If you often feel compelled to jump on the latest market trend—or bail out during a big market drop—one solution is to turn over management of your portfolio to an adviser, for a fee. But you can also avoid common mistakes by adopting a steadier, more-disciplined approach.
Emotion long has driven investment decisions by many people—and it is particularly true this year, amid all the scary headlines about the European debt crisis and the U.S. economy's sputtering performance. Investors continue to pull more money out of U.S.-stock mutual funds than they pump in, and yet the Standard & Poor's 500-stock index returned a flashy 16.4% (including dividends) in the first nine months of 2012 and an average of 13% a year over the past three years.
Poorly timed buying and selling causes returns of individual investors on average to significantly lag behind the returns of the funds they invest in. Morningstar calculates that over the decade through August, investors got returns of 5.6% a year, well below the 7.3% average for all of the mutual funds the firm tracks.
But investors who have a good, long-term strategy and are sticking to it despite all the noise in the news are likely faring better. If you have a sound plan and you understand why you own certain things, that will really reduce the odds that you panic when markets go down.
Here is some advice on how you might boost your fund-investing returns by being more disciplined:
Create an investment framework for all of your future needs
Divide your money into "buckets," each dedicated to one key goal. Dollars earmarked for a car purchase in three years might go into a bank account or a conservative, short-term bond fund. Another bucket—which you could invest in a diversified equity fund—might be dedicated to tuition payments in 15 years.
The bucket approach can help you take an appropriate amount of risk for each goal—and keep you focused on the timing and magnitude of the goal. For a big, distant target, for instance, the slim returns you'll get from "safe" investments like U.S. Treasurys won't go very far. Hence the need for stocks. You get paid for taking risk, not for being comfortable.
Set up a regular schedule for adding money to the buckets while being careful to keep enough cash around in case of emergencies.
Get real about what you can expect from your funds
Many investors choose funds that have just posted several stellar years, so it isn't surprising that they expect more juicy gains. Then, when a fund starts to fade, investors rush to dump it.
Neither approach necessarily makes sense. For starters, whatever the asset class, be realistic about your return expectations. Then, make careful notes about each fund so that when you review its performance at year-end, you'll remember why you bought it and how you thought it would benefit your overall portfolio.
Consider if a fund is having an off year because of a development at the fund firm—such as the departure of a star manager—or whether it is down because investors generally are steering away from the area the fund invests in.
Industry data show that even top managers often slip in peer-group rankings in about three of every 10 years. The three years may be consecutive.
Have a plan for how you react: Unless there has been some fundamental change in the management, give a fund at least two years to recover, advisers say. If it is still seriously lagging behind its peers, do some more research before selling.
Zag when others are zigging
Resist the temptation to follow everyone into a sizzler. Doing that could mean you are buying into a fad at its peak. As dollars pour into a hot fund, it also can overwhelm the manager's ability to effectively invest the new money, leading to lower future returns.
A better strategy is to look for a fund that has a solid long-term record and a good manager, but has just had one or two years of negative returns, he says. The odds are that the fund is due for a rebound soon.
If you tend to panic during market meltdowns, pick funds that are less volatile than the market
Funds that invest in a broad mix generally gyrate less. Because these portfolios contain a diverse range of stocks and bonds, they can be an effective single solution for people who don't want to keep a close eye on their portfolios.
Whenever you buy or sell a fund, consider the impact on your overall portfolio
Although some of your funds usually will be lower on any given day, building a diversified portfolio can help preserve portfolio value against a big drop in any one market area. You may lose that benefit if you're too quick to dump the fund with the most mediocre return in a quarter or year.
Source: Michael A. Pollock, Wall Street Journal
The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
The Jacksonville Business Journal has ranked D2 Capital Management in
the top 25 of Certified Financial Planners in Jacksonville
No comments:
Post a Comment