Re-posted from CNBC.COM
- We tend to second-guess decisions when the market is up more than our portfolios. Don’t make the mistake of comparing your portfolio’s performance to just one market index.
- The only accurate way to track performance is based on a basket of indexes comparable to your overall portfolio.
- Educate yourself about investment, maintain portfolio diversification, invest only after careful analysis, consider your overall goals and focus on investment value going forward.
The simple answer to the question “Should I go all in?” is “Don’t do it.”
It is very difficult to stay focused on your long-term goals when the market has gone up for an extended period of time. Most people recognize the feeling they get when they watch the financial markets rally or they review their investments after a really positive couple of months and realize they aren’t keeping up with the Dow Jones Industrial Average.
We all seem to second-guess our decisions when the market has gone up more than our portfolios, and have those moments when we start thinking maybe we are doing something wrong.
The reality is that you may not actually be doing anything wrong in your investment portfolio. To that point, tracking your portfolio based on one index is definitely not the way to measure performance.
Remember the Dow is 30 stocks of 30 different companies. It is not a good benchmark for determining if your portfolio is performing well, for two reasons.
First, it includes only 30 stocks out of the thousands traded on other exchanges. Second, because of the way the index is calculated, higher-priced stocks exert a greater influence over the index than lesser-priced ones. If your portfolio is invested in many different asset classes, comparing your overall performance to an index like the Dow isn’t very helpful or accurate.
The only accurate way to track your performance is based upon a basket of indexes comparable to your overall portfolio. For example, if you own mutual funds that invest in U.S. small cap stocks, the best index for comparison may be the Russell 2000. If you are looking at U.S. large cap stocks, the S&P 500 is a better measure than the Dow since it is a broader-based index with 500 companies, compared to 30 for the Dow.
I have had many questions from investors about whether they should increase their equity exposure, and consequently the risk in their portfolio.
For many the answer is no, but for some it is a matter of reviewing whether the potential increased return outweighs the increased risk that has to be taken. The best way to view this risk-reward relationship is by looking back at periods of time where we had either a really good market or a really bad one.
Regarding the latter, the two years that come to mind are 2008 and 2009. So if your portfolio lost 20 percent in 2008 but would have lost 30 percent with an increase in equity exposure, this is a start for determining the extent to which that extra risk impacts a specific portfolio.
The next step is to translate that percentage to real dollars. When we look at a percentage loss of 20 percent or more, we can rationally or intellectually say “Sure, I can deal with that.” But once we translate it to real dollars, it has a different feel. So a 20 percent loss may seem OK but, if it represents a $10,000 or more loss in real dollars, it may not be so easy to accept.
Maybe there are things you could do to more effectively manage your portfolio but it is not an all-or-nothing decision. Given the uncertainty surrounding the financial markets these days, now is a great time to take a good look at your portfolio. As you review your overall portfolio and the investments in it keep the following in mind:
- Think about your overall goals and objectives. What are you trying to achieve with these dollars? Can you target a higher return and accept higher risk and still reach your objectives? If not, take it slow increasing the risk of your portfolio.
- If you don’t have a financial plan, this review is a great reason to develop one starting right now. Planning now means a lot less stress and regrets later. Think about what a financial plan could mean to you and your family. A major benefit is that it keeps you focused and on track for the longer term and not just the short term.
- Make sure you understand the basics of investing, even if you hire a professional to help you manage your money. You need to understand the reasoning behind how your dollars are managed.
- Review your overall asset allocation to make sure it makes sense for you. The overall asset allocation and the asset classes you select are the most important part of building a solid investment portfolio for the long term, and the primary determinant of your portfolio’s overall performance over the long term. Make sure you rebalance periodically to bring it back in line with your original asset allocation if there has been no change in your financial situation or investment objectives. If there has been, you need to revisit your original asset allocation. If you originally targeted 30 percent in bonds and 70 percent in stocks, is this what you currently have?
- Review each individual investment. If you own a stock, is it still a good company? If you own a mutual fund, is it performing like comparable funds? If not, why not? Would you buy it today? Slow down and really think about the investments you currently have. Even if an investment has lost money, it is not necessarily a bad long-term investment. Don’t just react to what is going on in the markets today.
- Maintain that diversification. Don’t let any stock or fund take over your portfolio. Even if an investment has done really well, make sure you take profits and don’t let it take over too much of the value of your portfolio. Diversification doesn’t mean having many different advisors or many different U.S. large cap stock funds. It means having investments in U.S. large cap stocks, U.S. small cap stocks, fixed income, international, emerging markets and various other asset classes. Investing in asset classes that can help diversify your risk is critical.
- Purchase new investments only after extensive analysis. That means don’t buy the latest hot investment or buy something on a friend’s or neighbor’s hot tip, or the one that has gone up the most this week.
- Focus on the investment value going forward and not just on past performance. Past performance is only one indicator and not necessarily a predictor of future performance. If you are investing in a mutual fund, all else being equal, stick with the fund with low expenses. Funds with lower expenses have to take less risk for the return.
- Think about the basics of investing. You want to buy low and sell high, not the other way around. Don’t get caught selling something after it may be close to a bottom, especially if you believe it is still a good company or a good mutual fund. The flip side is, don’t fall in love with an investment and hold onto it in spite of continuing poor performance.
- If you aren’t sure what to do, or you find yourself unable to make a decision, hire someone to help you. There are many very good financial professionals out there that are capable of helping you work through some of these tough decisions. Don’t be afraid to ask for assistance in a difficult market.
The bottom line
The bottom line: Don’t make the mistake of moving in and out of investments trying to find the “right answer” in a volatile market. Unless you have a crystal ball, a diversified portfolio is still the right answer to most investment questions.
Remember that many investors lose money not because of bad investments but because of really poor timing of buying and selling investments. This happens because by the time they are convinced that the market is going down forever and actually sell may be right before the market does go up. It is also true of rising markets. You cannot time markets no matter how smart you are so invest in a diversified portfolio and keep rebalancing.
“Sooner or later the market will back up. … Until then, keep that go-for-broke mentality under wraps and don’t let emotions control your investment decisions.”
This time is not different and the market will not go up forever. The key is to plan your investment program, select individual investments carefully and don’t make changes without extensive analysis. And remember that mantra: “I am a long-term investor, I am a long-term investor, I am a long-term investor.” You get the idea.
Like any other bull market, this one will not last forever. Sooner or later the market will back up and we will once again experience the fear that is the other part of the equation. Until then keep that go-for-broke mentality under wraps and don’t let emotions control your investment decisions.