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Tue 13 Dec 2011 02:42 PM

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Four investing mistakes to avoid in 2012

The lessons we learned from the stomach-churning volatility of world markets

Four investing mistakes to avoid in 2012
World markets have had a rollercoaster ride in 2010

The ongoing turmoil in world markets has made for a
herky-jerky ride this year. What did you learn? While most professional money managers expect
stomach-churning volatility to continue, there's no reason why you can't still
position your portfolio for safety, income or growth. Here are some mistakes to
avoid:

1. Staying out of the market

Sure, the market this year was crazier than selling
snowballs to Inuits. But by staying out - and pretending you knew when to come
back in - you missed plenty of profit opportunities. The Select Sector
Utilities SPDR ETF, for example, offers a nearly 4 percent yield and has
returned about 16 percent year to date through Dec 7.

The FTSE NAREIT Residential Index ETF, which samples real
estate securities throughout the US, is up about 9 percent year to date with a
3 percent yield. The greater lesson is not that these funds did well - I'm not
predicting they will do well in 2012 - but that diversification offers returns
in a number of places. The "all in or all out" approach will deprive
you of profits and you just can't know where they will come from.

2. Ignoring inflation

While the current US Consumer Price Index is running at
slightly more than a 3 percent annual rate of increase, inflation has never
really gone away. Just look at your medical expenses. Annual premiums for
employer-provided health care plans rose 9 percent this year, according to the
Kaiser Family Foundation. That's three times the rate of general consumer
inflation and more than four times the rate of wage increases. With inflation,
everything is relative. If your essential expenses are outpacing your wage
growth, you're falling behind.

While there's little you can do to get a raise in a sour
economy, you can protect your portfolio with Treasury Inflation-Protected
Securities or I bonds, both of which pay a premium based on the government's
cost-of-living index increase.

3. Not having an investment policy statement

If you are constantly watching the headlines and business TV
shows, you're not paying attention to your real bottom line. An investment
policy statement puts in writing your goals, risk tolerance and portfolio
allocation. Do you want to retire at 60? Are you saving for college? Are you
living on a fixed income? Each kind of objective requires a different
allocation. And I'm not just talking about just stocks and bonds. There's a
whole range of alternative investments from public real estate investment
trusts to commodity funds that can enhance your returns. So if you haven't
crafted a personalized investment policy statement, now's the time to do it.

4. Trying to time the market

Did you get out of gold when it turned south earlier this
year? How about European stocks and bonds? It's much more sensible to determine
how much of your portfolio should be in different asset classes based on your
age, vocation and risk tolerance (see investment policy statement above). If
you need to preserve capital, maybe you need to build a portfolio of individual
bonds and hold them to maturity. Searching for income? Create a portfolio of
dividend-paying stocks and buy on a monthly basis while reinvesting your dividend
payments in new shares.

Will next year bring more bad news from Washington and
Europe? What about China and the developing world?

You can count on market hiccups. Volatility is now the rule
rather than the exception. Yet any strategy that's predicated on actively
dodging bullets is doomed to fail because you're competing with light-speed
robo-traders. It's more important to have a working knowledge of market and
credit risk to understand how much money you can lose.

Make your mission to hedge risk in the coming year. How do
you offset bond market risk? Do you have a way of protecting your stock
positions? Are you over-concentrated in US or European stocks? Now's the time
to face the truth and make adjustments.

(John Wasik is a
Reuters columnist. The opinions are his own.)

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