Most of us are pretty good consumers. We use coupons, look for deals online, and buy on sale. Somehow, those good habits go out the window when we shop for investments.
Avoidable Mistake #1: We buy when prices are high. Most people get into an investment based on its one year return that looks fantastic. Then we sell when that investment’s return goes down. So, we’ve bought after the price was marked up and sold when the price was marked down. Is that how you would buy jewelry or a TV?
Avoidable Mistake #2: We buy lots of the same kind of investment. This goes along with Mistake #1 and it’s like Imelda Marcos buying 10 colors of the same kind of shoe. When trying to get a diversified investment portfolio, people buy 3 of the top performing mutual funds over the last 1-year time period. Guess what? The reason they are all in the 3 top three with similar returns is that they are probably all invested in the same area of the market (i.e. US Large company stocks, or real estate). So, when that area of the market goes down, our whole portfolio goes with it.
Avoidable Mistake #3: We get frustrated with an investment and get rid of it. There is a saying that goes, “If you have a properly diversified portfolio, you’ll always hate at least one thing in it.” This means if you are truly diversified, there are always one or two investments that are doing way worse than the others. That’s okay! Every dog has its day and every area of the investment markets has its good and bad times. We just can’t predict when they will be. Tossing out your underperforming funds when you are mad is like throwing away your best suit because you don’t want to wear it to the gym that day.
So, I’ve told you what not to do. How about something positive? Here’s how you should shop for investments:
- Decide what percentage you want of your portfolio in each area of the investment market. For example, a classic growth portfolio might have 70% stocks and 30% bonds.
- Only compare similar types of funds to each other. For example, compare international small cap funds to each other, not to international bond funds.
- Use screening tools to look for the following
- Morningstar ratings of 4 stars or higher
- Lower than average expense ratios
- No load funds (no commissions to buy or sell funds)
- Higher than average returns
- Lower than average standard deviation (risk)
- Use mutual fund or ETF screeners to narrow the field. There are good ones at www.fidelity.com and www.morningstar.com
Tune in next week for more exciting investment education from Kristi!