We all want to do the right things with our investments. And, while it's possible to create a successful investment strategy by yourself, the flip side is that you can really mess things up by ignoring your investing plan.
Before you stray from your strategy, stop and think about whether you're making one of these common mistakes:
1. Panic Selling
In the moment, it's hard to control your fear. When everyone around you is selling, and the financial media are screaming about financial doom, it's hard not to panic and think that this is the end. However, there is a good chance that panic selling will mess up your portfolio more than riding it out will. Instead of selling as a knee-jerk reaction to what is happening around you, stop and look at your investments. Have the fundamentals changed? No? Then there is a good chance that your solid investment will recover once this week's crisis is over. Panic selling sets you up to sell low, and that means you lock in your losses, and can throw your portfolio off.
2. Failure to Rebalance
Every so often, it's a good idea to look at your portfolio, and then rebalance. Over time, your assets are likely to drift along with the various parts of the market. Funds change their composition, and your needs and risk tolerance change over time. Look at your asset allocation once or twice a year, and make necessary tweaks to keep on track. If you don't, you run the risk of letting your asset allocation drift away from what you want, and your portfolio could end up not meeting your needs.
3. Holding On Beyond the Point of Reason
While you don't want to be involved in panic selling, you also don't want to hold on to a money-losing investment beyond the point of reason. There are times when you do need to cut your losses. Most of the time, the sell signal should be when something about the investment changes fundamentally for the worse. Evaluate the value of your holdings, and occasionally cut the dead weight before it drags your whole portfolio down with it.
4. Thinking You're an Investing Genius
My husband, who has a Ph.D. in psychology, tells me that most people believe that they are of above-average intelligence. This is a bias that can work against you when managing your portfolio. It's easy to think we're investing geniuses when something goes well. The portfolio improves (usually because the market is doing well, and not through any special knowledge we have), and we immediately credit our brilliant investing savvy. Unfortunately, this idea that good results equal investing skill can lead to overconfidence in your abilities. The end result is that you think that you can do no wrong, and begin to take bigger and bigger risks. This is compounded if you think that losses are due to market circumstances, and that your genius stock pick will turn around. You end up holding on, and your portfolio suffers for it.
5. Unrealistic Expectations
Many of us have it in our heads that the stock market is going to return 10 percent over time, and that we will get 5 percent for bonds. The last few years have shown us that this is mostly wishful thinking. Indeed, even over the long-term, it makes more sense to estimate a more conservative return of 6 percent or 7 percent on stocks.
When you have unrealistic expectations, you are likely to invest less than you should. For example, if you invest $1,000 a month over the course of 30 years, and you see a 10 percent annualized return, you end up with more than $2 million. In order to get $2 million at 7 percent, you need to invest $1,700 a month. You can see the difference. If you have unrealistic expectations, you may not plan properly, and your portfolio could be inadequate.
Miranda is a freelance contributor to several investing and personal finance web sites. She also writes for her own blog, Planting Money Seeds.