THE BLOG
01/15/2008 10:21 pm ET Updated May 25, 2011

Smart Advice for the HuffPost Investor

Breaking news! Some major investment banking firms are predicting (gasp!) a recession for the U.S. economy.

This prediction comes from the same folks who failed to predict the tech bust in 2000 (which cost investors trillions of dollars) and who also missed the sub-prime bond crisis (which cost investors and these firms hundreds of billions of dollars).

Should you heed the advice of these "investment professionals" and flee to gold or other hard assets?

Since this issue is on the minds of so many investors, I am devoting my entire column this week to it.

Please add your questions as comments to this blog and I will answer as many of them as I can.

Question From themodernleader:

My 2008 question. Is it wise to be in other than asset leaden stocks in 2008? Even that is risky if the economy implodes and credit dries up. Buy gold or silver.

themodernleader,

I can certainly understand why you might want to be in a portfolio of all gold or silver.

The financial media is all atwitter about the possibility of a recession. The number of times "recession" is mentioned in the press has increased exponentially. Recent surveys of hedge fund managers indicated that a majority of them believe that a recession in 2008 is "very likely." The likelihood of a recession has now become a hot political topic.

Defining "recession" is difficult.

The traditional definition of two consecutive quarters where gross domestic product and employment are down has been sharply disputed by Alan Greenspan and the prestigious National Bureau of Economic Research.

Predicting when a recession will occur is even more challenging.

Edward Yardeni, the chief economist for Deutsche Bank Securities Corp, predicted a recession related to anticipated Y2K computer issues in 2000.

"The recession forecast was just wrong,'' Yardeni conceded.

Many economists predicted "economic disaster" if oil reached $50 a barrel. Imagine that!

Faulty predictions for 2006 included "the recession/depression of 2006."

On the flip side, Mark Vitner, the senior economist for Wachovia Securities, was reported to be of the view in February, 2007 that a recession was not on the horizon. According to Mr. Vitner, housing was "in the process of correcting itself."

Don't get me wrong. I am not saying there will not be a recession in 2008. I am just skeptical of predictions about recessions.

If there is a recession, what does it mean to investors?

The data indicates that recent recessions are of shorter duration than previous ones. The average length of recessions in the U.S. between 1870 and 1945 was 21 months (7 quarters). In contrast, the average length of a recession since 1945 was only 11 months (4 quarters).

It can take anywhere from six to eighteen months before there is a formal pronouncement that a recession has actually occurred. By the time the definitive word is out to investors, the "smart money" has bailed out of commodities and returned to the markets. The average investor can be left with that deer caught in the headlights look.

There will be a lot of pressure on investors to sell their portfolios, switch to commodities and then sell commodities and reenter the markets when the self-styled investment gurus announce that the recession is "over." A cynic might argue that this is just good business: Trading generates an estimated $500 million per day in commissions and related fees.

This is not a prudent course for investors. I agree with Charles D. Ellis, author of Winning the Loser's Game, who said: "Market Timing is a wicked idea. Don't try it -- ever."

Instead, investors should determine their asset allocation and use low cost index funds to construct a portfolio consistent with their investment objectives and tolerance for risk. Investors who cannot tolerate the kind of short term market correction that a recession is likely to cause should not be exposed to significant market risk. Their portfolios should be invested primarily in a low cost, short or intermediate term bond index fund. The stock portion of all portfolios should be invested in a broadly based index fund that benchmarks the Wilshire 5000 and a similar fund that provides exposure to the international markets.

If you want more exposure to commodities, consider allocating no more than 5%-15% of your portfolio to fully collateralized commodity index funds. Some excellent, low cost options include iShares S & P GSCI Commodity-Indexed Trust and the iPath Dow Jones-AIG Commodity Index.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.