Missing out on a hot stock isn’t going to make or break your portfolio. The real mistakes — the ones that can do big damage to your long-term investing success — are more powerful than the movement of any one stock. Here are the top investing pitfalls to avoid.
1. Setting the wrong asset allocation: Asset allocation is how you divide your portfolio — the percentage of assets in bonds, large-cap stocks, international equities and so on. Financial advisers, backed up by lots of studies, say the individual mutual funds you buy aren’t as important as the asset classes you choose.
2. Ignoring your death … or your longer life: Most folks walking into retirement have no idea how long they will live, and it seems they’re not good at guessing. The average person in the United States retires at 62, says Douglas Buchan, a certified financial planner with Main Street Financial Solutions in Pennington. And, he says, actuarial tables say a 62-year-old couple should expect one spouse to be alive 30 years from now, even longer with good health care. This means you need to plan to still have income in 30 years — something many people don’t do.
3. Worrying about the wrong risk: Buchan says most people worry too much about the risk that their principal will decrease. Because of this fear, they allocate too much to fixed-income investments, which he believes is a huge error. “Over long periods, the biggest risk to investors is not principal risk, but that every year, stuff you want to buy will cost more,” he says, noting that you can protect your purchasing power
by owning diversified equities.
4. Not rebalancing: As asset classes rise and fall, your portfolio ends up with percentages that don’t match your initial plan, so advisers recommend you rebalance once a year. Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton, recently had a client who was reluctant to rebalance by selling some equities and buying fixed-income securities because the client was sure the bond market would soon decline. Hook says he asked the client under which of the declines — the stock or bond market — would the portfolio be hurt more. The client answered, “The stock market.”
So he asked the client another question: “Based on that, wouldn’t you prefer to rebalance and reduce your exposure to the stock market?” The client agreed to rebalance.
5. Gambling with money you need: It’s a mistake to treat investing as a game or hobby. “If you’re having fun investing, you’re not investing. You’re speculating or gambling,” Buchan says. “If a friend or brother-in-law tells you how much money they made in a stock, remember, he gambled. He may have won, but he gambled. He didn’t invest.”
6. Using your crystal ball: Even the most revered market watchers are wrong much of the time, and they’re watching trends all day, every day. “The most repeated mistake that I come across from clients in both good markets and bad markets is their belief that they know what is going to happen next with 100 percent certainty,” Hook says. This “overconfidence bias” is fed by constant reinforcement from the media, all predicting the same things. But reality is no one knows what’s going to happen next.
7. Letting that tax tail wag your portfolio dog: It’s smart to pay attention to tax consequences, but you shouldn’t let taxes make your investment decisions. “There is only one thing worse than paying capital gains taxes on your portfolio or stock holdings. Not paying capital gains taxes,” says Buchan. “Tax mitigation is important in proper planning, but it can’t be in the driver’s seat.”
8. Being underdiversified: Owning too much of one stock is a common mistake among those who invest in an employer’s stock within a 401(k) plan. You’re leaving too much of your fate in the hands of only one company. Instead, have no more than 5 percent to
10 percent in any one stock. Best to use hundreds or thousands of stocks through diversified mutual funds.
9. Letting your emotions run the show: Chasing hot fads or trends — such as internet stocks in 1999, Florida real estate in 2005 or oil/commodities in 2008 — is not a smart move. Panicking out of the market is just as bad. If you can’t keep your emotions out of it, consider working with an adviser.
10. Paying high fees: Hook says it’s common for investors to underestimate the impact that higher fees can have on an investment portfolio. For example, compare two $100,000 portfolios that are invested identically. Portfolio A pays 1 percent in fees and Portfolio B pays 1.5 percent. Both earn 8 percent before expenses. “Over 25 years, the investor in Portfolio A ($542,000) will have 12 percent more than the investor in Portfolio B ($482,000),” Hook says.
That’s a whole lotta early-bird specials.