A midlife money checkup

Are you still on pace to reach your goals despite today's market woes? Find out by taking this nine-step test of your financial health. It won't hurt a bit.
By Penelope Wang, Money Magazine senior writer

Where did the time go?
Just yesterday your financial life was all about scrambling to make rent, learning what a 401(k) was and lobbying to get out of the cubicle and into an office. Now you're pushing 45 or 50, you've got a mortgage and college tuition bills, and you're the boss of a crop of ambitious 22-year-olds.Face it, you've reached middle age. Sure, you have a long road ahead - three or four decades or more. But when it comes to your finances, you're not a kid anymore."Back in your twenties, you probably thought turning 50 was far in the future," says Mari Adam, a financial adviser in Boca Raton, Fla. "Guess what? Your future is starting now." Will that future work out the way you want? Hard to say, but you'd be wise to see how you're doing so far. That means conducting a head-to-toe money checkup that covers everything from investing to insurance.Once you know the state of your financial health, you should find it easier to get in shape and then stay on track toward your goals, whether they include early retirement, career changes or starting a business.How do you take this test? Ask yourself the same questions that a financial planner would pose. Your answers will lead you to your diagnosis and, if you find ills, a cure. Get started.

1. Are you saving enough for retirement?
When you're just starting to save and invest, this question is hard to answer with any precision. Who knows how much money you'll need in retirement when those days are eons away? Now that you're in your forties or fifties, it's easier to make an educated guess.You have a 401(k) balance or other plans you can check on (if you can bear to look today). And you probably know how long you want to keep working and have an idea of what you want to do afterward - travel, launch a second career, kick back. You still have time to refine your goals. But as retirement draws closer, you can't put off creating a concrete savings target and measuring your progress.One way to look at this is to come up with the Big Number. As a rule of thumb, figure you'll live on 80% of your pre-retirement income when you stop working. So if you make $100,000, that's a retirement income of $80,000. If you assume you have no pension and that you'll collect $20,000 a year from Social Security (get an actual estimate at ssa.gov), the remaining $60,000 will come out of your savings.The standard financial planning advice is that you can safely withdraw up to 4% of your assets in the first year of retirement. You then increase that amount each year to match inflation. So in this example you'll need to amass $1.5 million by the time you quit ($60,000 divided by 0.04, if you're keeping track at home).Work up your own Big Number and an annual savings goal with our retirement calculators. You can also use the worksheet to the right to see where you should be by now. Whether you're on target or behind, remember to keep saving. It may seem hard to buy when the market is stumbling, but think of it as a 10%-off sale on stocks you have to buy anyway.

2. Is your portfolio properly diversified?
In just the first weeks of this year, the stock market has slid some 8% and recession talk has reached fever pitch. That's especially worrisome for midlife investors. You've lived through bear markets before - 1987, 1990, 2000-02 - but now you have more money on the line and a tighter portfolio-building schedule to meet.At times like this, you want to make sure you have a mix you can live with. So check on your investments but don't chicken out. As long as you are properly diversified, you can ride out this market downturn too. Retirement may seem close, but your investing time horizon is still decades long.While boomers should have a sizable stake in bonds and cash to cushion risk, stocks should continue to be the linchpin of your portfolio. Yes, stocks can often deliver sharp losses, but they remain your best bet for outpacing inflation.By your late forties, a sound asset mix, according to planners at T. Rowe Price, is 83% stocks and 17% bonds. Gradually shift so that by age 65 you have a 60/40 mix. For maximum diversification, your equity stake should include large-caps, small-caps and foreign stocks.

3. Are your investments in the right accounts?
If you've been stashing away money for 15 or 20 years or more, you've probably built up savings in both tax-deferred plans, such as a 401(k) or an IRA, and taxable accounts. Now you need to consider what's called asset location - that is, putting investments that trigger a high annual tax bill in tax-deferred accounts and keeping more tax-efficient ones outside your plans.A study by Vanguard found that effective asset location can improve your after-tax returns by as much as 10% over 10 years. Investments that throw off a lot of income are tax-inefficient. Prime examples: bond, real estate or high-dividend stock funds. If the payouts are in the form of interest or short-term capital gains, you'll owe taxes at a rate as high as 35% on the money.Growth stock and index funds are tax-efficient. They tend to generate few short-term payouts, while any long-term gains would typically be taxed at a 15% rate. Municipal bond funds are also low (or no) tax, and the case for owning them is quite strong now

4. Have you taken on too much debt?
You've become an expert juggler - what with the mortgage, college tuition and monthly bills. But in that financial scramble, you may have lost track of just how much you owe, especially if you keep tapping your home equity for spending money.Sure, some debt makes sense - taking out a loan to buy that house in the first place, for one. But too much debt can cripple your finances, especially if you carry credit-card balances. The worst scenario would be to head into retirement with mushrooming interest payments and only a fixed income to pay them off.
Use these four guidelines to see if you're in over your head:
- 28%: Devote no more than this amount of your monthly pretax income to your mortgage.
- 75%: By age 45, limit your home loans to this portion of your home's value, says Phil Dyer, a financial adviser in Towson, Md.
- 36%: Spend no more than this much of your pretax income on all debts, including your mortgage and credit cards.
- 3 months: Set aside three months' worth of living expenses for emergencies. In tough times, six is even better.

5. Is your estate plan in order?
For better or for worse, life has grown more complicated, what with a spouse, kids, a former spouse, free-spending kids, health worries. You've worked hard to protect your family. But if you die or become incapacitated, what will happen? That depends on how well you've handled estate planning.You probably have a will - by age 50, two out of three Americans do. But that's only a start. When did you last update it? And did you complete other essential paperwork? Probably not."You want to be sure your kids and spouse will be taken care of," says Robert Armstrong, president of the American Academy of Estate Planning Attorneys in San Diego. "And you don't want all your money going to your ex-spouse or, worse, her no-good second husband, which all too often is what ends up happening."
Here's what you need:
A will: In it you need to designate a guardian for your children if they're younger than 18, as well as a financial guardian for the money they'll inherit (or a trustee if you set up a trust). "You may want to choose different people for these tasks, since they call for different skills," says Bill Knox, a financial adviser with Regent Atlantic in Chatham, N.J. "A guardian must be willing and able to raise your child, while the trustee should be good with money management."
Beneficiaries: Name them for your 401(k), IRA and investment accounts. Your will may state that all your money goes to your spouse, but that won't override the beneficiary documents if you've listed someone else.
Durable power of attorney: With this document, you give a trusted friend or family member the legal right to manage your affairs if you are disabled.
Health-care proxy: Also known as a living will, this document enables a family member to direct your medical care if you can't do so yourself.
Living trust: Consider this alternative to a will if you live in a state with slow-moving or costly probate courts. With a living trust, your estate can bypass probate.
Trusts for your children In most states, your kids will control any money put in their name at age 18 or 21. Putting their assets in a trust allows you to dictate when they collect or make sure they use the funds for college, not a convertible.

6. Are you expecting an inheritance?
A quarter of households have received at least one inheritance, according to AARP. The median amount: $49,000. As a boomer, you may see even more. The most affluent boomers (the top 40% by income) get two-thirds of all inheritance dollars, the AARP study found."If you are in line to receive a sizable inheritance, consider the impact on your financial plan," says Ross Levin, a financial adviser in Edina, Minn. First talk to your parents. If they say they hope to leave you money and you feel confident that they've accounted for long-term health-care costs, work this sum into your own plans."The amount may be enough to live on while transitioning to a more flexible career or you may be able to help your own kids with a down payment," says Levin. Or suggest that your parents look ahead to the next generation and help your children with college. If they pay tuition bills directly, that doesn't count against the annual gift-tax-exemption limits.

7. Do you have enough insurance?
You're pushing 50 (or more), but hey, you still feel like you're 40. There's no denying statistics, though, and the numbers show that the odds of developing serious medical conditions rise as you get older. If you delay purchasing or updating certain policies, you may find that coverage has become unaffordable or impossible to get.
Check your protection against this list:
Life: Back in the '80s and '90s, you did the right thing by taking out life insurance to protect your family. They'll still depend on you for another 10 years or more, but is your old coverage generous enough to replace the fatter paycheck you're bringing home today? (Conversely, if you've built up enough assets, you might not need it.) To calculate how much insurance is right for you now, fill out the online worksheet from the Life and Health Insurance Foundation for Education. If you need to buy more, term is almost always your best choice. Compared with a whole life policy, you can purchase more coverage for fewer dollars, and rates have been dropping steadily in recent years. Compare premiums at insure.com or accuquote.com.
Disability: You are far more likely to have a temporary disability than to die prematurely. But few people purchase disability coverage on their own, since annual premiums are typically 1% to 3% of your income. Still, if you don't have a group policy at work - or if you think your next job might not provide it - talk to two or three independent insurance agents to compare policies (the Web isn't much help here).
Homeowners: You've expanded the family room, redesigned the kitchen and turned the basement into a home theater, all while home prices have been skyrocketing around you (at least they were). When is the last time you compared the value of your home with your homeowners coverage? You may need a bigger policy.
Liability: You could be sued for millions if someone slips on your sidewalk or gets rear-ended by your car. As a highly paid professional, you're a more alluring lawsuit target than you were as a penniless 25-year-old. And you have more to lose. That's why in your peak earning years you need umbrella liability coverage, which provides added protection on top of your auto and homeowners insurance. Most people buy a $1 million policy.

8. What do you want to do next?
Call it a midlife crisis or call it sensible planning. But after 20-plus years in the work force, you may be a little restless. In a recent Money Magazine survey, 43% of boomers said the idea of a new job was appealing. Among young boomers, 50% said so."Now's the time to ask yourself," says financial planner Sheryl Garrett of Shawnee Mission, Kans., "do you want to keep doing what you're doing for the rest of your life?" You still have plenty of time to build a new career or launch a business, but you don't want to jeopardize your family's security by trying out random ventures.Your first step should be a career assessment, says Mike Haubrich, a financial adviser in Racine, Wis. Ask yourself: Am I happy? Have I advanced as far as I hoped? What are the prospects for my industry? Maybe you'll decide you're satisfied where you are. If so, keep acquiring new skills and network regularly to stay competitive.Or you may decide you want to switch jobs. Trouble is, an economic slowdown might be the worst time to look for work. So use this time to lay the financial groundwork:
Save more: It takes cash to cultivate your career: for training and college courses, for networking events and to pay expenses during a transition. Says Haubrich: "You have to invest in your career just as you do with your portfolio."
Budget: If you're leaving a corporate job to go solo, price individual health insurance before you leap. Or see if you can switch to your spouse's coverage. Figure out your monthly expenses so you know how much you need to earn. Trim your debt while you still have a steady paycheck.
Do research: Know the value of the retirement benefits you're giving up, including a 401(k) match and a pension. A traditional pension is worth 20% to 30% in higher pay.

9. Are you staying healthy?
Your health isn't something you'd expect to review in a financial checkup. But what could have a greater impact on your retirement security? Your physical condition will dictate everything from your medical bills to how long you can work - in a recent McKinsey & Co. survey, 40% of retirees said they'd left the job earlier than planned largely because of health problems.Unfortunately, the health outlook for boomers is far from bright. Despite a youth that spanned Jane Fonda workouts, spin classes and yoga, many are in poorer health than their parents, says Olivia Mitchell, head of the Pension Research Council at the Wharton School of Business. In a recent national health survey, many early boomers (those who are now in their mid-fifties to mid-sixties) reported difficulty walking one block or climbing a flight of stairs.So what does it take to stay in shape? Just four healthy habits can help you live 14 years longer on average, according to a recent Cambridge University study: eating plenty of fruits and vegetables, regular exercise, moderate drinking and not smoking.As longevity expert Laura Carstensen points out, if you maintain your health, you have nothing to fear from getting older. You'll actually leader a richer and more satisfying life.

Weyerhaeuser posts loss, sees 'erosion'

Lumber company swings to a loss on housing weakness, predicts difficulties will continue through 2008.

NEW YORK (AP) -- Weyerhaeuser Co. said Friday it swung to a fourth-quarter loss as the deteriorating U.S. housing market cut into demand for lumber - a downturn the paper and wood products company expects will continue through 2008.
Federal Way, Wash.-based Weyerhaeuser (WY, Fortune 500) reported a loss of $63 million, or 30 cents per share, compared with a profit of $507 million, or $2.12 per share, a year earlier. Excluding write-downs from housing-related business, restructuring costs and other special items, Weyerhaueser would have earned $90 million, or 42 cents per share, in the latest period.
Revenue fell 18% to $3.94 billion from $4.8 billion.
Analysts polled by Thomson Financial had expected a profit of 35 cents per share excluding items, but forecast higher revenue of $4.13 billion.
Chief Executive Steven Rogel called 2007 a "challenging year" for the paper and wood products industry. Paper demand has been gradually weakened by a shift to the Internet for news, billing, mailing and other information that was once communicated on paper. The housing downturn has made it more difficult for the industry to maintain profits.
"The continuing erosion of the U.S. housing market created very unfavorable market conditions," Rogel said in a statement. He added that the company expects those conditions to continue through 2008.

Recession? Where to put your money now

Gloom in the markets means great opportunities, if you've got courage and patience.
By Shawn Tully, editor at large

(Fortune Magazine) -- Here we go again. Day after day, Americans are being bombarded by a relentless drumbeat of unsettling economic news. The Dow regularly swings by hundreds of points in a single session as it gyrates near bear-market territory. Oil prices keep bubbling toward $100 a barrel. The dollar is crumbling, and a rogue trader in Paris is blamed for triggering a synchronized selloff heard round the world. We're constantly warned that an ugly recession is looming, if not already here. It's all enough to cause a panic attack.
Don't let the doomsday headlines and the careening markets scare you. Take a sip of Chardonnay - or a shot of bourbon - and remember your history. We've been through this kind of wrenching volatility many times before: during the meltdown in October 1987, the S&L crisis of the early 1990s, the Asian Contagion of 1997 and 1998, and most recently, the tech bubble of 2000. These plunges are both predictable - because they're part of the bumpy ride that holding stocks is all about - and unpredictable, because you never know when they'll strike. In fact, stocks offer big returns in the long term precisely because their performance zigzags wildly at times like these. "Investors should be grateful for bear markets, because without them stocks would offer bondlike returns," says Larry Swedroe, a financial advisor with Buckingham Asset Management in St. Louis. So while it's tough to see anything good about this rocky market while watching your 401(k) shrink - the S&P 500 index is off 13% from its high in October, and the Nasdaq has shed 18% - remember that big selloffs present rare and essential buying opportunities, and the current one is no exception.
Still, investors need to temper their courage with caution by picking investments that are genuinely cheap, not just less expensive than they were a year ago. This isn't a shopper's paradise like the early 1980s, when every type of stock seemed to be a screaming buy. But for the first time in years we're seeing lots of genuine bargains, chiefly in beaten-down sectors that have already gone through the equivalent of a steep recession. It's a great time to grab big-dividend-paying bank and pharma stocks, for example. Meanwhile, keep plenty of cash so you can pounce when still-overpriced issues - hint, the tech sector is full of them - spiral downward. It's going to happen: That's why bear markets are a gift to nimble investors.
This story will help you make smart decisions to profit from today's turbulence. We'll guide you through the market noise and Wall Street chatter so that you'll make the right moves at the right times. We'll start by looking at current conditions; then we'll get down to specific stocks, bonds, and funds to buy now.
Wall Street wisdom says that the biggest danger to the markets is the R-word: recession (generally defined as two quarters of falling gross domestic product, but "officially" determined after the fact by the National Bureau of Economic Research). However, the predictions of a deep downturn are highly exaggerated, in part because Washington is rushing to revive the flagging economy. GDP increased 0.6% in the fourth quarter (on first estimate), after a powerful 4.9% surge in the third quarter - so no contraction yet. Exports are booming, growing at an annual rate of 13%, thanks to the weak dollar. The employment picture is surprisingly resilient. Jobless claims, a reliable harbinger of recession, have averaged about 325,000 for the past four weeks, far below the danger point. "We haven't seen the 25% increase in jobless claims we had before the last two recessions," says Michael Darda, chief economist with MKM Partners, an equity trading and research firm. "We're not getting a recession signal."
The forces weighing down the economy are soft consumer spending and plummeting housing prices, along with far more expensive credit that's slowing everything from auto purchases to the creation of new businesses. Those factors are a serious drag on demand. But they pose their gravest threat in the first two quarters of 2008. If we're going to get a recession, it will most likely happen amid this turmoil, in the first half of this year.
But any slump is likely to be short and mild, mainly because Washington is on the case. Since mid-September, Federal Reserve chairman Ben Bernanke has reduced the target for the Fed funds rate by 2.25 percentage points, with the biggest move, a sudden 75-basis-point cut, coming on Jan. 22. On Jan. 30, the Fed cut another half-point, bringing the target to 3%. It usually takes six to nine months for a Fed rate cut to bolster consumer and business spending. By midyear the flood of liquidity will be channeled into new loans for companies and consumers. A resurgence in easy credit - stoking the appetite for everything from big-screen TVs to capital equipment - will be practically irresistible. Consumer spending will get another boost from the roughly $150 billion economic stimulus plan Congress is poised to approve. Checks that could range from $1,000 to well over $2,000 are likely to start going out to families this summer. The easy money doesn't stop there. The Fed has practically promised even more rate cuts. The markets are predicting that the Fed funds rate will be 2% to 2.5% by year-end. With that kind of aggressive stimulus, look for growth to jump back to the 3% to 3.5% range in the second half of the year. Says Brian Wesbury, chief economist at First Trust Advisors: "You simply don't get recessions when the Fed funds rate is at 3% or below, and the Fed is in a strongly expansionary mode."
Those low rates, though, are creating the conditions for a bigger crisis down the road. "The real challenge will be inflation," warns Darda, "not the near-term economic worries that the financial press is harping on." After fretting over surging prices early last year, the Fed is now ignoring them in its all-out campaign to revive the economy. But the threat isn't going away. In 2007 the consumer price index rose 4.1%, the biggest jump in 17 years. The combination of high oil, food, and metals prices, along with low interest rates and growing global demand, is a classic recipe for inflation. "Much higher inflation is practically inevitable," says Carnegie Mellon economist Allan Meltzer. Eventually the market will wake up to the problem, and so will the Fed. "The real danger is in 2009 and 2010," says Meltzer. "The Fed will be forced to raise rates substantially to kill off inflation, possibly causing a recession."
While the economic outlook is highly uncertain, one key fact is not: Stocks are still expensive. Wall Street analysts never tire of telling investors that equities are cheap. They cite the current price/earnings ratios, which indeed appear reasonable. The problem is that corporate earnings are coming off not just a cyclical peak but a historic pinnacle, which makes P/E ratios look artificially low. Until late 2006, average earnings for the stocks in the S&P 500 had jumped by at least 10% over the previous year for 18 consecutive quarters, a feat never before achieved. (Profit margins rose to well above their historical average as well.) Yale economist Robert Shiller has developed a formula that smooths out earnings to remove the cyclical spikes. It shows that stock prices now stand at a lofty 24.5 times earnings - well below the towering 27.5 posted in March but still leagues ahead of the long-term average of around 15.
Now we're ready to get down to business. As an investor, you face two challenges in today's tumultuous market: First, you have to choose bargain stocks while recognizing that the overall averages are still extremely pricey and have plenty of room to fall. Second, you must assemble a portfolio that will protect you from the claws of inflation, while keeping plenty of funds in cash so you can grab the beaten-down buys when they appear. We offer our advice with a big proviso: If you already have a sound, highly diversified portfolio spread across a wide variety of U.S. and foreign large-cap, value, and small-company stocks, you're already positioned to withstand and even profit from market shocks. In that case, we recommend that you do nothing. Simply stay with your plan. But if you're about to start building a portfolio, or if you've just received a big bonus or inheritance, or if you're stuck in high-cost funds guaranteed to sap a huge part of your future gains, even if you're regularly adding to your 401(k), Fortune can guide you to both profit and protection of your money in turbulent times.
Watch those fees
One thing is true in good markets and bad: Investors who pay big fees will fare far worse than those who exclusively buy ultra-cheap funds. Vanguard founder John Bogle, the leading apostle of low-cost investing, estimates that the average actively managed mutual fund absorbs an astounding 2.5 percentage points in expenses (the total of sales charges, management fees, and trading costs) - vs. one- or two-tenths of a point for most index funds and exchange-traded funds. Research shows that index funds perform just as well as actively managed mutual funds before fees, and that after fees, it's no contest. "All the studies show that expenses are the most powerful indicator of a fund's performance," says Russell Kinnell, director of research at Morningstar.
Index funds and ETFs come in all varieties, covering large and small stocks, growth and value styles, foreign and domestic, and everything in between. The most popular are those that cover the whole range of large-cap U.S. stocks, including Vanguard 500 Index (VFINX) and Fidelity Spartan 500 (FSMKX). ETFs are similar to index funds, except that they trade on exchanges like stocks. The Rydex Russell Top 50 (XLG) is a Morningstar favorite that holds the 50 largest U.S. stocks. It's a bit pricier, with annual expenses of 0.2%, but still a bargain.
Dividends can cushion the blow
The big selloff is creating a rare opportunity: a chance to buy big-dividend-paying companies at yields we haven't seen in years. Dividend stocks offer fatter yields when their prices fall - and that's precisely what has happened in sectors as diverse as financial services, pharmaceuticals, and tobacco.
There are lots of reasons to love dividends. They're taxed at only 15% at the federal level, at least until 2010. Unlike the fixed interest payments on bonds, they generally grow with earnings. So yield stocks are a great hedge in America's jittery new world of sharply rising prices, and the ability to pay a consistent dividend signals that the company is healthy. "It shows that management believes the prospects are good," says Lowell Miller of Miller/Howard Investments, a money management firm. (Of course, an unusually high yield can be a warning sign: Citigroup's yield jumped into double digits shortly before the beleaguered bank cut its payout.) For investors, the crucial task is to find solid players that are unloved but boast strong, predictable earnings. Those companies will keep dispensing - and increasing - dividends. If you want growing income for life, now is the time to pounce.
Where do you go hunting for yield? One place to start is pharma. Today Bristol-Myers Squibb (BMY, Fortune 500) and Pfizer (PFE, Fortune 500) yield over 5%, and GlaxoSmithKline (GSK) isn't far behind at 4.5%. A second category is utilities. Here, prices are far stronger, but yields remain attractive: Consolidated Edison (ED, Fortune 500) for example, pays over 5%, and its earnings are solid as granite. A number of big utilities that specialize in energy distribution offer attractive yields, and they're protected from the bumpy economy by regulated rates of returns. Pepco Holdings (POM, Fortune 500), AGL Resources (ATG), and WGL Holdings (WGL) are all paying around 4.3%. A smart strategy is diversifying via ETFs and index funds. Vanguard's SPDR S&P Dividend ETF (SDY) spreads the risk among 52 stocks that have increased their payouts steadily. Current yield: 3.5%.
Buy battered shares, if you dare
If you have a strong stomach for risk, read on. In this section we'll talk about the two most reviled, bloodied sectors in the current carnage - banks and homebuilders. The argument for buying them selectively is compelling, for this reason: They pass the test of being genuinely cheap. When it comes to banks and homebuilders, the market's expectations are extremely low, hence easy to beat. Let's look first at banks. The best buys aren't the Wall Street giants, which depend heavily on highly erratic profits from trading, but the big, diversified players that sell lots of retail products, from credit cards to checking accounts. They've suffered from write-downs too, but the worst is behind them, and the Fed's rate cuts will boost their profit margins on loans. Four excellent picks are Bank of America (BAC, Fortune 500), Wachovia (WB, Fortune 500), Wells Fargo (WFC, Fortune 500), and US Bancorp (USB, Fortune 500). BofA and Wachovia earnings have been dented by bad subprime debt but are still extremely strong. Both stocks are trading at less than 12 times the past 12 months' earnings and boast dividend yields of better than 6%. Wells and US Bancorp skirted most credit problems, yet Wells pays a dividend of almost 4%, and US Bancorp yields over 5%.
True daredevils may want to consider the homebuilders. Keep in mind, stocks usually rebound not when news in a stricken sector gets better, but well before. So it's a good time to start building stakes in the battered builders, a bit at a time, via dollar-cost averaging. Despite all the chaos in real estate, Americans aren't going to stop buying homes in the future, and the future is what counts. We recommend two. The first is Toll Brothers (TOL, Fortune 500) which has lost 60% of its value since 2005. Toll specializes in high-end homes, so it stands to reap excellent margins when markets recover. Our second pick: NVR (NVR, Fortune 500), which is known for innovative, mass-production building techniques and carries relatively little debt.
Look abroad
Want to improve your returns without increasing your risk? One answer is tilting your portfolio heavily toward international stocks. As always with a sound portfolio, the benefits will materialize over a number of years. But the time to start is now. In the past two years foreign stocks have wildly outperformed U.S. equities. European stocks soared at a 23% annual rate in 2006 and 2007, while emerging markets jumped 35% a year. In 2008, however, both markets have suffered sharp corrections, as have equities worldwide. The EAFE index of big-cap stocks worldwide now looks like a bargain: Its P/E stands at under 14, far below multiples in the U.S.
Not all foreign stocks deliver diversification. Players like Sony (SNE) or Unilever (UL) are fully global - they simply mimic the performance of other international colossi like Coca-Cola and IBM. "To get diversification, you need to go to the less liquid part of the market, to small-cap stocks," says Dan Wheeler of Dimensional Fund Advisors, a pioneer in index funds. Why do small caps work best? Because far more of their sales are concentrated in local markets. And since those markets offer very different dynamics from the U.S., they often thrive when America is swooning. The benefits? According to a study by Rex Sinquefield, DFA's co-founder, investing heavily in stocks that track local markets and in value shares yields investors an extra two points of return, without increasing volatility.
With that in mind, we suggest devoting 35% of your equity stake to foreign shares, with about two-thirds going into small-cap and value stocks, via funds like Vanguard International Explorer (VINEX). Divide the rest of your stake between a broad large-cap ETF like iShares' MSCI EAFE Index (EFA) and an emerging-markets entry like iShares MSCI Emerging Markets (EEM). DFA offers a variety of strong choices, available through financial advisors.
Beware of bonds
The problem with most bonds is that they're not paying enough to compensate investors for today's inflation, let alone the surging prices that haunt our future. Right now ten-year Treasuries are yielding just 3.6%, because in these rocky times, many investors are willing to sacrifice returns for short-term safety. As Wharton economist Jeremy Siegel puts it, "There is no value for investors in most bonds."
Indeed, for your fixed-income portfolio, only two choices make sense: municipal bonds and Treasury Inflation-Protected securities, widely known as TIPs. Now is an ideal time to buy munis. Bonds issued by state and local authorities in New York and California pay around 3.3% and are exempt from federal taxes (and local levies if you live in those states). That's the equivalent of a pretax return of almost 5%, far above the yield on Treasuries. For a diversified blend of munis, an excellent choice is Vanguard Intermediate-Term Tax-Exempt (VWITX), which boasts a yield of 3.4% and fees of just 15 basis points.
With increased inflation almost a sure thing, TIPs are an essential. They are the only investment guaranteed to keep pace with inflation. The face value of each TIP is adjusted every six months to reflect the change in the CPI. You can buy TIPs online the same way you buy Treasuries, with no fees. Simply log in to treasurydirect.gov. And Fidelity, T. Rowe Price, and Vanguard, among others, offer TIPs funds.
Finally, let's deal with cash. The best place to park it is in CDs. Even though the Fed is chipping away at short-term rates, the yields on CDs are holding up amazingly well. The reason is that banks are competing ferociously for funds, especially now that longer-term lending rates are rising. The key is to stay in maturities of six months or less - and shop around. Corus of Chicago, for example, is paying 4.1% on a six-month CD. That term is just about right. If rates rise, you can quickly move your cash into CDs or bonds that yield more.
Winning in these treacherous times is as much about psychology as following the rules. It takes guts to be daring when markets are melting down. But that's the quality that makes great investors. As Warren Buffett says, "Be fearful when others are greedy and greedy when others are fearful." Now's a time when greed, Buffett-style, is good. Just make sure your greed is highly selective.

Refinancing: Only for the privileged few

Sure, now is a great time to refinance - that is, if you can still qualify. Here is what lenders are looking for.

NEW YORK (CNNMoney.com) -- The good news: mortgage rates are down. The bad news: it's much harder to qualify for a refinanced loan these days.
What's more, the borrowers who need to refinance the most - because their adjustable rate mortgages (ARMs) are resetting to higher interest rates - are among those having the most trouble winning approvals.
"I'm turning away about 60% to 75% of the clients who come to me for a refi," said Bob Moulton, president of Americana Mortgage Group on Long Island, N.Y. "Some don't have enough equity and others have bad credit scores."
During the boom years, lenders approved most anyone with a pulse. Not so today. Mortgage brokers recognize this and are now being very selective about the clients whose applications they choose to submit to the likes of Wells Fargo or Bank of America.
If an applicant has poor credit, or a home whose value is rapidly deteriorating, they're just not going to bother.
"If the person is Sweet Polly Purebread - good income, good assets, high credit score - there's money out there," said Moulton. "But if not, then it's harder."
Interest rates are way down - 5.67% is the going rate for a a 30-year fixed loan this week, according to Freddie Mac. That has generated a spike in refinancing applications.
Total mortgage applications were up 73% last week compared with the same period 12 months ago, according to the Mortgage Bankers Association (MBA), and 69%of those applications were from borrowers seeking to refinance. Last February, when interest rates were about 6.3%, about 46% of applications were for refis.
The make-or-break metric for anyone looking to refinance right now is home equity - the difference between what is owed on a house and what the house is worth. But with home prices down, many homeowners have little of that precious commodity left.
"If you have an 80% loan, with a 10% home equity loan, you may not be able to refinance," said Peter Grabel, a mortgage broker in Connecticut - especially in down markets.
Consider a homeowner who bought in Miami a year ago with 20% down. Home prices have fallen 15% there in the past year, wiping out three-quarters of the equity. Lenders, who want collateral that's worth more than the value of the loan, are wary about having so little cushion. If they have to repossess and resell the house, they're on the hook for a big loss.
"No lender would take that deal," said Marc Savitt, president of the National Association of Mortgage Brokers. "It's a lot different from two years ago."
The bar has also been raised for credit scores when it comes to refinancing, according to Grabel. And sometimes, it's not a matter of whether someone can get refinancing but at what price.
"Those with high credit scores are getting very good rates, but the lenders have heightened the requirements to qualify," said Grabel. Instead of a score of 680 for the best rate, a borrower might need 700 now.
For example, Grabel has a client who wants a cash-out deal. The client has lots of equity in his house but a dismal credit score - 552.
"I used to have 20 lenders I could send him to; now there's maybe one," said Grabel. "The rate, though, will be high, higher than what he's paying now."
The only reason that this client will take the deal is because he's going through a divorce and needs to buy out his wife. He doesn't have time to rebuild his credit rating, but he's lucky that at least his house appraises well.
Indeed, appraisals are another tool that lenders are using to eliminate unqualified applicants.
"It used to be a formality," said Grabel. "Now it's, 'Lets do the appraisal first and see what value comes in." Lenders are scrutinizing them to a degree unheard of during the boom. They don't want to lend $160,000 on an appraised value of $200,000 unless they're sure the house is truly worth that.
Ted Grose, a past president of the California Association of Mortgage Brokers, said lenders now often conduct what he called "bench reviews" of appraisals. "They have an experienced, independent third-party go over the appraisal to make sure the numbers are accurate," he said.
Grose called many of the applicants he sees "very challenging, mostly because of high loan-to-value ratios."
Many of these people took exotic loans to get into high-priced properties. They used hybrid ARMs that are resetting to higher rates, or interest only loans.
Particularly deadly are option ARMs, which act as negative amortization loans; the payments don't even cover the interest and the balance grows over time. Combine that with falling home prices, and the loan balance may be more than the home's market value.
Under those circumstances, said Grose, few borrowers can be helped.