timing your exit from the market, and timing your re-entrance, when it appears the coast is clear. The problem with this strategy is that when economic conditions improve, and many of today’s problems are distant memories, stocks will probably be much higher.

How should an investor deal with the next recession?

1. Make sure stock exposure does not exceed risk tolerance. Sell as much stock as necessary to maintain a proper balance.

2. Maintain a higher-than-normal cash position so that when opportunities present themselves, advantages can be gained. The next recession should not be viewed as the world coming to an end, but rather an opportunity to buy great companies at cheap prices.

This is exactly what the greatest investor of the last half century, Warren Buffett, does. And this seems to be the secret to his success.

3. Buy high-quality companies that have consistently increased their dividends over five, 10, 15 or even 25 years. Why buy stocks that pay dividends? Because they tend to hold up better in difficult markets and you get paid while you wait.

The key to dealing with the next recession is to view it as an opportunity to buy things at reasonable prices. The world is not ending, but fear and panic will not go away.

When the next recession ends, a cyclical recovery will begin. Companies will continue to provide products and services that a growing middle class around the world will need and want to consume. Innovation will continue to drive economic activity and our standard of living.

Years from now, when we look back at this time, we will wonder why we didn’t take advantage of the opportunities available. In my opinion, don’t be scared; be an opportunist!

David G. Wilson Jr. is senior vice president of investments with the Wilson Financial Group of Stifel, Nicolaus & Co. Inc. in Portland. Contact him at 503-499-6260 or wilsond@stifel.com. Information herein is from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Investment involves risk and may result in losses.

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It’s easy to get caught up in worries over the European debt crisis, massive government spending, high unemployment and weak economic activity. Many investors today are tempted to go to cash until the future looks a little clearer. Investors can’t control the markets, the economy or the government, but they can control their actions and behaviors to try to avoid the following pitfalls:

Pitfall No. 1: improper asset allocation

A strong foundation is the most important part of home construction, and the same rule holds true for portfolio construction. The foundation of any well built portfolio is asset allocation, which should be aligned with age, goals and risk tolerance.

For example, a working 50-year-old with a fairly strong stomach and 15 years until retirement may have an asset allocation of 70 percent stocks. However, at age 70 this same person may be retired and drawing an income stream from the portfolio. At this point, the asset allocation should, perhaps, be only 30 percent stocks.

While appropriate asset allocation does not ensure a profit or protect against loss in declining markets, it can help investors stay focused on a strategy through volatile periods. Because of the two 50 percent corrections we sustained in the last decade, many investors are improperly allocated between stocks and bonds. They have, in many cases, under-weighted stocks to reduce risk and protect capital. This is understandable, but they may have over-weighted bonds as an unintended consequence.

Many investors feel much safer over-weighting bonds, but they are doing so just when bonds are paying record-low interest and a 30-year bull market for bonds is probably ending. Their portfolios are probably riskier than they think, but they won’t realize so until there is a sudden rise in rates and bonds depreciate in value.

Pitfall No. 2: not understanding the cost of investments

It is amazing how little transparency there is for total fees that investors are paying for money management. When speaking with an adviser or investment company representative, ask the person for a detailed summary of all fees and charges. This includes adviser fees, manager fees, and miscellaneous expenses.

Many advisers today are moving to a business model where they are paid based on a percentage of assets, usually ranging from 1 percent to 3 percent. Typically, there is a sliding scale, and asset management fees fall as the asset level rises.

When the onion is peeled back, many investors are surprised to learn that there are additional charges for the investment manager as well. If the adviser is charging 1 percent and the investment manager is charging 1.25 percent, that’s 2.25 percent annually.

In the end, it’s important for an investor to understand the fees and believe they are reasonable, given the value received from the client/adviser relationship.

Pitfall No. 3: buy and hold … forever!

“Until death do us part” is great in marriage, but it can be devastating for investors. They too often fall in love with a stock – usually because it has performed well in the past. These smitten investors take on a buy-and-hold mentality – and won’t let go. But this can be dangerous and ultimately very costly.

At the peak of the technology bubble, there was a well known company that was trading for more than $80 a share. An investor had a sizable profit and was unwilling to diversify, take some profits and reduce his exposure to this stock, which represented a large portion of his net worth. With almost $1.5 million of value at the peak, his stock position is now worth slightly more than $234,000. In addition to this loss in value, the stock has paid no dividends over the last 10 years, and the future doesn’t look bright.

While this won’t happen to every stock, investors need to be diligent in assessing each stock position. That means evaluating the quarterly earnings, management outlook and industry forecast, and making sure the reason the stock was purchased is still intact.

Too often as time passes, less and less attention is given to the stock holding and the company’s future prospects. Lost market share, management departures and a changing competitive environment can all gradually weaken an otherwise strong holding.

In many ways, a stock portfolio is like a garden. In order to thrive, a garden needs to be watered, weeded and cleared of vegetation so that sunlight can nurture its growth. The same goes for stocks: without periodic care, investments can slowly die.

Investors who keep these principles and potential pitfalls in mind can help them control what they can – their behavior – and cope with what they can’t control – the government, economy and markets.

David G. Wilson Jr. is senior vice president of investments with the Wilson Financial Group of Stifel, Nicolaus & Co. Inc. in Portland. Contact him at 503-499-6260 or wilsond@stifel.com. Information herein is from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Investment involves risk and may result in losses.

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When the financial crisis hit, many retirees put most of their money into short-term bond instruments or savings accounts. While capital was preserved, little income was generated. This, in turn, magnified the importance of a pension, Social Security or some other source of cash flow to supplement retirement income. Those who had little pension income also were hurt by decimated 401(k) balances and significantly lower real estate values.

Combined, these conditions are causing worry for retirees, particularly about income – and rightfully so. But despite all these problems, a silver lining may have emerged this past decade: high-quality, dividend-paying stocks.

While the S&P 500 index lost 0.9 percent in the prior decade, high-quality, dividend-paying stocks provided 8-9 percent annual returns. According to Ned Davis Research, from 1973-2009, companies that increased their dividend or initiated a dividend grew an average of 9.27 percent per year; companies that did not pay a dividend grew only 1.73 percent per year.

These statistics are important, because they show that returns could still be achieved amid some of the worst stock market periods in U.S. history. And new data indicates that stocks produce above-average returns following periods of significant underperformance, otherwise known as “regression to the mean,” which I believe we just experienced. So the table may be set for possibly even better returns over the next five to 10 and maybe up to 20 years.

For baby boomers close to retirement, ownership of high-quality, dividend-paying stocks could be the difference between living comfortably in retirement or moving in with the kids.

Conventional wisdom says investors should withdraw no more than 4 percent annually from a portfolio; however, if this past decade is any indication, investors may be able to withdraw 5 percent or even 6 percent if they own high-quality, dividend-paying stocks.

For example, assume a retiree has a $1 million portfolio that includes 60 percent in dividend-paying stocks and 40 percent in bonds/hard assets. Assume that the dividend-paying stocks appreciated 8 to 9 percent annually. If an investor were to withdraw $50,000 a year (5 percent) and increase this amount 3 percent annually to account for inflation, a retiree would have withdrawn $573,190 in the previous decade, and the portfolio would have actually grown to around $1.2 million. Of course, past performance is not indicative of future results.

But the same strategy with a 6 percent withdrawal rate would have provided $687,837 of income and an end-of-decade value of slightly more than $1 million. Likewise, a 4 percent withdrawal strategy would have provided $458,555 of income (4 percent of $1 million indexed for 3 percent inflation) and an end-of-decade value of almost $1.4 million. So, investors seeking a higher stream of income may have to sacrifice appreciation and vice versa.

If the investor chose to invest in the S&P 500 index, instead of dividend-paying stocks, the end result would have been dramatically different. With the assumption of a 5 percent withdrawal rate, the same level of income would have been achieved ($573,190) but the portfolio’s end-of-decade value would have been only about $900,000 – a difference greater than $300,000. The key factor in making these higher withdrawal rates work is being 60 percent invested in high-quality, dividend-paying stocks.

So, to potentially maximize retirement income, consider assembling a portfolio of high-quality, dividend-paying stocks. And I’m not talking about high-yielding, dividend-paying stocks.

I’m talking about companies that have been paying higher dividends for 10, 15, 25 and even 40 years in a row. These companies typically have dominant market positions, strong management and strong balance sheets. They aren’t difficult to find, but they are scarce. Fewer than 250 of these companies fit the bill.

While 5 percent or even 6 percent withdrawal is possible, 4 percent makes more sense initially in case another “black swan” bear market emerges. But as time goes on, and assets grow, there is no reason the rate can’t be raised. One variation of this strategy would be to start off at 4 percent withdrawal and wait for the account to reach a certain amount before increasing to 4.5 percent or 5 percent. A 6 percent withdrawal rate, however, puts a lot of strain on any portfolio, and a bear market can have significant impacts.

The best possible results should come from being nimble, prudent and not greedy. However, consult a financial professional before implementing such a strategy.

David G. Wilson Jr. is senior vice president of investments with the Wilson Financial Group of Stifel, Nicolaus & Co. Inc. in Portland. Contact him at 503-499-6260 or wilsond@stifel.com. Changes in market conditions or a company’s financial condition may impact the company’s ability to continue to pay dividends. Companies may also choose to discontinue dividend payments.

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For the last 15 years, large cap stocks have been out of favor. Many top blue-chip companies once commanded premiums above the market multiples, but now many of them trade at discounts.

However, this may be the year for a shift back to large caps. They tend to do best as the economic cycle matures, and this may be happening now. Also, they have been neglected long enough that an interesting and possibly bullish scenario exists: boring, unloved, out-of-favor stocks at reasonable prices.

Over the last decade, large cap stocks – defined as having more than $5 billion in market capitalization – have woefully underperformed in comparison to small and mid-cap stocks. In fact, according to Standard & Poor’s, over the last 10 years, large-cap companies are down almost 5 percent versus gains of 75 percent for mid-cap companies and almost 90 percent for small-cap companies.

And the numbers are even worse over the last 15 years, when small caps beat large-cap stocks by almost 150 percent and mid-caps beat large-cap stocks by more than 200 percent.

But why have these large companies performed so poorly? The simple answer for many is that their valuations got stretched to unbelievable levels during the late 1990s. If a large company is trading for almost 50 times earnings while its growth rate is only 7 percent a year, then 50 times earnings is unsustainable unless earnings can accelerate rapidly. If earnings continue to grow only 7 percent a year, then the company’s stock price may experience a decline – sometimes a significant one – even while possibly experiencing rising dividends and a solid return on equity.

There is a good lesson to be learned from this example: Valuation matters! Just because a company has a good reputation and solid prospects doesn’t mean an investor should pay astronomical prices to own them.

If a company is trading at 15 times earnings, it might be worth considering if it is growing its earnings 10 percent annually. But along with this should come strong management, a leading market position, and the ability to expand in the years to come. In other words, an investor may be willing to pay some multiple of earnings if the future potential warrants it.

This same concept applies to more growth-oriented stocks as well. If earnings are growing 15 to 20 percent a year, an investor should not pay 50 times earnings but rather something closer to 20-25 times earnings, unless it has the cure for the common cold or cancer. Growth-stock companies tend to plow much, if not all, of their earnings back into the business, leaving investors only the appreciation to count on in getting a return on their investment.

Historically, small-cap and mid-cap stocks have performed better than large caps when the markets are rebounding from a large drop. This pattern repeated itself following the market lows in March 2009 with small- and mid-cap stocks posting big gains.

Typically, large caps outperform as the economic cycle matures. So as our economy gains traction and economic conditions improve, investors need to be prepared for the possibility of stronger performance from the large caps.

When picking stocks, it’s important to be selective in the midst of this secular bear market. Choose large-cap companies with earnings that are growing at such a strong clip that they can consistently increase dividends year in and year out, even in the worst of times. The key ingredient is an increasing dividend.

These kinds of companies have produced solid returns over the last 37 years, and with less volatility. According to Ned Davis Research, from 1972-2009, companies that increased their dividend or initiated a dividend returned 9.27 percent annually vs. only 1.73 percent for non-dividend paying stocks. And they did so with generally less risk.

So, investors looking for something out of favor, but reasonably priced, should consider looking at high-quality, dividend-increasing, large-cap stocks.

David G. Wilson Jr. is senior vice president of investments with the Wilson Financial Group of Stifel, Nicolaus & Co. Inc. in Portland. Contact him at 503-499-6260 or wilsond@stifel.com. Information herein is from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Investment involves risk and may result in losses.

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Since the onset of the financial crisis, corporations have been preserving cash to ensure their survival. Now, more than two years later, corporate giants have built a war chest of almost $2 trillion in cash. This, according to a December issue of the Wall Street Journal, represents 7.4 percent of company assets – the highest level in over half a century. But those tight purse strings may finally be loosening in 2011. Cash is earning virtually nothing and as economic conditions improve and cash reserves grow even stronger, companies may finally be willing to part with some of that cash. Following are a few likely scenarios for 2011:

With the extension of the Bush tax cuts, the tax on dividends remains at a maximum of 15 percent. This alone should help boost corporate willingness to pay more dividends. In 2010, dividends increased 8 percent, and with strong profits continuing and cash flows increasing, dividends could reach 9 percent in 2011.

More importantly, I believe shareholders are hungry for higher payouts because yields on fixed-income instruments are paltry and dividend payout ratios are still very low. So if companies gain more confidence, they could easily surprise investors with more generous payouts. In my opinion, large corporations have an advantage because they have easier access to capital markets and are in better position to aggressively increase dividends in 2011.

Abundant cash, available credit and improved confidence could make 2011 an active year for mergers and acquisitions. According to leading investment bankers, this activity has already picked up significantly. Worldwide merger activity increased 25 percent in 2010 and could jump another 15 percent in 2011. In addition, shareholders may also begin pressuring boards to start doing something with all that cash.

Following the financial crisis, valuations were hard to determine given the dislocations in the market, and companies were reluctant to part with cash until confidence returned. With domestic growth rates still below normal recovery levels, corporations should look for new growth initiatives and strategic mergers.

Private-equity firms may be eager to jump-start the acquisition trail and bankers may now be more willing to fund deals. A new source for deals also has arrived: Emerging countries such as China and Russia are becoming much more active in major transactions. 2011 could bring increased international acquisitions, particularly in emerging markets.

Strong balance sheets and higher confidence levels should make companies more willing to invest in their future through new equipment, research and development, and new manufacturing and processing facilities. According to a January issue of the Wall Street Journal, in the third quarter of 2010, capital spending on software and equipment by U.S. companies increased 15 percent to over $1 trillion, nearing pre-recession levels.

And now after year-end legislation, corporations can deduct 100 percent of expenditures for certain types of equipment. Probably the biggest reason to increase capital spending is to stay ahead of the competition and increase productivity and margins, because most companies have already squeezed out about as much as they can without hindering growth.

If these scenarios pan out, how might an investor take advantage of the situation? First, look for companies that have significantly increased their cash position and are in solid position to raise their dividend.

Second, find companies that might be good acquisition candidates – minimal sales penetration overseas, struggles to obtain credit or refinancing during the financial crisis, and openness to a merger partner. In my opinion, investors should “follow the money.”

And as always, consult with a financial adviser before making any investment decision.

David G. Wilson Jr. is senior vice president of investments with the Wilson Financial Group of Stifel, Nicolaus & Co. Inc. in Portland. Contact him at 503-499-6260 or wilsond@stifel.com. Information herein is from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Investment involves risk and may result in losses.

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Investors looking for potential growth opportunities over the next five years need look no further than China, India and other emerging economies. Their consumption levels are expected to climb rapidly as a growing middle class emerges. In fact, according to Capital Research and Management, over the next 15 years as many as 2 billion people may join the middle class. That is an astounding figure that has huge implications for investors seeking growth.

Historically, when the world comes out of a recession, the U.S. leads the way. But since the Great Recession, emerging economies of China, India, Brazil and other Asian countries have recovered quickly and spurred global growth. And now for the first time ever, emerging economies account for a greater share of global consumption than the U.S. These emerging economies are likely to play an even greater role in world consumption in the years to come.

One of the more interesting aspects of the emerging middle class is its desire to have what Americans already have. They want homes for their families, they want BMWs and other luxury branded items, and they want better educations for their children. Basically, they have many of the same goals and aspirations we do. And while much of their progress to date has been achieved through exports, in the future a greater emphasis will be placed on consumption and domestic demand in these countries.

In China, this shift from an export-driven economy to an end-user economy will be achieved through subsidies and higher incomes. The long-term objective is to be less reliant on exports and manufacturing and to grow knowledge-based industries like technology, aerospace, etc.

There are many ways to participate in emerging markets. One is through U.S. multinationals that generate 40 to 50 percent of their revenues and profits overseas. Many of these companies have brands that are recognized around the world. They tend to have solid balance sheets and leading market positions, and emphasize rising dividends.

Of course, investments can always be made directly in individual emerging stocks, but that is much riskier and requires a lot of local knowledge that may be hard to uncover. This is probably best left to professionals who research these companies in person and have many years of experience.

Another means of finding potential growth overseas is through hard assets. These are commodities like gold, platinum, oil, silver, copper, nickel and lead. The primary reason to consider hard assets is because emerging economies need many of these raw materials to build infrastructure like roads, bridges, highways and industrial complexes. For example, China is now the world’s largest consumer of copper, steel and coal, and the second largest consumer of oil, according to Barron’s. By 2020, China is expected to have more than 200 million cars on its roads, as reported in the Wall Street Journal. That’s a lot of consumption that may well lead to upward pressure on oil prices.

China seems to get all the attention with regard to the emerging economies. And it’s only natural, considering it has the world’s largest population. But I believe a sleeping giant in the emerging world is India. Its population is greater than 1.1 billion, it’s a democratic society, and English is spoken there. China may be the growth engine for the next 10 years, but India may be the growth engine for the next 20 years.

What does this mean for investors? To participate in some of the potential global growth, make sure part of a portfolio is invested overseas or at least in U.S. multinationals. Remember that overseas investing entails risk and volatility, and professional advice should be sought beforehand.

David G. Wilson Jr. is senior vice president of investments with Stifel, Nicolaus & Co. Inc. in Portland. Contact him at 503-499-6260 or wilsond@stifel.com. Information herein is from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Investment involves risk and may result in losses.

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Investors mulling over how to rebuild their portfolios after the financial crisis may want to consider adding a hard asset component to provide diversification while also taking advantage of macro-economic trends around the world.

Hard assets are commodities like gold, platinum, oil, silver, copper, nickel and lead. In my opinion, unlike stocks in a long-term bear market, hard assets appear to be in a bull market that may last for several more years. Hard assets are negatively correlated to stocks and bonds, meaning they tend to behave differently and move in the opposite direction. Thus, hard assets may help cushion the blow should stocks take another tumble or bond values fall.

The primary reason to consider hard assets is that economies are growing rapidly in China, India and other emerging countries around the world. According to the International Monetary Fund, in the next five years Asia will represent a third of the world’s output and its economies will grow nearly 50 percent. That implies significantly higher levels of energy and raw material consumption primarily to build infrastructure like roads, bridges, highways and industrial complexes.

Consider China’s need for oil in the years ahead. In 2009, The Wall Street Journal reported that auto sales in China grew 46 percent to 13.6 million units – making it the largest car market in the world. By comparison, U.S. auto sales in 2009 were 11.1 million units. By 2020, China is expected to have more than 200 million cars on the road. That’s a lot of oil consumption, which may lead to upward pressure on oil prices.

Another factor to consider is the movement of people from rural China into the cities. The U.S. has just one city (New York) with more than 6 million inhabitants; China has 34! That migration will spur consumption of a variety of goods and services, and the raw materials needed to supply them.

Television and radio broadcasts these days are flooded with commercials touting gold. I believe many investors these days now recognize that hard assets like gold and silver are becoming a store of value in anticipation of falling currency values. Recently, silver reached a 30-year high of $24.65 per ounce and gold hit an all-time high of $1,381 per ounce. Interestingly, gold is still below its early 1980 price on an inflation-adjusted basis. In my opinion, the appreciation of gold and silver is a direct result of developed countries like the U.S. debasing their currencies in order to stimulate exports and accelerate economic growth through quantitative easing.

In addition, worried businesses and governments around the world may begin hoarding hard assets because of increasing global instability. These entities know they will need raw materials for a specific project or for day-to-day operations, so they may accumulate these raw materials now to protect themselves against future uncertainty. This could lead to additional demand, which could boost the price of hard assets.

Participation in this market is much simpler than previously. There are now a number of investment products that invest in hard assets. Heretofore, individual investors had virtually no means of participating in the hard assets market unless they ventured into futures contracts. Now, the process of purchasing hard assets is as easy as purchasing a stock.

Keep in mind that it’s important to exercise caution when investing in hard assets. They are risky, and even a diversified portfolio can be highly volatile. Investors looking to diversify their portfolio should seriously consider hard assets, but seek professional advice before buying.

David G. Wilson Jr. is senior vice president of investments with Stifel, Nicolaus & Co. Inc., member SIPC and NYSE, in Portland. Contact him at 503-499-6260 or wilsond@stifel.com.

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Ten years is a long time to endure a flat or declining stock market. Can investors stomach a few more years of turmoil before the next bull market begins? They may have to, but they also may still find opportunities if they learn how to invest in an unpredictable, long-term bear market.

Since the Internet bubble burst in 2000, stocks have been in what is called a secular bear market. It is characterized by long periods of volatility and flat or declining stock prices. Dating back to 1870, there have been four secular bear markets lasting from 13 to 16 years. Secular bears tend to be long and painful. The good news is that we are well into the current secular bear market. The bad news is that it could still last for several more years. Secular bears usually end when no one wants to own stocks anymore, and I don’t think investors have reached that point yet.

So, what can investors do in this bear market? There are many alternatives. Here are a few: 1, Cash: It’s earning virtually nothing, and that’s before inflation and taxes are considered; 2, Bonds: They’re earning some interest, but paltry returns and the risk of higher interest rates increase the chance of losing one’s principal; and 3, Real estate: It peaked in 2005, and probably has years to go before it fully recovers, when incomes catch up with home prices again.

Despite the intense volatility of stocks over the last few years, investors can navigate through a secular bear market if they understand its nature and how to respond. First, a buy-and-hold strategy probably does not work well in this environment. The S&P 500 Index has been virtually flat since the beginning of the decade, but it has been as high as 1,576 and as low as 667. That’s a lot of gyration with nothing to show for it.

Investors must manage more actively in this kind of environment. Some of the best buying opportunities could occur during secular bear markets, so investors need to be poised to take advantage of potential opportunities. The period from March 2009 through April 2010 marked one of the best investment opportunities in the last century. In that 13-month period, the S&P 500 Index gained over 82 percent, but many investors sat on the sidelines after they panicked out of stocks from fall 2008 and through winter 2009.

A potentially effective way for dealing with a secular bear market is to implement a strategy for buying low and selling high. This is easier said than done, but it is helpful.

In the last secular bear market (1966-1982), selling each time the Dow Jones Industrial Average approached 1,000 would have made a great deal of sense. In fact, on six occasions the Dow got very close to 1,000 only to fall back near 800 – a level that would have been great for buying. That secular bear market continued through the Vietnam War, Watergate, the oil embargo, President Nixon’s resignation, and stagflation – a long and frustrating time period for stocks and the economy that rivals our problems today.

A buy low, sell high strategy may have helped investors endure those 16 years when the stock market declined 1.18 percent annually. Of course, no one can predict market performance with any certainty, and past performance does not guarantee future success.

A systematic approach for implementing a buy low, sell high strategy employs what I call a valuation threshold. It is the price level at which stocks would be sold. For example, let’s say an investor has a $500,000 stock portfolio. He or she establishes a $550,000 valuation threshold, so that when the stock portfolio appreciates by $50,000, or 10 percent to this level, a certain percentage of stocks would be sold and added to another asset class such as bonds or cash.

When the valuation threshold is reached, the next step is to determine how much should be sold. This is where a professional wealth adviser’s help may be useful. Even if an investor has a sound strategy, its implementation often fails because fear and greed overtake rational thought. The help of an objective, experienced adviser can keep damaging emotions out of the picture.

Each time a valuation threshold is reached and a stock sale is executed, the threshold needs to be reestablished so that if the stock market continues higher, further reduction of the stock portfolio would occur.

There also needs to be a valuation threshold set below the current stock portfolio level. Using the same example of the $500,000 stock portfolio, an investor would determine a threshold on the lower end, which could be $450,000. When this level is reached because of declining stock prices, cash or bond proceeds would be used to add to stocks. But it is important to be selective in a secular bear market, so look at stocks that consistently raise their dividends, have solid balance sheets, leading market positions and a strong management team.

As the secular bear market drags on, investors become more and more discouraged with their buy and hold positions and they begin to lose faith in the system, their strategy and stocks in general. They may eventually give up hope. Other signs, such as magazine covers, usually appear. For instance, BusinessWeek trumpeted the “Death of Equities” on Aug. 13, 1979. It is at this juncture when a new secular bull market could begin – perhaps several years from now. But for now, investors can take advantage of the market’s volatility by implementing a strategy to buy low and sell high.

David G. Wilson Jr. is senior vice president of investments with Stifel, Nicolaus & Co. Inc., member SIPC and NYSE, in Portland. He has over 26 years of industry experience as a financial advisor. Contact him at 503-499-6260 or wilsond@stifel.com.

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Investors poured $409 billion into bond investments in the 12 months ending in March 2010, according to the Investment Company Institute. In my opinion, the problem with this strategy is that when unusually high sums of money are chasing a particular asset class, it doesn’t end well.

Investors need to be cognizant that interest rates are at record low levels, and when economic conditions improve or bond vigilantes demand a greater return on their fixed income investments, interest rates could head higher – possibly much higher. Bondholders may be in for a rude awakening unless they take action to fix their portfolios. And now may be a good time to do so.

Investors who went into bonds because they wanted their money to be “safe” and away from the gyrations of the stock market, may feel pretty good right now, particularly after events such as the “flash crash” on May 6, when the stock market lost 539 points in just five minutes. Many people think that because bonds offer low volatility, they are also low risk. But this may not be the case much longer. Higher interest rates, if and when they come, will materially affect virtually all bondholders, particularly those in long-dated bonds. The end result will be lower bond values, and the potential decline could be significant. A 10-year Treasury would drop 14 percent if interest rates rise two percentage points.

The best way to deal with higher interest rates is to prepare before values start to deteriorate. One way to do that is to build a laddered portfolio of individual bonds and hold those bonds to maturity. By doing so, an investor might not be hurt by paper losses caused by higher interest rates. In fact, higher interest rates could even be beneficial because when shorter-term bonds mature, an investor will most likely be able to invest those proceeds into higher yielding instruments further out on the yield curve.

Investors can find a suitable ladder by determining their outlook for interest rates and inflation, their income needs and their risk tolerance. Typically, longer-term ladders provide a higher yield, but also more volatility and potentially larger paper losses, so an investor who needs more income should consider a ladder of five to 10 years. If investors don’t need income and think interest rates will head significantly higher over the next few years, they may want to shorten the ladder to three to five years.

The ladder strategy is simple: When the first bond matures and cashes out, simply roll those proceeds into the sixth year or into the 11th year, depending on the length of the ladder. The beauty of individual bonds and ladder building is the creation of an income stream and a potential return of capital along with low to moderate volatility depending on how far out the ladder extends. Uncertainty also may be greatly reduced with a bond ladder. Investors know when the bonds mature and what their income will be, and they may have protected themselves from higher interest rates because they are holding the bonds to maturity. No matter what happens with interest rates, investors know that if the business or government entity that issued their bond is solvent when the bond matures, they will receive back the par value of the bond.

When building a ladder, we usually recommend short-term bank instruments, investment-grade corporate and municipal bonds. In an IRA, consider adding inflation-protected securities to the mix. Investors in a high tax bracket with non-IRA accounts should consider a laddered portfolio of tax-advantaged municipal bonds – particularly because tax rates are almost certainly heading higher.

Don’t wait for higher interest rates to take hold before taking action. Evaluate portfolios now! If investors have already established ladders, they may want to sell long-dated maturities to shorten them. Above all else, don’t let the relatively calm waters in the bond market mask the potential risks of higher interest rates.

When investing in bonds, it is important to note that as interest rates rise, bond prices will fall. High-yield bonds have greater credit risk than higher quality bonds. Also, income from particular municipal bond issues may or may not be subject to state and alternative minimum taxes.

David G. Wilson Jr. is senior vice president of investments with Stifel, Nicolaus & Co. Inc., member SIPC and NYSE, in Portland. He has over 26 years of industry experience as a financial advisor. Contact him at 503-499-6260 or wilsond@stifel.com.

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One of the most difficult dilemmas high-net-worth investors face is how to deal with a concentrated stock position. If a company’s prospects are deteriorating, I believe the answer is simple: sell as fast as possible. But if a company’s prospects are bright, a different approach is required.

Ideally, no more than 15 percent of a portfolio should be in any one stock, but many investors with a concentrated stock position have upwards of 30, 40, 50 percent or more in one stock, which can potentially be very risky. The list of fallen stars is long. Deep down investors probably understand the risk, but a strong emotional attachment to the stock may keep them from taking action. This is understandable because the concentrated stock is often an investor’s primary source of wealth. Perhaps the investor has worked for the company or inherited the position from a family member. In order to help keep emotions at bay, consider taking a systematic approach to reduce a concentrated position.

First, determine the future value of the stock. Let’s assume an investor has a $3 million portfolio and a concentrated stock position worth $900,000 (15,000 shares of XYZ stock at $60 per share). In other words, this concentrated position represents approximately 30 percent of the portfolio. There are various ways to determine the future potential value of a company’s stock over the next 12 to 18 months. Consider using a multiple of cash flow, next year’s expected earnings multiplied by historical price divided by earnings ratio, or a combination of methods.

Second, apply a 15 percent discount. Once the future potential value has been determined, a haircut of 15 percent should be used to arrive at the initial price to begin to sell the stock. Let’s say the investor determined the future potential value over the next 12 to 18 months at $72 a share. A 15 percent haircut would mean shares should be sold starting at $61 a share.

Then, start selling. After evaluating the stock the investor decides to sell 1,475 shares at $61, which equals approximately $90,000. If the sale occurred at $61 a share, this would reduce the holdings to around $810,000 or 27 percent of assets.

Finally, establish and maintain a threshold. After the initial sale, the investor’s total stock position is now worth $810,000. This figure is the selling threshold. Do not sell any additional stock until it appreciates substantially above this level. For example, let’s say the stock reaches a value of $66.50 per share and a total value of $900,000. At this point, the investor would sell off another $90,000, which would reduce the position to the $810,000 threshold. Continue this process until the concentrated position represents no more than 15 percent of assets.

The above hypothetical examples are for illustration purposes only. But this strategy, if it is followed, can help investors sell at progressively higher prices. It also takes the emotion out of the equation and can help prevent investors from being too greedy. Each year investors will need to reevaluate the stock’s future potential value and make adjustments to the selling price, if necessary. Tax considerations are also important, but should not interfere with the basic premise of the strategy, which is to gradually reduce the risk of a concentrated stock position.

Time and patience are two of the keys to making this strategy work. I developed this strategy after witnessing the devastation caused by individuals who refused to sell their concentrated stock during the 2000 bubble. Unfortunately, these investors never did anything to reduce their risk, diversify and protect a once-in-a-lifetime asset.

Implementing this strategy can be simple, but sticking with it requires discipline. If an investor owns a large concentrated stock position, the psychological problem of selling at the appropriate time must be addressed. Investors don’t want to sell too soon and leave money on the table or hold too long. That is why it is so important to determine a company’s future potential value, establish a reasonable selling price and create a selling threshold that helps keep emotions in check.

David G. Wilson Jr. is senior vice president of investments with Stifel, Nicolaus & Co. Inc., member SIPC and NYSE, in Portland. He has over 26 years of industry experience as a financial advisor. Contact him at 503-499-6260 or wilsond@stifel.com.

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