Investing can be intimidating, particularly in volatile markets. But even when markets are gaining, it can be helpful to know what not to do.
Here are the “Terrible Ten” actions investors should stay away from:
- Overlooking the importance of asset allocation. Getting your asset allocation right is the foundation of successful investing, but many investors ignore this step, instead building their portfolio “from the bottom up,” by buying securities that they like – without reference to an overall strategy or structure. “Asset allocation isn’t fun or sexy,” Miccolis says. “It’s methodical—but essential if you want to be an investor, not a speculator.”
- Confusing diversification with asset allocation. Asset allocation goes beyond diversification. It involves (i) picking asset classes (e.g., bonds, stocks, and alternatives), and subclasses/sectors, that don’t move in synch with each other, and (ii) putting the right proportions of each in your portfolio. For instance, you could have a “diversified” equity portfolio by picking a couple of stock index funds, but if all your investments are in stocks, you probably don’t have a properly allocated portfolio.
- Neglecting to rebalance regularly. Setting up your initial asset allocation is just the start because, over time, your portfolio will become unbalanced as some asset classes grow faster than others. You need to periodically trim back your winners and add to your losers to keep your allocations on target. “It’s counterintuitive, but it works,” Miccolis says, “because it imposes a discipline on yourself to systematically buy low and sell high, over and over again.”
- Favoring short-term needs over long-term goals. Think about your long-term goals and sources of income and how much risk you’re comfortable with. “This is work, but it will benefit you for years,” Miccolis says. Write down your plan and stick to it.
- Letting your emotions control you. When you have a solid long-term investment plan in place, greed and anxiety won’t have a grip on you. Those emotions tend to lead you to exactly the wrong investment decisions at exactly the wrong times. This is especially important today, when the markets are so volatile.
- Getting addicted to the financial media. It’s smart to stay informed, but a 24/7 diet of talking heads can drive you crazy and ratchet up your anxiety. What the market does on a single day isn’t important in the long run.
- Chasing performance. Buying the latest hot stock or sector is like “driving a car by looking in the rearview mirror,” Miccolis says. By the time something gets hot, it’s usually yesterday’s news, and not much profit is left in it. And hot investments can turn cold with frightening speed.
- Trying to outsmart the market. It’s tempting to think you can outperform market averages by buying the right securities or actively managed mutual funds, or timing the market. Studies have shown that active management underperforms passive management in the long term—largely because higher fees eat into your returns. Uninformed market timing is similarly ineffective.
- Disregarding tax implications while investing. Common mistakes include putting annuities in an IRA, putting tax-inefficient investments like REITs in a taxable account, failing to harvest tax losses, and not taking advantage of lower tax rates for long-term capital gains.
- Allowing caution to supersede the reality of inflation. Even modest inflation adds up; for instance, after 20 years of 3.5 percent annual inflation your dollars will be worth half as much as they used to be. Some investors believe the safest investments are things like money funds, CDs and Treasuries. But such “safety” can be dangerous: these low-return investments won’t keep up with inflation over the long haul. As Miccolis says, “For most people, inflation is their biggest financial threat over their lifetimes, not what the markets happen to be doing this year.”
Jerry Miccolis, CFA®, CFP®, and Fellow of the Casualty Actuarial Society (FCAS), is a senior financial advisor, Chief Investment Officer, and co-owner of Brinton Eaton, a boutique wealth advisory firm in Madison, N.J.