Though the financial panic of 2008 is now behind us, many investors may still worry the economic turmoil of the last recession lingers. With uncertainty in the financial markets, you may wonder how you’ll keep your own portfolio on track to meet your financial goals. Successful investing requires more then just selecting the right stocks or bonds. It also requires avoiding big mistakes that can seriously hurt your long-term portfolio growth potential.
Use this guide to help you make better investment decisions. It explains some common mistakes investors make and how to avoid them. Just sidestepping any one of these mistakes could greatly improve your ability to reach your investing goals.
Mistake #1: Not Having Clear Investment Objectives or an Appropriate Time Horizon
Sadly, people often invest without clear investment objectives or an appropriate time horizon, and focus instead on short-term
returns and price swings. Many investors who experience significant declines in a bear market think to themselves,
“I just need to get my portfolio back to where it was before this bear market started, and then I’ll get out,” or “ I need to
stay away from stocks because they’re to risky.”
While both of these emotional reactions are understandable in the midst of a bear market or correction, they are too
narrowly focused on recent events. Neither reaction reflects a cohesive investment strategy. Will either approach provide
an investor with enough money to last through retirement? Will either reaction ensure assets will be available for heirs?
It’s impossible to say without understanding an individual’s personal goals and objectives.
If you don’t have clearly defined investing goals over an appropriate time horizon, you’re much more likely to “knee-jerk” reactions
to short-term market events. That means you’ll have to rely on luck to achieve your goals rather than a strategy with a high
probability of success.
This guide can help you begin to identify some personal portfolio objectives – a first step to reaching your long-term financial goals.
Since every investor is different, this guide is simply meant to illustrate some goals and objectives you might identify as your own.
I encourage you to not only review these goals and objectives, but to also have a detailed discussion about your personal investment
strategy with a qualified investment adviser.
Don’t skip this critical step – you can significantly increase you chances of long-term investment
success by starting with clear investment goals and objectives.
Personal Investment Objectives
Grow my assets. Have $______ at the end of my time horizon.
Maintain my purchasing power. Ending value will be at least as much as initial investment, adjusted for inflation.
Provide cash flow for my lifestyle. Provide $______ per year.
Provide cash flow for my spouse. Provide my spouse with $______ per year.
Provide cash flow for my lifestyle and grow my assets. Provide $______ per year and have $_____ at the end of my time horizon.
Have a trusted adviser who can manage portfolio for my spouse. Work with the adviser for _____ years.
Mistake #2: Underestimating the Time Horizon for Your Assets
Perhaps the most unpleasant risk investors face is running out of money during retirement. People work their entire lives
to accumulate enough wealth to make sure this doesn’t happen. Unfortunately, investors often underestimate how long their
portfolio will need to provide for them. People are simply living longer today on average then decades ago, which means their money
needs to last longer.
Given rapid advances in health care and nutrition, I believe this trend will continue. This presents a challenge to today’s investors not
faced by previous generations. You simply must plan for a longer time horizon then your parents or grandparents did.
Having an accurate sense of you life expectancy can mean the difference between investing success and failure. One of the primary
drivers of a successful portfolio strategy is the ability to accurately identify the time horizon for your assets. Time horizon is the amount
of time your assets need to be working for you.
A common example of time horizon is your life expectancy. You may need your assets to provide cash flow for as long as you (and your spouse)
live, without regard for what is left over. Your time horizon could be based on something different altogether,like purchasing a vacation
home at some point down the road.
Average Life Expectancy
Current Age Life Expectancy Current Age Life Expectancy
51 81 61 83
52 81 62 83
53 81 63 83
54 82 64 83
55 82 65 84
56 82 66 84
57 82 67 84
58 82 68 84
59 82 69 85
60 83 70 85
These projections likely underestimate hove long people will actually live given ongoing medical advancements. And don’t forget these
are projections of average life expectancy-planning for the average is not sufficient since about half of people in each bracket are expected
to live even longer. Factors such as current health and heredity can also cause individual life expectancies to vary widely.
Once you have evaluated your own life expectancy, be sure to consider other factors that may affect the time horizon for your assets.
If your spouse has a longer life expectancy, that could increase your investment time horizon. Planning to leave money to your heirs or charity
can further increase the time horizon for your assets.
Though some money managers may use cookie-cutter “rules of thumb” based on your age to construct your portfolio (e.g., 100 minus your age equals your percentage in stocks), a more in-depth consideration of the true time horizon for your assets can better help you achieve your investment goals.
As you evaluate your retirement portfolio, don’t put your lifestyle or investment goals at risk by planning for too short a time horizon.
Mistake #3: Ignoring the Impact of Inflation on Your Portfolio
Investors all too often focus on the dollar value of their portfolios without considering their purchasing power. Over time, a portfolio’s
purchasing power can diminish due to inflation. As the prices of items increase, today’s dollars will buy less in the future. For example,
a first-class postage stamp cost only $0.04 in 1959 and rose to #0.44 fifty years later. Inflation’s negative impact on purchasing power
means many investors may need more portfolio growth than originally anticipated.
Since 1925, inflation has averaged about 3% per year, though it does fluctuate over time. It can rise dramatically as seen in the mid-1970s
and early 1980s, or it can be relatively subdued as it has been this past decade. If we assume prices continue their long-term trend and rise
about 3% per year for the next 30 years, a person who currently requires $50,000 to cover annual living expenses will need approximately
$67,000 in 10 years, $90,000 in 20 years and about $120,000 in 30 years just to maintain the same purchasing power.
Similarly, if you placed $1,000,000 under your mattress today, in 30 years that money would only be worth around $415.000 in today’s dollars.
When considering your portfolio’s return, its critical to include the impact of inflation. If inflation averages 3% per year, a portfolio that grows at 5% annually has a real annual return of only 2%-your portfolio can actually only purchase about 2% more, not 5%. That’s not much growth in purchasing power.
Investors need to consider inflation and how to grow their purchasing power, as well as the dollar value of their portfolio.
Mistake #4: Turning Away From a Long-Term Investing Strategy After Suffering Losses
After a correction or bear market, some investors may be tempted to abandon stocks once they’ve recovered their losses.
Some may swear that when they “get back to even,” they’ll never look at a stock again. Such emotional decisions can be harmful
because they remove the focus form achieving investing goals. In times like these, it’s especially important that investors stay
focused on their long-term strategies.
Prudent investor know stock markets can sometimes be bumpy and unsettling. However, historically, that volatility has come with a
benefit-stronger long-term returns relative to bonds. Since 1926, the stock market has returned about 10% a year on average.
This includes both bull markets and bear markets. Collectively, bull markets have been greater than bear markets, resulting in the
stock market moving higher over time. If stock prices never surpassed their previous highs, growth would not exist. A look at the
stock market following significant drops provides historical perspective.
Stocks typically forge ahead after recovering from a bear market and go on to new highs. Previous highs for stocks don’t foretell
how the stock market will perform in the future. In the throes of bear market, it’s easy to think the market will never recover.
Truth be told, it’s impossible to know exactly if and when stock prices will again reach their previous highs, but there’s no reason
to think they’ll stall out once bear market losses have been recovered. Though remaining calm during volatility can be challenging,
capturing market moves above previous highs is essential to achieving long-term stock market gains.
Investors need to focus on long-term goal in all market
conditions, especially after suffering a loss.
Mistake #5: Improperly Judging Risk
Many investors improperly judge risk. Generally, the longer the time horizon of your investments, the more risk that may be appropriate,
depending on your cash flow needs and return objectives. However, many investors take too little risk. That’s right-they incorrectly focus on
short-term volatility rather than the probability of achieving their long-term objectives. Increased risk can allow for increased returns
over the long term. But overly conservative portfolios can under perform.
While increased volatility, like that experienced in a correction or bear market, might make it tempting to switch to less volatile investments,
you might actually be increasing the risk of not meeting your long-term goals.
For example, some investors may load their portfolios with low-yielding Treasury Bonds to avoid stock market volatility-even if their time horizons are greater than 20 or 30 years. This strategy typically offers meager returns, especially when you consider the impact of inflation.
The short-term volatility inherent in stocks can make them feel risky, but stocks are much more likely to help grow your portfolio if you have a
long time horizon. When stocks out perform bonds over 20 year periods, it tends to be by a wide margin. When bonds out perform stocks, the
performance tends to be far more modest.
Conversely, investors with short time horizons are often exposed to too much risk, which increases the potential for loss during periods of short-term volatility.
Understanding your exposure to risk-as well as your time horizon and investment objectives- can help you make better allocation decisions.
Mistake #6: Avoiding Foreign Securities
Most investors know it’s smart to diversify, yet most American investors aren’t nearly as diversified as they think. American
investors tend to focus on US stocks. After all, America is a big country. Shouldn’t investing here be enough?
The answer may surprise you. A portfolio with only US stocks misses out on an important factor – the rest of the global stock
market. America represents about half of the world’s developed equity market (as measured by market capitalization) and less
then 25% of the global economy. In fact, if you look at the best – performing stock markets each year, the US has been a top five
performer only there three time since 2004.
Investing only in US stocks may cause investors to miss out when foreign stocks out perform, a particular challenge for investors who rely on mutual funds.
14,000 (14,228) equity mutual funds housed in the US, just over 30% (30.096%) are classified as “international equity” mutual funds. As a result, many mutual fund investors may be missing out on foreign opportunities.
Don’t make the mistake of focusing solely on US securities, many investment opportunities can be found overseas.
Mistake #7: Making Investments Based Only on Widely Known Information
What information do you use when considering an investment? Many investors regularly read various newspapers and magazines, subscribe to newsletters and do additional Internet research.
Unfortunately, countless hours spent reading and researching may not help you beat the market. The morning newspaper, research from a broker and commentary on the radio, television or the Internet are all widely available and can be counterproductive.
Why? Because capital markets efficiently price in all widely known information. As soon as news is available to the public, it becomes reflected in share prices. So looking at the same things as everyone else doesn’t give you a leg-up on other investors.
Despite this fact, many investors still make trading decisions based upon widely known information. That’s not to say news should be ignored. Rather, in order to beat the market over time, investors must either know something most others don’t or interpret widely known information differently and correctly. This unique knowledge and insight can enable you to take advantage of things other miss.
Gaining this knowledge is difficult but not impossible. It take experience, research, strong analytical skills and a significant amount of time and dedication.
Many individual investors simply do not have the time needed to research and uncover unique information to help generate excess returns – a key reason why they fail to do better then the market.
Basing your investment decisions on widely known information is simply not the best way to beat the market.
Mistake #8: Forgetting the Importance of Supply and Demand
Investors open the newspaper each day to a near avalanche of information. Pundits, economists, analysts and journalists all have theories on what factors will move stocks. Yesterday, it was energy prices. Today, it’s currency movements. Tomorrow, it’ll be interest rates. The reasons they cite seem endless.
Despite all this conjecture, the most fundamental factors determining stock prices often go unnoticed: supply and demand. Basic economic theory states supply and demand for any asset traded in a free market will determine prices. Though this fundamental an be easy to overlook, it’s vital for understanding stock movements.
The run-up and drop in housing prices a few years ago is an example of supply and demand working in the marketplace. As mortgage rates reached historic lows in 2002 and 2003 (and more “non-traditional” mortgages were introduced, many with low down-payment requirements), demand for homes increased as both down payments and monthly payments became more affordable. Initially, housing supply remained relatively steady, since new homes could not be built overnight.
Therefore, housing prices rose. But soon developers and builders began to flood the market with new homes to meet this increased demand, significantly increasing supply, particularly in “high demand” areas like parts of Florida, California, Nevada and Arizona. A glut of new homes and sagging demand caused home prices to tumble. While this is a greatly simplified explanation, it helps underscore the importance of supply and demand in the market.
Stock prices can behave similarly. The supply of equities is relatively fixed in the short run because it takes time for companies to issue new shares.
Therefore, shifts in demand are the primary cause of short-term price movements. However, in the long run, supply has an almost infinite ability to change. IPOs, stock buybacks, mergers and acquisitions combine to make supply the dominant factor in stock prices over longer time periods.
Consider the bull market in the late 1990s. At that time, demand surged as investors clamored to purchase stocks. Initially, stock supply remained relatively steady, and stock prices rose. But in late 1999 and early 2000, a huge influx of stocks came to market through initial public offerings (IPOs).
The new supply overwhelmed demand, stock prices fell and a bear market ensued. After the bear market, the supply trend reversed as a high rate of cash mergers and acquisitions reduced stock supply and boosted prices.
The ability to screen out unimportant noise and accurately track, analyze and evaluate basic supply and demand is important in making successful market forecasts.
Finding a Successful Investment Adviser Can Help You Avoid Mistakes and Build a More Secure Financial Future.
Avoiding these mistakes take discipline and time. Even the most savvy investors find it difficult to avoid all investing pitfalls. Many investors simply don’t have time to process the vast amount of information available today and apply it to their individual, sometimes complex, investment needs.
I hope this information will be beneficial to those looking to avoid unnecessary mistakes.
I wish you all the best with your future.
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