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Of the mistakes made by investors, we seen five of them as repeat offenses. In fact, investors have been making these same mistakes since the dawn of modern markets, & will likely be repeating them for years to come. You can significantly boost your chances of investment success by becoming aware of these common errors & taking steps to avoid them.
1. No Plan
As the saying goes, if you don’t know where you’re going, any road will take you there. Solution?
Have a personal investment plan or policy that addresses the following:
- Goals & Objectives – Find out what you’re trying to accomplish. Accumulating $10 million for retirement at age 60 or $100 million & Building a Legacy of Wealth for your children are simple examples of appropriate goals. Beating the market is not a goal.
- Risks – What risks are relevant to you or your portfolio? If you are a 30 year old saving for retirement, volatility isn’t (or shouldn’t be) a meaningful risk. On the other hand, inflation – which erodes any long-term portfolio – is a significant risk.
- Appropriate benchmarks – How will you measure the success of your portfolio, its asset classes & individual funds or managers?
- Asset allocation – Decide what percentage of your total portfolio you’ll allocate to U.S. equities, international stocks, U.S. bonds, high-yield bonds, real estate, etc. Your asset allocation should accomplish your goals while addressing relevant risks.
- Diversification – Allocating to different asset classes is the initial layer of diversification. You then need to diversify within each asset class. In U.S. stocks, for example, this means exposure to large-, mid- & small-cap stocks.
These guidelines will help you adhere to a sound long-term policy, even when market conditions are unsettling. Having a good plan & sticking to it is not nearly as exciting or as much fun as trying to time the markets, but it will likely be more profitable in the long term.
2. Too Short of a Time Horizon
If you are saving for retirement 30 years hence, what the stock market does this year or next shouldn’t be the biggest concern. Even if you are just entering retirement at age 70, your life expectancy is likely 15 to 20 years. If you expect to leave a Legacy of Wealth to your heirs, then your time horizon is even longer. Of course, if you are saving for your daughter’s college education & she’s a junior in high school, then your time horizon is appropriately short & your asset allocation should reflect that fact. In general, though, most investors are too focused on the short term.
3. Too Much Attention Given to Financial Media
There is almost nothing on financial news shows that can help you achieve your goals. Turn them off… There are few newsletters that can provide you with anything of value. Even if there were, how do you identify them in advance?
Think about it – if anyone really had profitable stock tips, trading advice or a secret formula to make big bucks, would they blab it on TV or sell it to you for $49 per month? No – they’d keep their mouth shut, make their millions & not have to sell a newsletter to make a living.
Solution? Spend less time watching financial shows on TV & reading newsletters. Spend more time creating – & sticking to – your investment plan.
4. Not Re-balancing
Re-balancing is the process of returning your portfolio to its target asset allocation as outlined in your investment plan. Re-balancing is difficult because it forces you to sell the asset class that is performing well & buy more of your worst-performing asset classes. This contrarian action is very difficult for many investors.
In addition, re-balancing is unprofitable right up to that point where it pays off spectacularly (think U.S.equities in the late 1990’s), & the under-performing assets start to take off.
However, a portfolio allowed to drift with market returns guarantees that asset classes will be over-weighted at market peaks & under-weighted at market lows – a formula for poor performance. The solution? Re-balance religiously & reap the long-term rewards.
5. Chasing Performance
Many investors select asset classes, strategies, managers & funds based on recent strong performance (my father, worst habit). The feeling that “I’m missing out on great returns” has probably led to more bad investment decisions than any other single factor. If a particular asset class, strategy or fund has done extremely well for three or four years, we know one thing with certainty: We should have invested three or four years ago. Now, however, the particular cycle that led to this great performance may be nearing its end. The smart money is moving out, & the dumb money is pouring in. Stick with your investment plan & re-balance, which is the polar opposite of chasing performance.
The Bottom Line
Investors who recognize & avoid these five common mistakes give themselves a great advantage in meeting their investment goals. Most of the solutions above are not exciting, & they don’t make great cocktail party conversation. However, they are likely to be profitable. And isn’t that why we really invest?
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