by Elliot Raphaelson
Believe it or not, there is a lesson for small investors to be learned from the recent $2 billion-plus loss by a sophisticated trading unit of JPMorgan Chase. Even "expert" traders make mistakes.
You shouldn't expect every investment decision you make to be perfect. And when you are wrong, it's best to recognize it and change course. You will be in good company. Even successful investment professionals such as Warren Buffett and Bill Gross have made humbling mistakes in the last few years.
However, you also need to understand how you are different from a major trader. JPMorgan Chase can recover from speculation gone wrong. You might not be able to.
Most individual investors need to adopt long-term objectives, develop an investment program, and try not to out-guess the market with an emphasis on short-term trading.
When individual investors falter, it is usually one or more of the following common mistakes:
- Failure to establish a long-term plan. Whether or not you make your own investment decisions, it's up to you to establish long-term objectives. How can a planner or broker make intelligent choices for you if you haven't given it a great deal of thought already? Do you want to retire at 55 or 70? Are you dependent solely on your income/assets, or do you expect an inheritance? What are your retirement objectives? Will you be satisfied with 75 percent of your inflation-adjusted income in the year you retire, or do you need or want 125 percent of that income?
- Not starting an investment program early enough. Many, if not most, investors put off starting a long-term investment program. If you wait until your 50s, it will be very difficult for you to build up enough assets for a comfortable retirement. If you find yourself in that situation, there are some actions you can take to help increase your savings. You may have to work past the normal retirement age or work part time in retirement. You might also consider downsizing your home or choosing a low-cost area in which to live in retirement. The first step to take is a frank assessment of what you will need in retirement, and how your current investments stack up. Start by using an online retirement savings calculator.
- Buying and selling at the wrong times. Most individual portfolios underperform the common indexes -- some by quite a bit -- generally because of poor timing. When the stock market falls, many investors sell close to the bottom and either wait too long to get back in the market, or never get back. Investors also tend instinctively to make most of their purchases close to market peaks. The best way to avoid this is dollar-cost-averaging: Decide how much you can afford to invest, and invest the same amount monthly regardless of market fluctuations.
- Insufficient diversifying, and not rebalancing regularly. No one can predict with accuracy when common stocks will outperform bonds, when growth stocks will outperform value stocks, or when global securities will outperform domestic stocks. I maintain a diversified portfolio at all times, and rebalance once a year. As individuals approach retirement, they should become more conservative and, for example, increase the percentage of intermediate-term high quality bond funds in their portfolio. One alternative, if you prefer not to develop your own portfolio, is to buy a no-load target fund with low expenses. For example, Vanguard's target funds have annual management costs of 0.18 percent.
- Being too conservative. Readers regularly indicate they are afraid of taking any risk because of the volatility in the stock market. Avoiding any risk simply won't work in the long term. Inflation is here to stay. Even if inflation is only 2 to 3 percent annually, investors cannot keep investing in money-market securities and short-term CDs and expect to have enough growth to meet retirement objectives. If you take some risks, you can't "bail out" as soon as the market falls. Invest for the long-term, diversify, and use dollar-cost-averaging.
- Having high expenses. Even when you take some risk, it is difficult to obtain recurring large returns in your portfolio. Selecting investments that have high costs, such as mutual funds with a sales load or with high annual expenses, makes it more difficult to achieve retirement objectives. Paying a financial planner who depends on commissions from high-fee products will hurt your long-term performance. It is easier to achieve retirement objectives if you do their own financial planning, or use the low-cost or free services of no-load mutual funds, or hire a fee-only financial planner.
- You may have been making any combination of these mistakes in your portfolio for years. Don't let that discourage you. Identifying mistakes and correcting them will set you on the path you need to take to achieve long-term objectives.
Elliot Raphaelson welcomes your questions and comments at firstname.lastname@example.org
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