Watch Out for These Investment Mistakes

by | Oct 13, 2017 | Business Strategies

When faced with all the decisions that need to be made to ensure you select the proper investments to meet your long-term financial goals, it’s easy to become overwhelmed.

How do you choose the right combination of investments to help you reach a goal that may be decades away? The answer is to focus on the fundamentals. Make sure you are getting these eight basics right:

1. Don’t wait — invest now. To put the power of compounding to work for you, start investing now. It’s easy to put off investing, thinking you’ll have more money or more time at some point in the future. Typically, however, you’ll be better off saving less now than waiting and saving more later.

Consider the savings habits of a 20-year-old couple. The husband starts contributing $2,000 per year to a tax-deferred investment, such as a 401(k) plan, when he is 20. After 10 years, he decides to stop investing and let his money grow until retirement. He has invested a total of $20,000. His wife starts investing when he stops, investing $2,000 per year in a tax-deferred investment from the time she is 20 until she retires at age 65. Thus, she saves every year for 35 years, making a total contribution of $70,000 — $50,000 more than her husband.

If they both earn eight percent compounded annually, who will have the potentially larger balance at age 65? Time and compounding of earnings favor the husband. Before paying any taxes, his balance would equal $462,649, while his wife’s balance would be $372,204. (This example is provided for illustrative purposes only and is not intended to project the performance of a specific investment.)

2. Live below your means so you can invest more. It’s a basic fact that most people have trouble coming to grips with — the amount of money you have left over for investing is a direct result of your lifestyle. Don’t have money for investing? Ruthlessly cut your living expenses — dine out less often, stay home rather than going away for vacation, rent a movie rather than going to the theater, cut out morning stops for coffee. Redirect all those reductions to investments. This should help significantly with your retirement. First, you’ll be saving significant sums for your retirement. Second, you’re living on significantly less than you’re earning, so you’ll need less for retirement.

3. Maintain reasonable return expectations.

4. Understand that risk can’t be avoided. All investments are subject to different types of risk, which can affect the investment’s return. Cash is primarily affected by purchasing-power risk, or the risk that its purchasing power will decrease due to inflation. Bonds are subject to:

  • Interest-rate risk, or the risk that interest rates will rise and cause the bond’s value to decrease, and
  • Default risk, or the risk that the issuer will not repay the bond.
  • Stocks are primarily subject to nonmarket risk, or the risk that events specific to a company or its industry will adversely affect a stock’s price, and
  • Market risk, or the risk that a particular stock will be affected by overall stock market movements.

These risks make some investments more suitable for longer investment periods and others more suitable for shorter investment periods.

5. Diversify your portfolio. When stocks had above-average returns for an extended period, diversification acted as a drag on total return. By definition, allocating anything other than all of your portfolio to the best-performing asset lowers your return. But when stocks declined substantially, the disadvantage of investing only in one asset class became apparent. Typically, you do not know which asset class will perform best on a year-to-year basis.

Diversification is a defensive strategy — it helps protect your portfolio during market downturns and helps reduce your portfolio’s volatility. Diversify your investment portfolio among a variety of investment categories, such as stocks, bonds, cash, real estate, and other alternatives. Also diversify within investment categories. For instance, in the stock category, consider value and growth stocks, small and large capitalization stocks, and international stocks.

6. Invest in the stock market for the long term. Stocks should generally be considered by investors with an investment time frame of at least five years. Remaining in the market over the long term reduces the risk of receiving a lower return than you expected.

7. Don’t try to time the market. Timing the market is a difficult strategy to accomplish successfully, since so many factors affect the market. Remember that most people, including professionals, have difficulty timing the market with any degree of accuracy. Significant market gains can occur in a matter of days, making it risky to be out of the market for any length of time. Instead of timing the market, concentrate on setting an investment program that works in all market environments and that you can stick with in both good and bad times.

8. Pay attention to taxes. Taxes are probably your portfolio’s largest expense. Ordinary income taxes on short-term capital gains are higher than those on long-term capital gains.

Using strategies that defer income for as long as possible can make a substantial difference in the ultimate size of your portfolio. Some strategies to consider include utilizing tax-deferred investment vehicles (such as 401(k) plans and individual retirement accounts), minimizing portfolio turnover, selling investments with losses to offset gains, and placing assets generating ordinary income or that you want to trade frequently in your tax-deferred accounts.