There’s nothing like a honking stock market rally to prompt us to declare the end of a financial emergency. But whether or not the economy and the financial markets are really out of the woods, it’s clear that the way we approach investing has changed forever.

Here are seven ways your money will never be the same.

1. Stocks are no longer king

As share prices keep rising, blogs and investor chat rooms crackle with rancorous shouting matches between folks who say the gains are justified and those who deride the charge in the Dow Jones Industrial Average ($INDU) from 6,500 past 10,000 as a “sucker’s rally.”

But the rally is legit because, at 6,500, stocks were priced for a disaster that never occurred and because many sectors of the economy have improved noticeably since the darkest days of the crisis.

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But the wild ride of the past two years holds deep, long-term significance. It undermines the doctrine that a well-diversified basket of stocks will trounce bonds, or a mix of stocks and bonds, over long periods. This principle is rooted in the notion that stocks are riskier than fixed-income investments and so will reward you with higher returns over the long term.

Alas, that is no longer a given. Why? Weak hands have replaced the strong hands of loyal, committed stockholders. It’s never been easier to trade enormous baskets of stocks indiscriminately at the drop of a news story, a rumor or some official’s comment going viral on the Internet.

This shoot-first-ask-questions-later mentality weakens the ties between share prices and any precise evaluation of an actual business’s future earnings and dividends. And because most of us despair at losing money more than we rejoice in making it, we will look harder at investments that pay reliable income and, presumably, protect us against inflation, deflation, currency-rate fluctuations, credit crunches and all the other complications that can cause stock prices to plunge.

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2. Diversification has changed dramatically

Once, you could fight a down market with counterweights like real-estate investment trusts, high-dividend stocks and foreign stocks. In 2000 and 2001, for instance, many small-company value funds and overseas stock funds made money even as the large-capitalization U.S. stock indexes tanked. During the 2007-09 bear market, virtually every asset class save Treasury bonds fell in unison. As a result, many experts have declared diversification a failure.

Video: Preparing portfolios for 2010

I disagree. Diversification isn’t obsolete. We just have to do it differently from now on. Instead of using a small-company value fund to shadow a large-cap index fund — such as one that tracks the Standard & Poor’s 500 Index ($INX) — we’ll want to own foreign-currency funds, international bonds, commodities funds, water, timberland, global real estate and anything else that is reasonably liquid and can be purchased without obscenely high fees. Wide-ranging mutual funds such as Pimco Global Multi-Asset (PGMDX) — the brainchild of Mohamed El-Erian, Pimco’s co-chief investment officer — will sprout.

3. Cash is never trash

Forget that cash, in the form of money market funds and bank savings accounts, pays next to nothing. Yields will nudge higher once the Federal Reserve lets go of its free-money policy. But even if that enables you to collect just 2%, never again should you equate cash with garbage.

Having cash on hand allows you to swoop in and pick up bargains that an often irrational stock market creates. Plus, cash can ease the burdens in other parts of your financial life. If your cellar floods or a tree falls on your house or you have high medical co-payments, you may have several thousand dollars’ worth of unexpected obligations. A large cash cushion helps you avoid running up big credit card bills or incurring penalties for tapping your retirement accounts early. Plus, you can use your cash to jump on the deep retailing discounts that will probably be common for years.

 

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