We see some of the same mistakes repeated over and over again by ordinary investors…
Mistake No. 1:
Looking For a 'Magic Bullet'
Many investors look for the “best” mutual fund thinking that there must be a handful of funds that can bring the desired return. In fact, each mutual fund focuses on very specific types of investments, such as large company stocks, small company stocks, government bonds, etc. In any given year, any one of these market sectors could do well or poorly. Investors may want to use a mix of different types of funds. This is called asset allocation. Many mistakenly believe that asset allocation is designed to provide greater returns. That's simply not true. Its goal is to reduce volatility risk. Smoothing things out can make it easier for investors to ride out market turbulence, and avoid major portfolio losses.
Mistake No. 2:
Getting out After Markets Drop
Market declines are inevitable. However, despite all advice about "staying the course," many investors sell out of their stock position during market declines, often after the decline has bottomed out. Somehow they believe that they can sit on the sidelines until the markets go back up again and then jump in. The problem is that we become aware of market declines and market surges only after they have happened – when it's too late to do anything. Following the market decline of 2008, investors sitting on the sidelines from March through December of 2009 missed one of the largest market rallies in history. Although there are strategies and indications when markets are overheated, it's tough for most individual investors to know when to get out and just as tough to know when to get back in.
Mistake No. 3:
Stopping Contributions When Markets are Dropping
For the long-term investor, there really is no better time to be adding money to investment accounts than when they are down in value. Although we know that past performance can't guarantee future results, long-term investors have the potential to benefit by continuing to purchase during market declines, reaping rewards later if the values return. This works best when the investor is using mutual funds or other broad collections of securities.
Mistake No. 4:
Confusing Stock Market Value with the Economy
The economy is the sum total of all the economic activity in the country: jobs, business profits, debt, consumer spending, and lots of other factors. The stock market represents the perceived value of stocks of individual companies. Companies can make money during recessions. And great economies can lead to poor stock market returns. Profits affect the perceived value of a company, and so stocks can rise during recessions. Just because the economy is slow to recover, that doesn't mean the stock market will be. The 1990’s were a great period for the stock market, but what we found that much of it was based on speculation and wildly over-inflated stock prices. Investors have to realize that the stock market and the economy can be two entirely different things.
Mistake No. 5:
Paying too much attention to the media
The almost constant onslaught of news about the markets and the economy can cause investors to focus on short-term data that really doesn't have anything to do with their long-term performance. There is always some crisis somewhere that affects the markets, but in the long run, the markets will for the most part reflect business profits of companies. Just make a list of all the worries and predictions made by the talking heads over the course of a week, and then see how many of those issues are talked about six months later – or six days later. Investors need to stay focused on their long-term plan and not be scared out of the market by short-term events. Remember: media exists to sell advertising – sensationalism sells.
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Robert C. Henderson is the President of Lansdowne Wealth Management in Mystic, CT. His firm specializes in financial planning and investment management for individuals approaching retirement or already in retirement, with an added focus on the particular needs of women that are divorced or widowed. He is an Accredited Asset Management Specialist and a Certified Divorce Financial Analyst. Mr. Henderson can be reached at 860-245-5078 or firstname.lastname@example.org. You can also view his personal finance blog at http://lwmwealth.com/blog and the firm’s website at http://www.lwmwealth.com.
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