Tune in to FOX61′s Money Matters on Tuesday March 13 between 9am and 10am for my updated Top 5 Tips for Investors in 2012.

BONUS TIP – Dividend paying stocks are NOT substitutes for bonds

Over the years, investors’ attachment to dividends has swung from being the Holy Grail to the worst use of capital in the markets.  And that typically depends on how well or poorly the stock market did the previous year or two.  In the late 1990s, dividend investors were laughed at as “out of touch” and “very old school” while the dotcom mania was in full swing.  Yet after a challenging 2011, high paying, quality dividend investments are all the rage.

What is most concerning is that investors who traditionally bought high quality corporate or municipal bonds or similar fixed income instruments are now using dividend stocks as substitutes.  Any time we have seen risk averse investors throw caution to the wind for better returns, it usually ends in misery and disaster.

If an investor buys a bond that does not default and holds until maturity, he or she receives par or one hundred cents on the dollar.  The bond may fluctuate in between the purchase and maturity time, but the amount received is known.  If an investor buys some top notch stocks that pay handsome dividends, not only does that stock’s price fluctuate, sometimes wildly, but the sale price can be substantially higher or lower than the purchase price.  That exposes the investor to the possibility of significant loss of the amount invested.  Just look back to 2008 to see the utter destruction some of these high paying dividend stocks saw during the crisis.  While there are some very good benefits to high quality, dividend stock investing, it is certainly not a substitute for old fashioned corporate and municipal bond buying.

6 – “I’m from the government and I am here to help!”

Those were Ronald Reagan’s nine most terrifying words. Not a new worry, but the biggest risk to the financial markets and economic recovery is politicians running even more amuck, especially with the hugely important election this year here and others around the globe.  Before long, all of the talk will turn to the two presidential candidates, Barack Obama and likely Mitt Romney with their dizzying array of media blitzes with half truths and partial facts.  Unfortunately, politics and the financial markets are forever linked.  With the power to tax and spend, the government has the ability to restrict and stimulate.

The problem isn’t as much a lack of intelligence as it is the strange fog that clouds their judgment at crucial moments.  No sooner does Congress get elected than they start campaigning for reelection and paying back their debts to special interest.  The best solution would be to extend their terms to 8-10 years, but not allow anyone to run for reelection.  That way, no one is worried about campaigning or beholden to lobbyists.

As sad as it is, the stock market typically performs best with gridlock in Washington.  That comes in the form of a split Congress or the Executive Branch from party and Congress from the other.  The most rewarding investment period of the modern investing era began when Newt Gingrich and the republicans won Congress in November 1994 and worked with Bill Clinton, not against for the next 6 years.

The President and Congress both moved toward the center, from the left and right respectively and the American people were the big winners!  In 2012, it’s unlikely that either party’s leaders will have learned their lessons from ObamaCare, the debt ceiling debate or the Bush/Obama tax cut extensions.  True bipartisanship is absolutely needed to get America going again.

5 – Look for the U.S. economy to continue to slog along

When economies emerge from recession, Gross Domestic Product (GDP) tends to accelerate very quickly and in steep fashion as consumers who have held off purchases begin to buy and companies who became lean and mean during the cleansing are not left with much inventory. That’s in “normal” times.

What we experienced in 2008 and 2009 was the bursting of a credit bubble and subsequent deleveraging (reducing debt). Recoveries from credit busts are very different from that of “normal” recessions which are usually caused by corporations becoming too fat and bloated. As we witnessed in the 1930s, it takes time and patience for the economy, corporations and individuals to return to a sense of normalcy.

Let’s not forget that it took decades to leverage up (borrow) to the point of collapse and history suggests that it will take about one third as long to fully deleverage and right the ship. Once the U.S. economy began to stabilize in 2009, it was in for a long period of sloggy growth, hampered by the effects of the credit bubble bursting. GDP growth should see periods where the economy teeters on recession along with times where it seems like it’s all systems go. It would not be unexpected to see growth rates range from -1% to +3.0%.

During this recovery, unemployment is expected to remain stubbornly high with muted progress as you can see from the solid red line on the graph below. It is going to take time, patience and some more pain before the employment picture really brightens this decade.

One of the big surprises is that while the economy has technically recovered what it lost, it is doing so with at least 6.6 million fewer jobs. And that’s why it still feels so difficult for most. The chart below perfectly depicts this.

Another item that should not be ignored is that corporations are making record profits with their smaller workforce and wages have not grown at all. It may be good news for Corporate America, but not so for workers.

Corporate Profits versus GDP

Two of the more outside the box indicators of economic activity can be found below. The first is an index of architectural billings. If architects are billing well, that usually translates into increased economic activity 6-9 months down the road, similar to the effects of Federal Reserve monetary policy. Over the past two years, you can see that billings have been plus or minus 10% of the neutral 50 line, another piece that supports a sloggy economy. This behavior should continue.

The next chart shows how restaurants are performing, another indicator of the average family’s health. Similar to the architecture billings, activity fell off a cliff in 2008, recovered sharply and has been in a range for almost two years.

The previous two charts, along with others before that, support an economy that will quietly trudge along for some time with subpar growth and occasional bouts of weakness as the world digests the aftermath of the credit crisis. There is a light at the end of the tunnel this decade from which the opportunity exists for a 20-30 year period of economic and market peace and prosperity. Just have patience!

4 – Don’t get complacent!

After a horrific climate in late 2007, 2008 and early 2009 where most asset classes were decimated, the last 9 months of 2009 saw tremendous “bounce back” where most people began to feel better as their portfolios and the economy stabilized.

Don’t get complacent and lazy, thinking the markets going to party like it’s the 1990s all over again. That time will come later this decade. The modern investor has a short memory and has been burned over and over again by drinking the Kool-Aid that Wall Street sells. The global economies and markets are in a longer-term hangover period with digestion and retrenchment, trying to recover from the massive debt and leverage party. It took decades for the “celebration” to envelope the world and it’s not going to get fixed in just one painful year.

It’s going to take years and years to correct all that ails us and we haven’t seen the last trap door or sink hole. From this period, the potential exists for another multi decade run of economic and financial market peace and prosperity. Stay active and focused!

3 – Beware the “Money Magazine Jinx”.

What worked well last year isn’t likely to be repeated next year. When the popular publications like Money and Fortune give kudos to a particular investment’s success last year, it’s usually close to the end. That’s been the case the vast majority of the time in bull and bear markets with geographic regions like Asian emerging markets, asset classes like commodities, mutual funds like the Fairholme Fund and Legg Mason Value Trust, sectors like technology and energy along with individual stocks.

My favorite examples of this were Time magazine naming CEO Jeff Bezos Man of the Year in 1999 and US News & World Report running a cover story entitled AOL Rules as the merger with Time Warner was announced (see below). Did you see who was recently on Time’s cover?

AOL - Time Warner Merger on US News & World Report Cover

Be VERY careful chasing the winners from year to year, but ESPECIALLY when the popular publications celebrate them! What stands out to you as the big winners from 2011?