5 Tips for Long-Term Investing As Markets Shudder

With shock waves roiling financial markets worldwide, investors are seeking new ways to protect their portfolios from the next upheaval.

But they may be ignoring the best weapons in their arsenal: straightforward strategies for managing money that, over time, boost returns.

"We're on this incredible volatility roller-coaster ride," said Andrew Lo, professor of finance at Massachusetts Institute of Technology and chief investment strategist at AlphaSimplex Group, a mutual-fund firm.

"For the next couple of years," he added, "my guess is we're going to have to spend more time thinking about managing losses than generating really attractive returns."

This week is a painful case in point. On Wednesday and Thursday combined, the Dow Jones Industrial Average (^DJI - News) fell 675 points or almost 6%, the largest two-day point drop since Nov. 20, 2008, and largest two-day percentage drop since Dec. 1, 2008.

Markets will go up again, Lo said, but there's "so much macro instability, you're going to get investors rushing to the left side of the moat together and then to the right side of the moat together. When you've got this coordinated herd mentality, you can get some wild swings in any investment."

Key strategies to eke out a profit include minimizing costs and getting as much diversification "as you're comfortable with," Lo said.

Plus, he noted, you need an investment plan that will keep you focused, so you don't panic "when markets start to dislocate, which they will."

Here are some building blocks for your portfolio's foundation:

1. Minimize taxes

High-tax-bracket investors lost an average of 2.4% of the value of their domestic equity mutual funds each year from 1981 through 2001, according to the Schwab Center for Financial Research.

That was before President George W. Bush's tax cuts slashed rates on qualified dividends and long-term capital gains, but also before the current dismal outlook for market returns made it even more important to seek tax efficiency.

Tax-loss harvesting and using tax-advantaged and taxable accounts to their best advantage are the two main ways to manage the tax hit.

Typically, put taxable bonds, which yield ordinary income, in a tax-deferred account such as a 401(k) or IRA, while stocks go in a taxable account since long-term capital gains and dividends currently are taxed at a maximum of 15%. (more)