Every couple of months an exciting new investment strategy comes along that everyone is talking about. But investors seldom become wealthy when they follow the crowd, and the investment change itself often triggers taxes and fees. It's time to stop making these three popular but misguided moves.
Avoid targeting a specific return. Using a conservative annualized return to plan for retirement is often useful. But many investors estimate a percentage and assume that's what they deserve. Unfortunately, the stock market is unpredictable and your returns can vary widely in any 10-year period, even when you're using a well thought out and diversified portfolio. Even if your returns approach the higher end of the spectrum, you might feel like you are falling short of your "target" investment gains and abandon the strategy at the worst possible time, ultimately losing out on the rebound that has treated every buy and hold investor well throughout the history of capital markets. Some financial planners might even ask their clients what percentage they are targeting for their return. But no one can guarantee any rate of return in the stock market. Instead, all you can do is realize that investing involves risk, take on only bets you can afford to lose and bet on the fact that capitalism will continue to thrive in your lifetime.
Stop making adjustments when new enticing ideas pop up. A few years ago, diversifying internationally was the big thing. Then, 2009 rolled around and tactical investing became popular. Since then some people have been tilting to small caps and selecting shorter bond durations. The "in strategy" seems to be a factor in investing for some people. There will always be hot new ideas that might seem better than your current strategy. However, the only thing that matters is whether the strategy will continue to outperform to a point where the excess return will overcome the higher fees and the tax cost of switching strategies. Considering the fact that many of these strategies are only popular after they've done very well recently and then fall out of favor once they start to underperform the market, you are really pushing your luck if you make a switch to follow what everyone else seems to be doing. Most of the time, staying the course is the best thing you can do for your portfolio. Don't be tempted to change your strategy all the time.
Don't neglect to understand the tax consequences of your investments. Few people ever read about how an investment will be taxed when the investment is first being purchased. But turnover in a fund, tax classification and whether it's a long-term fund or something you are going to sell portions of in the near term are all facts that can change how an investment is taxed that need to be taken into account when you make an investment. I invested with a money manager who buys and sells stocks and did well during the time I had money invested with him, but all the changes in investments also resulted in an extra 2 percent a year in tax costs. Switching investments on a regular basis might not be worth it once you factor in the tax consequences of each action. That's why the case for index funds is so strong. Since you are owning a cross-section of the whole market, the only times you sell are when you need money or need to rebalance.
Investing can be easy. All you have to do is save, invest in a diversified simple portfolio of equity and bond index funds covering the entire market and stay the course. This simple strategy of index investing allows you to skip targeting a specific return, making expensive adjustments to your portfolio and triggering exorbitant tax consequences. But if it's important to you to own a more complicated portfolio, then take heed and skip these common investment errors this year.
David Ning is the founder of MoneyNing.com.
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