Home financing does have its tax benefits, though, especially if you refinanced for a low rate or bought or sold a home in 2002. Here’s what you need to know.

How Low Can You Go?

With interest rates as low as 4% on some loans, 2002 was the year of the refinanced mortgage. Many people refinanced more than once.

For the most part, the tax reporting process is pretty straightforward. But if you paid points on a refinanced loan, pay attention.

Points are charges paid by a borrower to secure a lower rate. Each point costs about 1% of the loan. Sometimes called “loan origination fees,” “maximum loan charges” or “premium charges,” points are out-of-pocket charges and you can deduct them.

The issue is when. In most instances, points from a refinancing are deductible over the life of the loan, says Mark Luscombe, principal federal tax analyst with CCH, an Illinois-based provider of tax information to professionals. So if you refinanced in 2002 and paid $1,000 in points on a 10-year loan, you could deduct $100 each year starting this April.

The deduction schedule is more advantageous on original mortgage loans. Those points are fully deductible in the year you get the loan.

If you got caught up in the frenzy and refinanced a refinanced loan (like yours truly), then the portion of the points that had not been deducted from the first refinance are fully deductible now, says Martin Nissenbaum, national director of personal-income-tax planning at Ernst & Young. Any points you pay on the new refinancing must be deducted over the life of the loan again.

There’s a groovy little exception to that rule, though.

The IRS put out a statement at the end of 2002 stating that if you refinanced and took extra money out to do work on your home, you can deduct a portion of the points you paid that are attributable to your home improvements, says Mr. Nissenbaum.

We need an example. Say your mortgage was $70,000 and you decided to refinance that amount in 2002 to lock in a lower interest rate. This time, though, you took $100,000 to build your dream kitchen. You paid $1,000 in points on that new loan. Since $30,000, or 30% of your loan, is going toward home improvements, you can deduct 30%, or $300, of the points you paid, on your 2002 tax return. The remaining points will be deducted over the life of the loan.

Where do you report all these points? On line 10 of your Schedule A – Itemized Deductions, along with your deductible mortgage interest, which we’ll tackle next.

Tally that Interest

As long the amount of your mortgage (original or refinanced) is $1,000,000 or less, any interest you pay on that loan is fully deductible, as long as your house secures the loan and you use the house as your principal or secondary residence.

If, instead, you decided to take out a home equity loan to build that dream kitchen, which just about everyone I know (except yours truly) did last year, your interest is deductible on a loan of up to $1,000,000 as long as the proceeds of that loan are used to acquire, construct or improve your home.

If you took a home equity loan to pay for junior’s college education and buy that 1972 Corvette you’ve had your eye on, the interest on that loan is only deductible on the first $100,000 of the loan’s principal, says Rande Spiegelman, VP of Financial Planning at the Charles Schwab Center for Investment Research.

Interest paid on mortgages and home equity loans is reported on Form 1098. But if you refinanced, you’ll receive two Form 1098s this year (or more if you refinanced more than once in 2002), even if you refinanced with the same bank. So be sure to pick up both numbers when reporting your mortgage interest on line 10, Schedule A.

If you borrowed money from someone other than a bank, e.g. your seller financed the deal, those lenders may not be required to send you a 1098. While you are still eligible to deduct any qualified interest, you’ll need to explain the situation to the IRS on your tax return, notes Mr. Nissenbaum. That unreported interest goes on Schedule A, line 11 and requires the name, address and ID of the person who made you the loan.

Trading Places

Even though the prices of homes were, uh, through the roof, people still bought and sold plenty last year. Sales create lots of tax fun.

Let’s say you sold your home in 2002. If, during the preceding five-year period, you owned that home for at least two years and lived in it as your main home for at least two years, you will not owe tax on up to $250,000 of gain from the sale as a single person and up to $500,000 as a married couple.

So if you bought your home for $300,000 and sold if for $500,000, the $200,000 is tax-free money to you as long as you meet the above rules.

That’s good stuff.

Be careful when calculating your actual gain, though. While it may seem that you just subtract the price you paid for the home from the sale price, there are other factors.

To start, improvements you made to your house over the years add to your original cost, so factor in that new roof and extra bedroom.

Then be sure to subtract from your gain all the ancillary costs you incurred to sell the place. Those include advertising, legal fees and sales commissions. So if you grossed $200,000 on the sale of your house but spent $30,000 to do it, you really only have $170,000 in your pocket.

On the buyer’s side, while none of those annoying out-of-pocket fees are deductible, they should be added on to the cost of the property you’re buying. So keep track of things like legal fees, settlement and closing costs, title insurance, surveys, and transfer taxes.

On a More Morbid Note

If you die and leave your home to someone, that person will inherit your home at its fair market value, reminds Mr. Luscombe. The technical folks say the beneficiaries received a “step-up in basis.” That means if you bought your home in 1950 for $20,000 and it’s worth $500,000 today, the lucky person inheriting your home after you’re gone will never pay tax on that $480,000 gain. This perk is set to expire in 2010 when the estate tax disappears, so if you’re going to die, do it within the next few years.

Hey, you do what you can to beat out Uncle Sam.

One thing’s certain: Hedge funds have become an integral part of financial markets. So are they good, evil, or a bit of both? And is their explosive growth just a fad or a permanent shift?

To answer both questions, it is worthwhile to look at the reasons why hedge funds appear to have come so forcefully to the fore, having grown their assets to a little over $1.11 trillion from just $40 billion a decade ago.

There is both a supply and a demand component.

The demand comes from pension funds and other institutional investors. Earlier this year I spoke at the annual conference for Commonfund, a not-for-profit company that manages about $30 billion in mostly small-to-midsize university endowment money. The sessions on hedge funds and alternative investments were standing-room only. The talk at the tables over lunch concerned the terrific returns earned by the Yale and Harvard endowments through skillful use of alternative investments.

To understand the reason for the heightened interest, you have only to look at stock-market returns over the past several years. You’ll see a lot of negatives. Many of these endowments and pension funds are required to distribute some of their funds each year, to be used for scholarships or sports or endowed chairs. Negative returns on their investments mean they are cutting into principal. That just couldn’t last long.

They went searching not so much for higher returns as more even returns. “One of the reasons that pension funds are moving money toward hedge funds, is because they’ve now sort of changed their objective to producing a more consistent return year after year,” says Bob Prince, co-chief investment officer for Bridgewater Associates, which has $115 billion under management and is one of the nation’s biggest hedge funds.

So what was attractive about hedge funds, then, was both higher returns and investments in alternatives that weren’t correlated to the stock market.

The demand for these hedge-fund services hit at just about the same time that there was an increase in supply for those who would offer them. Recall the two critical investment mantras from the 1990s: that markets were instantly efficient and couldn’t be beaten and, therefore, the best way to invest was to buy and hold. Along came “benchmarking” which acted like a ball and chain around the necks of investment managers. Beating the benchmark became the be all and end all. And the best way to beat or at least match the benchmark was to hold a preponderance of the securities in that benchmark index.

“What happens is that we as an industry have tended to force kind of good investment managers into a smaller and smaller boxes,” said Verne Sedlacek, CEO of Commonfund. “The investment managers tend to look at that and say, ‘Well, that doesn’t make any sense. I can go out and I can invest in growth stocks, I can invest in value stocks, I can invest in emerging markets. I can see a great opportunity here. And as a result, I can add value for my client by being much less constrained.’”

Changes on Wall Street have also driven the move of top investment managers from the big firms to hedge funds. The shift from partner to public ownership has made many big investment banks more concerned about quarterly earnings and less willing to accept the kind of volatility that can accompany hedge-fund like trading.

Says Mr. Sedlacek, “A lot of what the hedge funds are doing today are things that were formerly done by proprietary desks at the large investment banks… when you go back to the heyday of partner-based Wall Street, that’s a lot of what they did.”

These managers are not, strictly speaking, trying to beat any benchmark (although they are more than happy to tell you when they do.) They market their ability to provide investors with what they call “absolute return” — a profit year after year that isn’t related to the vicissitudes of the stock and bond market.

It is no small part of the motivation that the fees in the hedge-fund world often equal 2% of the assets under management — and then 20% of the gains. Finance professor William Goetzmann says the fee structure is significantly different from how mutual funds are organized.

“Mutual-fund managers are really compensated if they are able to attract assets under management,” Mr. Goetzman said. “Now if you’re a really hot manager and your performance increased 25% year, then the money will flock into the fund and you’ll get some payoff for that. But it’s not a direct one-for-one relationship. The mutual-fund industry is often called an asset-gathering industry rather than an industry dedicated to making high rates of return.”

But for hedge funds, “You have to be able to deliver the goods if you’re going to make the big bucks.”

So we arrive at an answer to one of the questions: Will hedge funds stick around? As long as the investors are willing to pay the fee structure, as long as big institutional money has reason to seek returns that aren’t correlated with the stock market and as long as big investment banks shy away from some of this business, hedge funds will be here to stay.

As to the second question, there is more debate. Former New York Federal Reserve Bank President Gerald Corrigan told me in an interview that he doesn’t believe another meltdown like Long Term Capital Management is likely. Mr. Corrigan is now at Goldman Sachs and heads a private-sector group, The Counter-Party Risk Management Group II, set up to offer guidelines for assessing risk in the derivatives market that is often the playing field for hedge funds. He believes the finance world has learned much from the LTCM meltdown and that leverage in the hedge-fund industry is not as great as it was.

Yet he acknowledges that there is simply no way for any individual banker or regulatory agency to know and he wouldn’t rule out a significant shock from a hedge-fund blowup. The best regulators can do is try to limit both the concentration of a single banks’ lending to a single fund and into a single asset class or trade.

By using leverage and trading spreads between asset classes, hedge funds tend to make our market more efficient. This can show up in everything from low interest rates to lower volatility in the stock market such as we’ve had during the past several years.

Which brings us to our next answer. The dominant principle of this column has always been the idea that there is no free lunch. And we must understand what we pay in economic terms for some benefit we receive, as well as understand the benefits we receive from what we have paid.

When it comes to hedge funds, we accept the lower volatility and the tighter spreads — between such things as the interest rate on corporate bonds and Treasurys that can lower borrowing costs for companies — that come from their investments. To enjoy that benefit, we pay a price in uncertainty that comes from the opacity of hedge funds.

Why International?
Most investors tend to invest in what they know. This isn’t necessarily a bad thing as it’s important to have a good understanding of your investments; however, it becomes detrimental when the blinders are put on and people refrain from learning about other investments. International investing, in particular, is a strategy sometimes overlooked by investors as a means of diversification.

With all the volatility found in stock markets, it’s difficult enough to pick winning stocks let alone winning economies. This is where diversification through international investing can help. Every year, the economic performance of a country will fluctuate and this undoubtedly affects the stock market. By buying securities in different markets as opposed to purchasing only U.S. stocks and bonds, you can reduce the impact of country or region-specific economic problems.

Different Types of International Investments
There are numerous ways in which the ordinary investor can invest in foreign markets without having too much trouble. Here are a few of the major types offered by most brokerages.

American Depositary Receipts – ADRs
American depositary receipts are used by foreign countries unable to list on the NYSE or Nasdaq, which have domestic country regulations. ADRs mimic their domestic stocks very closely and offer you a way of investing internationally without actually buying stock from a foreign exchange. One popular ADR found on the NYSE is Nokia (NOK). This company tracks it parent stock on the Helsinki Exchange almost identically, allowing investors the convenience of international diversification without actually leaving American exchanges. (To learn more, see What Are Depositary Receipts?)

Exchange-Traded Funds (ETFs)
These investments offer a wide variety of international flavors. You can buy ETFs that track most of the major foreign indices, and they allow investors to obtain a return based on a specific foreign market without having too great of an exposure. Also, because they trade and work like any other ETF, they aren’t expensive to trade and are relatively liquid. (To learn more, see Introduction to Exchange-Traded Funds.)

International Funds
International stock funds are comparable to international ETFs as they also provide for diversification but have same drawbacks and benefits that are associated with regular funds and ETFs. One thing to remember is that in these international funds, a hired professional portfolio manager is in charge and decides what to place in the portfolio. Be sure you do your research before buying such a fund to make sure that these investments and the trading strategy of the fund are in line with your preferences.

Foreign Securities
Many brokerage firms will offer investors the ability to buy investments from different countries directly from the brokerage’s international trading desk. So, if you wanted to buy a stock in a company that doesn’t trade on American markets, you can inquire with your brokerage to see if it will facilitate the trade for you through one of the brokerage’s affiliated international companies that has a membership on the foreign exchange or market. Because these trades are typically more expensive and less liquid than regular domestic trades, you should carefully check out all the other alternatives before you decide to do it this way.

Eurobonds
Not recommended for the beginner investor, these are bonds issued in foreign markets by domestic companies. An example of this would be if Sony were to issue a bond that matures in yen for American investors. Eurobonds don’t always offer higher yields than domestic bonds, and they are only as secure as the company issuing them, but they are a way you can participate in a foreign fixed-income market. One of the main reasons that beginner investors should be wary of these bonds is that they pay a foreign currency that the investor will probably have to exchange.

Conclusion
Aside from allocating assets amongst different securities and industries, international investing is a good alternative for diversification. It reduces the impact investors experience from the downturn of a specific economy and helps to increase returns on portfolios concentrated in domestic markets that are no longer growing at a rapid rate. Furthermore, the availability for international products has increased dramatically with the globalization of equity markets, so even the average investor can take advantage of the benefits without paying too much. Before you decide upon diversifying internationally, be sure you research your investment closely so that you can make an informed decision.

-What services do you offer? The services a financial planner offers depend on a number of factors including credentials, licenses and areas of expertise. Generally, financial planners cannot sell insurance or securities products such as mutual funds or stocks without the proper licenses, or give investment advice unless registered with state or Federal authorities. Some planners offer financial planning advice on a range of topics but do not sell financial products. Others may provide advice only in specific areas such as estate planning or on tax matters.

-What are your qualifications? The term “financial planner” is used by many financial professionals. Ask the planner what qualifies him to offer financial planning advice and whether he is recognized as a CERTIFIED FINANCIAL PLANNER professional or CFP practitioner, a Certified Public Accountant/ Personal Financial Specialist (CPA/PFS), or a Chartered Financial Consultant (ChFC). Look for a planner who has proven experience in financial planning topics such as insurance, tax planning, investments, estate planning or retirement planning. Determine what steps the planner takes to stay current with changes and developments in the financial planning field. If the planner holds a financial planning designation or certification, check on his background with CFP Board or other relevant professional organizations.

-Will you be the only person working with me? The financial planner may work with you himself or have others in the office assist him. You may want to meet everyone who will be working with you. If the planner works with professionals outside his own practice (such as attorneys, insurance agents or tax specialists) to develop or carry out financial planning recommendations, get a list of their names to check on their backgrounds.

-What is your approach to financial planning? Ask the financial planner about the type of clients and financial situations she typically likes to work with. Some planners prefer to develop one plan by bringing together allof your financial goals. Others provide advice on specific areas, as needed. Make sure the planner’s viewpoint on investing is not too cautious or overly aggressive for you. Some planners require you to have a certain net worth before offering services. Find out if the planner will carry out the financial recommendations developed for you or refer you to others who will do so.

-How much do you typically charge? While the amount you pay the planner will depend on your particular needs, the financial planner should be able to provide you with an estimate of possible costs based on the work to be performed. Such costs should include the planner’s hourly rates or flat fees or the percentage he would receive as commission on products you may purchase as part of the financial planning recommendations.

-How will I pay for your services? As part of your financial planning agreement, the financial planner should clearly tell you in writing how she will be paid for the services to be provided.

-Have you ever been publicly disciplined for any unlawful or unethical actions in your professional career? Several government and professional regulatory organizations, such as the National Association of Securities Dealers (NASD), your state insurance and securities departments, and CFP Board keep records on the disciplinary history of financial planners and advisers. Ask what organizations the planner is regulated by and contact these groups to conduct a background check. (See listing at right.) All financial planners who have registered as investment advisers with the Securities and Exchange Commission or state securities agencies, or who are associated with a company that is registered as an investment adviser, must be able to provide you with a disclosure form called Form ADV Part II or the state equivalent of that form.

-Could anyone besides me benefit from your recommendations? Some business relationships or partnerships that a planner has could affect her professional judgment while working with you, inhibiting the planner from acting in your best interest. Ask the planner to provide you with a description of her conflicts of interest in writing. For example, financial planners who sell insurance policies, securities or mutual funds have a business relationship with the companies that provide these financial products. The planner may also have relationships or partnerships that should be disclosed to you, such as business she receives for referring you to an insurance agent, accountant or attorney for implementation of planning suggestions.

This difference is the reason behind the first main advantage of bonds: investing in debt, in general, is safer than equity. The reason for this is the priority that debt holders have over shareholders. If a company goes bankrupt, debt holders are ahead of shareholders in the line to get paid. In a worst case scenario such as bankruptcy, the creditors (debt holders) usually get at least some of their money back, while shareholders often lose their entire investment.

Those just entering the investment scene are usually able to grasp the concepts underlying stocks and bonds. Essentially, the difference can be summed up in one phrase: debt vs. equity. That is, bonds represent debt and stocks represent equity ownership. (If you are unfamiliar with the differences between these two securities or need a quick refresher on the subject, check out the stock and bond tutorials.)

On the other end of the safety spectrum, bonds from the U.S. government (Treasury bonds) are considered “risk free.” (There are no stocks that are considered as such.) If capital preservation, which is a fancy term for “never losing any money,” is your goal above all else, then a bond from a stable government is your best investment. Now, keep in mind that although bonds are safer as a general rule, that doesn’t mean they are all completely safe. Very risky bonds are referred to as “junk bonds” and you can learn more about them in this article.

If history is any indication, stocks will outperform bonds in the long run. However, bonds outperform stocks at certain times in the economic cycle. Investors who diversify their portfolios by including bonds are able to stabilize returns when the stock market is lagging. The chart below summarizes time periods in which bond returns were much higher than stock returns.

Slow and Steady Predictable Returns

There are always conditions in which we need security and predictability. Retirees, for instance, often rely on the predictable income generated by bonds. If your portfolio consists solely of stocks, it would be quite disappointing to retire two years into a bear market! Imagine that you retired at the end of 1999 and your portfolio was strictly composed of stock. According to the numbers in the chart above, your portfolio would’ve dwindled by almost 50% in three years! By owning bonds, retirees are able to predict with a greater degree of certainty how much income they’ll have in their golden years. An investor who still has many years until retirement has plenty of time to make up for any losses from periods of decline in equities.

Notice that it wasn’t so much that bonds improved when the stock market was down; they just didn’t crash like the stocks did. It’s not unusual at all for stocks to lose 10% or more in a year, so when bonds comprise a portion of your portfolio, they can help smooth out the bumps when a recession comes around.

Sometimes bonds are just the only decent option. The interest rates on bonds are typically greater than the rates paid by banks on savings accounts. As a result, if you are saving and you don’t need the money in the short term, bonds will give you the greatest return without posing too much risk.

Better Than the Bank

How Much Should You Put Towards Bonds?

College savings are a good example of funds you want to invest to help increase your savings and protect them from risk at the same time. Simply putting money in the bank is a start, but it’s not going to give you any return. With bonds, aspiring college students (or their parents) can predict their investment earnings and determine the amount they’ll have to contribute to accumulate their tuition nest egg by the time college rolls around.

Conclusion

There really is no easy answer to this question. Quite often you’ll hear an old rule that says investors should formulate their allocation by subtracting their age from 100. The resulting figure indicates the percentage of a person’s assets that should be invested in stocks, with the rest spread between bonds and cash. According to this rule, a 20 year old should have 80% in stocks and 20% in cash and bonds, while someone who is 65 should have 35% of assets in stocks and 65% in bonds and cash. That being said, rules of thumb are just that. Determining the asset allocation of your portfolio involves many factors including your investing timeline, risk tolerance, future goals, perception of the market, and income. Unfortunately, exploring the various factors affecting risk is beyond the scope of this article.

As you can see from the accompanying graph, high yield bonds now pay north of 18% a year. The yields have shot up in recent months as a sickening economy has increased worries that marginal firms may start defaulting on their bonds. To compensate for the extra risk, investors are demanding higher and higher yields.

Junk bonds are issued by firms with shaky credit the ones that have to pay extra to convince investors to lend them money. These bonds arent officially labelled as junk, of course. Theyre more politely known as high yield bonds.

If youre intrigued about the potential of this market, forget about buying individual bonds. The risk is high that youll guess wrong and pick a dud. Instead, buy a diversified selection of bonds. The iShares iBoxx $ High Yield Corporate B. (HYG) is an exchange traded fund that trades on the New Y. Stock Exchange. It gives you exposure to a wide range of high yield bonds and charges only 0.5% per year in fees. If you prefer to rely on a managers expertise, Chou B. fund is a good pick even if its management expense ratio is 1.34% per year. Just remember, high yield bonds arent for the faint of heart and most people should only put a small fraction of their portfolio into them.

The current yields look very tempting indeed. During the last two recessions the default rate for these bonds peaked near 12%, which suggests that at their current prices, highyield bonds offer a healthy margin of safety even in a nasty recession.

How do you make money from this? Anyone who offers to help you manage your cash is looking for a piece of it. Bank employees are encouraged to push bank products. Financial advisers earn hidden fees for selling you mutual funds. Bestselling authors have to tantalize readers with the prospect of huge returns to sell their books. The more willing someone is to explain how he makes money from helping youand the more specific he is about how much hes makingthe more trustworthy he is. A good adviser will disclose what his fees are for selling you a mutual fund or buying a stock for your portfolio. He will also be happy to show you how much each mutual fund is charging you in the way of management fees, or MERs.

This is when you begin to realize that the most fundamental investing skill of them all is the ability to recognize who you can trust and who you cant. Like a poker player, you have to be able to detect the bluffers from the people who truly do hold a good hand. Here are five questions that you should ask anyone who wants to help manage your money:

What else should I read? If the experts answer is to grab a sheaf of marketing materials and push them into your hand, you should cross that person off your list. Genuine experts will welcome your interest and suggest some fine background reading. Some excellent books are A Random Walk Down W. Street by B. Malkiel, Winning the Losers Game by C. E., Buffett: The Making of an American Capitalist by R. Lowenstein and Contrarian Investment Strategies by D. Dreman.

What are your qualifications? A surprising number of supposed financial experts have no qualifications. Oh, sure, theyll hand you a line about how they graduated from the school of hard knocks, but thats not real knowledge. You should steer clear of any financial adviser who doesnt possess the Certified Financial Planner (CFP) qualification and ignore any money manager who doesnt possess the Chartered Financial Analyst (CFA) designation. If youre assessing authors, prefer those with PhDs in finance, especially those that teach at top universities.

What do you think of index funds? Lowcost index funds beat 75% of actively managed mutual funds over time. Not everyone is a fan of indexing, but any financial adviser should be willing to discuss indexing with you. If he or she wont, look elsewhere.

What returns can I expect? Be suspicious of anyone who talks glibly of 12% a year returns or better. Mutual funds that invest in Canadian and U.S. stocks have returned 9% a year or less over the past couple of decades. Funds that invest in Canadian bonds have returned about 7.5%. Those returns have come during an unusually prosperous time for both markets. A reasonable expectation for your portfolio is 6% to 8% a year.



I started by saving $300 a month when I was 32, but you could start later if you’re willing to save more. I opened a discount brokerage RRSP account at my bank and chose a couple of low cost balanced mutual funds to invest in. I set up an automatic transfer from my chequing account, so that twice a month when my paycheque was deposited, $150 was immediately whisked away and invested.

To make your own million, it’s better if you start young. If you have 30 years before you retire, you’re very lucky. You may not be flush with cash, but you’re rich in time. All you have to do is save about 10% of your salary each year, invest it automatically in a low cost portfolio that’s heavy in stocks, and wait.

That’s quite a bit short of a million, but I had done the hardest part: I had started. To make my million, all I had to do next was gradually increase the amount I saved each month as I made more money. It’s easy to increase the amount you save when you get a raise, because even after bumping up your savings, you still have more left over to spend than you did before. Now I have only 28 years left until I retire, but I’ve increased the amount I save every month so I’m on track to make my million.

Then I surfed over to the online Vancity savings calculator to see how I was doing. (Go to www.vancity.com, click on my money, then tools & calculators, then online calculators, then savings calculator.) I entered my facts: I had 33 years to go until I retired at 65, I was saving $300 a month, and I hoped for a 7% return. The savings calculator told me I was on my way to a nest egg of $440,000.

For instance, if you were making $75,000, your double your salary mark would be $150,000. If you had that much in your portfolio and you were saving 10% of your salary each year, in one year your savings would grow by $18,200 (assuming a 7% return). Of that growth, $7,500 would be due to your contributions and a full $10,700 would be from investment growth. If you reach that point by your early 40s, you’re well on your way to becoming a millionaire.

The most difficult period is up until you reach the double your salary mark. Before that point, most of your growth comes from your deposits, so your portfolio sometimes seems to be treading water. However, once you have double your salary in your portfolio, youll be delighted to find that most of your growth is produced quickly and easily by the magic of compounding.

If you invest in the markets, you should invest in an RRSP to reduce the drag from taxes, and choose a low cost portfolio to reduce the drag from fees. I recommend our Classic Couch Potato Portfolio, which has the lowest fees going, and has produced an average annual return of 11.8% since 1976. Or you could go with a low cost balanced mutual fund. Find out more about the Couch Potato and check out our latest mutual fund ranking.

Getting an investment return of 7% a year is tough, but it’s certainly not impossible. I recommend investing in a portfolio that’s at least 60% stocks, because stocks have beat every other type of investment over the long run. Yes, real estate has been on fire lately, but it has its cold periods, too. Toronto, for instance, has seen average home price increases of only 2.4% a year after inflation since 1980, even with the recent run up.

Since my saving is on autopilot, I rarely even think about it. But if my resolve ever falters, I just go back to that Vancity calculator to check in on my plan. So far, it’s doing just fine. In fact I’ll be able to finish paying off some debt this year, so I’ll have an extra $250 a month to play with. I could easily spend the cash, but the calculator tells me that saving it might be worthwhile. If I do, I’ll retire with $1.3 million.

The longer you save, the easier it gets, because it’s near the end that your money really balloons. In the last few years, your portfolio will be rocketing up by more than $70,000 a year.

Thanks to a healthy economy and a booming real estate market, REITs have produced sizzling returns over the past five years, with most achieving gains of more than 20% a year. Calloway REIT of V., Ont., which owns 1.7 million sq m of space in shopping centres across Canada, tops the pack with an amazing 81% annual return since 2002, but even the median performer among Canadian real estate trusts achieved a 25.5% total annual return over the last five years.

Fortunately, there is an easier way to become the next D. Trump. Rather than buying rental units directly, why not invest in property through Real Estate Investment Trusts? REITs are professionally managed trusts that buy investment properties such as hotels, apartments, office towers and warehouses. They rent out these properties and generate cash for investors. In effect, you get to be a landlord without ever having to paint a kitchen or evict an ornery tenant. If rents go up, you benefit just as you would if you owned the property directly. And if times turn tough, REITs offer you the benefits of geographical diversification. Since most real estate trusts own dozens if not hundreds of properties scattered across the country, a downturn in one market isn’t as disastrous for them as it would be for a landlord with just a single property.

REITs can still be attractive investments, but you should approach them with caution. Before buying, take a moment to add up the amount of real estate that you already hold. If you’re a homeowner, consider how exposed you want to be to the vicissitudes of the property market. In general, it’s not a great idea to have more than 33% of your total assets in real estate — if you own a home, you may be over that mark already. On the other hand, if you’re renting while you save up for a home, and you’re concerned that real estate prices will keep going higher, you can buy real estate trusts as a partial hedge against soaring property prices — if home prices go higher, so, too, should the value of your REITs.

Can REITs keep producing double digit returns? The short answer is that it seems unlikely. The gradual decline in long term interest rates over the last few years propelled many of the recent gains in real estate trusts and it’s difficult to see how rates can go much lower than current levels. Another factor that helped REITs in recent years was massive buying by large pension funds, which came around to the notion that real estate was a good long term diversifier against the ups and downs of the stock market. That factor, too, appears to have largely run its course.

Most investors’ eyes will immediately shoot to the column labelled “Distribution yield.” This is the percentage of your purchase price you’ll get back each year if the trust maintains its current distribution. A distribution yield of 10% on a trust that sells for $20 a unit implies you’ll get $2 a year in cash payouts.

Right now, the REIT party is going strong and prices are high. So bide your time and wait, if need be, for the right buying opportunity. You may be glad you did. Some REITs are facing an uncertain future because of the federal government’s decision last fall to crack down on income trusts. The government initially announced that most REITs were to be exempted from the new rules — but since then many trusts (including Calloway, RioCan, and IPC U.S.) have discovered that they may be clipped by the changes after all, depending on how the final REIT exemption is worded. REITs that hold hotels, retirement homes, and non Canadian properties face the greatest risk of being hit. Some may have to restructure, and a few could be hurt.

Tax matters, too. A distribution may be made up of many types of cash — capital gains, return of capital, or operating profit. Since each of these sources of cash is taxed differently, two trusts with the same distribution before tax can wind up putting significantly different amounts in your pocket after tax depending on exactly what makes up the distribution. Before buying any REIT, you should figure out the true after tax distribution in your own case. Don’t rely on generalizations.

Before you buy any REIT, make sure you know how it stacks up against its peers. You can assess a good cross section of Canadian real estate trusts in Realty roll call below. In compiling the table, we stuck to trusts for which we had a large amount of information.

One good reason to pay attention to these upstart economies is their sheer size. The four biggest of the emerging nations are Brazil, Russia, India and China, which are often referred to collectively as the BRIC countries. Just like a true brick, the BRIC countries pack a wallop. China and India are the world’s two most populous nations; Russia and Brazil also rank in the top 10, with populations many times that of Canada.

The BRIC countries are just the beginning of what’s available outside the developed world. The emerging markets category ranges from Poland to South Korea to Mexico to South Africa. Taken together, emerging markets now represent about a quarter of the global economy. Since 2001, their economic growth rate has been triple the growth rate of developed economies. Stock markets in these emerging market economies have churned out 21%-a-year gains over the past three years.

Strangely, though, Canadians don’t seem much impressed by this sizzling growth. Emerging market equities represent less than 1% of the money held in Canadian mutual funds. I fear that Canadians are simply not recognizing the new realities of the marketplace.

The most common objection I hear to investing in emerging markets is that these markets are too volatile. To some degree, I can sympathize with the complaint. Last summer, emerging market equities lost 25% of their value in less than two months. They subsequently regained all their losses, but their temporary plunge was scary.

The unfortunate reality is that you can expect more of the same. Emerging markets involve risk. Brazil and Mexico suffer from social imbalances and inefficient tax systems. Russia is moving back towards autocracy. India has to deal with inflation and a growing current account deficit. China is still a communist country where the rule of law is unpredictable.

But the problems don’t outweigh the potential. The key to investing in emerging markets is protecting yourself so you enjoy a high chance of profit and a low chance of losing your shirt. Here are four tips to help you on your way:

Think about the big picture

It’s reasonable to dedicate 15% to 20% of your portfolio to emerging markets. Don’t invest more unless you are a gambler.

No matter how much or how little you invest, make sure you diversify your holdings to ensure that a downturn in one region or country can’t sink your portfolio. In particular, you should avoid mutual funds that specialize in a single emerging market country or a small region. The risk is simply too high. A well-diversified emerging markets portfolio would have the bulk of its assets in the Asia-Pacific region (outside of Japan) with smaller portions invested in Latin America, Eastern Europe and Russia, and South Africa

To hedge your bets, look at what else is in your portfolio. Emerging market funds usually move in ways that are out of step with Japanese equities, Canadian financial services or even Canadian balanced funds. If you mix your emerging markets investments with one or two funds from those other categories, you reduce your overall risk, since any downturn in one area is likely to be counterbalanced by gains in the other.

Go global

Choosing your own emerging market mutual fund can be tricky, since the funds available in Canada tend to be expensive and often go on hot or cold streaks that have little to do with management skill. As an alternative, consider investing in a global equity fund that has an emerging market component. The Trimark Global Endeavour Fund, the Chou Asia Fund and the Mawer World Investment Fund are all good examples.

Cut costs

If you decide to go all the way with a pure emerging equity fund, buy an exchange-traded fund (ETF) such as the MSCI Emerging Markets Index Fund, which trades on the American Stock Exchange (AMEX: EEM). This ETF gives you instant exposure to emerging markets around the world at much lower cost than an equivalent mutual fund.

It’s not just stocks

Consider emerging market bonds. A diversified portfolio of emerging market bonds is now yielding 2.5 percentage points more than a portfolio of Canadian bonds (or two percentage points more than U.S. bonds). With Canadian 10-year bonds currently offering a paltry 4% yield, this extra return is a welcome bonus for income-hungry investors.

The additional return isn’t without risk, of course. As Argentina demonstrated two years ago, governments in emerging countries sometimes default on their bonds. Still, if you keep a diversified mix of bonds, the risk premium should more than compensate you for any losses caused by default.

Before investing, you should be aware of a couple of specific pitfalls. The first is currency risk. You may take a hit if the currency the bond is issued in loses value against the Canadian dollar. This is true of any foreign investment and the best defence is a well-diversified portfolio that is split up among many different currencies.

You should also be aware that emerging market bonds fluctuate depending on how investors perceive their relative risk. The current two percentage point spread between emerging market bonds and U.S. government bonds is low by historical standards, suggesting to some observers that emerging market bonds are overvalued. Remember, though, that these are bonds, not stocks. If you (or your portfolio manager) hold on to your investment, you can enjoy the extra yield from these bonds and get back your principal upon maturity. The key is to invest only money that you will not need in the next few years.

To find a good emerging market bond fund, you will have to go outside of Canada and look at some of the ETFs available on the U.S. stock exchanges. You can examine the selection at a website called ETFconnect.com. Look for emerging market funds under the “Fixed Income” category. The site shows you the current annual interest payments and the degree of risk the fund is taking on. Risk is measured by the average credit rating of the portfolio. The holdings of emerging market bond funds typically range from relatively low risk BB+ bonds (one notch lower than investment grade) to high-risk C issues. You should look for a mix of high yield with relatively low risk. Right now, I think the Western Asset Emerging Markets Income Fund II, Inc. (NYSE: EDF) is appealing. It offers an 8% current income distribution level and has a BB+ average portfolio rating