5 Investing Pitfalls to Avoid
October 24th, 2016 | Posted in Investing
If you’re thinking of making changes to your investment portfolio, now’s the perfect time to consider potential errors that could derail your long-term portfolio growth. This guide can help you avoid some of the most common mistakes investors make, including:
- Not understanding your tolerance for risk
- Trying to time the market
- Failing to diversify
- Believing that sophisticated asset management is only for ultra-high net worth individuals
- Focusing more on returns than on managing risk
1. Not Understanding Your Tolerance for Risk
All investments involve some degree of risk. It’s important that you understand what your tolerance for risk is before you invest so that you don’t find yourself making emotional decisions that could derail your long-term returns.
The first step in understanding your risk tolerance is defining it. Risk tolerance is a measure of your willingness to accept higher risk or volatility in exchange for higher potential returns. Investors with high tolerance are willing to accept losing capital in search of higher returns. Investors with low tolerance are more conservative and want to preserve capital.
Your personality type, behavior and decision making tendencies should all factor into determining your risk tolerance. The Zacks Advantage automated online questionnaire makes it simple for investors to determine their appropriate investment goals and risk profile while determining the ideal Zacks Advantage portfolio to match their unique investment needs.
2. Trying to Time the Market
When markets are rallying, it’s often very tempting to try and seek out the top to sell, or the bottom to buy. The problem is that investors usually guess wrong, missing out on the best market plays. Does the cost of trying to time the market make a big difference in your returns? You bet it does.
For example, between 1986 and 2005, the S&P 500 compounded at an annual rate of 11.9%, Over that period, $10,000 invested in 1986 would have grown to over $94,000. However, according to a recent Dalbar report, the average investor’s return during that period was just 3.9%, meaning that same $10,000 grew to just over $21,000. Why? Often times they were trying to time the market.
The average investor misses out because their money tends to come in near the top and come out at the bottom. However, the majority of equity gains are made in a very short amount of time. If you’re not in the stock when it moves, you miss out on the whole play. The bottom line is that it’s virtually impossible to accurately find the top or bottom of the market, and no one can do it consistently.
3. Failing to Diversify
When it comes to investing, there’s no way to know everything about an investment and no way to predict the future. To protect yourself you must diversify between asset classes. This means maintaining a good mix of stocks, bonds, cash, and perhaps some other types of alternative investments like real estate, derivatives, or commodities that are a good fit for your goals and risk tolerance.
The problem is that many investors have a tendency to chase performance by aggressively investing in a single class of investment: stocks when the equity markets are rallying, and bonds or cash during a market decline. This lack of diversification can play havoc with a portfolio during times of market turbulence.
The second part of a properly diversified portfolio is diversifying within an asset class. For example, it’s important to have a good mix of small-cap, large-cap, international, and sector-diverse equities in a portfolio. While a certain stock or sector might be affected by a market decline, a gain in another might offset it.
4. Believing that sophisticated asset management is only ultra-high net worth individuals
Terms like “asset mix,” “diversification strategies” and “risk tolerance” suggest that investing is complicated. And it can be. That’s why ultra-high net worth investors have long relied on the expertise of financial advisors.
But they aren’t the only ones who can benefit from experienced asset management. No matter what size your portfolio, many of the same questions apply. How much will you need? When will you need it? How much volatility are you willing to tolerate to get there? Which investments are most likely to address your needs?
Every investor can benefit from sophisticated approaches to answering those questions. Zacks Investment Management created Zacks Advantage so that everyone can enjoy the edge that experienced wealth management can provide. The Zacks Advantage investment team uses rigorous economic and market analysis, constant evaluation of changing conditions, and a consistent approach. So every investor can benefit, regardless of asset level.
5. Focusing More On Returns Than On Managing Risk
While investing for performance is important, chasing performance is one of the biggest mistakes investors make. If you take the time to study past performance, you’ll discover that it’s not always a reliable way to predict which investments will perform well in the future.
If a particular asset class has outperformed for three years, you can know one thing with certainty: you should have invested three years ago. Frequently, by the time the average investor has decided to invest, savvy traders have already pulled out while the not-so-savvy investors continue to pour in money. Don’t make this mistake. Stick to your strategy, rebalance, and focus on getting into investments with great fundamentals that meet your long-term goals.
Avoiding these mistakes takes discipline and investment management experience. Most investors don’t have the time, patience or expertise to evaluate investments, construct a plan and manage all of their investment options. Zacks Advantage’s low fee, performance driven, actively managed automated wealth management service handles all the heavy lifting, leaving you to invest confidently and with peace of mind.
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Past performance is no guarantee of future results. Inherent in any investment is the potential for loss
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