Downgraded Debt Imparts Lessons for Investors

Here is how to grow your portfolio under any market conditions.

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The downgrading of the long-term U.S. credit rating by Standard & Poor’s has spurred a new round of doom and gloom that is likely to roil the markets. And there was already plenty of cause for concern prior to the downgrade.

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The market dropped dramatically on news of an insipid deal to raise the debt ceiling, which provided little confidence the U.S. was capable of dealing with its long-term economic woes. Lackluster economic growth in the U.S. demonstrated that recovery from the great recession is anemic at best and that we are possibly heading into a double dip recession at worst. Problems with euro zone debts involving Greece, Ireland, Portugal, Italy, and Spain contributed to concern about a global international crisis.

The financial media is in overdrive, offering special reports to make sense of all this. Many of the commentators reinforce the bad news and encourage investors to flee to safety, although it’s not clear what safe means these days. Many investors are paying heed and dumping stocks. Stock funds had a net outflow of over $7.4 billion in the week that ended August 3. Missing from all the hype is an analysis of an intelligent way for you to deal with this crisis, based on a vast amount of historical data. Here are some investing suggestions you probably haven’t heard:

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Stay invested in U.S. stocks. It’s counter-intuitive to buy U.S. based stocks with all the economic woes we are experiencing and little reason for optimism. But the perception that the U.S. may experience lower growth prospects means that expected returns from U.S. stocks are higher than stocks of high-growth countries. A number of studies show that countries with better than average growth rates have lower than average returns. While GDP growth is only one of many factors that determine returns, you shouldn’t assume that lower projected GDP growth for the U.S. means lower expected returns.

Globally diversify your portfolio. Bad news instills fear and panic. Fear and panic increases TV ratings and encourages bad investor behavior. There’s a lot of good economic news, but it’s not well reported. As summarized in a recent blog by Jim Parker, vice president of DFA Australia, Germany, which is Europe’s biggest economy, is thriving. Brazil continues to experience rapid growth. Japan reported higher retail sales in June. The Chinese economy continues to grow at a blistering rate. Southeast Asia is booming. Australia and New Zealand are thriving.

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A prudent investment course is to insure your portfolio is globally diversified, using low management fee index or passively managed funds in an appropriate asset allocation. The global economy is far less dependent on the U.S. than it has been in the past. Keep the big picture in mind and ignore the daily focus on bad news.

Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011.