Avoiding portfolio pitfalls the key to successful investing

key to successful investingIt’s no simple task to put together and carry out a comprehensive investment plan. In fact, the process of matching a portfolio to the current market environment can leave some investors exasperated and confused.

However, avoiding the common portfolio pitfalls noted below may help you to invest successfully.

Be wary of emotions

Buying low and selling high is an investing 101 lesson. While many understand this concept, few are able to execute it. What gets in the way of making the right investment decisions? More often than not, it is emotions. Investors often allow their emotions to rule their decision making to the detriment of their portfolio.

From panic selling during market volatility to chasing returns when the market is overvalued, investor psychology tends to cause investors to overact. Always keep in mind that market timing can be dangerous. According to a study by Brinson, Hood and Beebower titled “Determinants of Portfolio Performance,” 93.6 percent of the variation of returns in a diversified portfolio is explained by the asset allocation policy, not market timing. That’s right — not market timing.

Avoid putting too much into risky investments and learn to expect that market values will fluctuate, as this will help you to avoid selling at the worst times. In addition, avoid “following the herd” and work to develop a contrarian approach.

For example, in 2005 when the herd was buying real estate, in many cases it was not the ideal time to purchase. Today, when most are not looking at real estate, is when the better opportunity may exist.

Stick to what you know

When the financial crisis hit in 2008, many types of investments declined simultaneously and the wisdom of diversifying between common assets such as stocks and bonds came into question. As a result, alternative investments that are touted as being less sensitive to market swings have increased in popularity.

While there are certainly alternative investments that may be beneficial to your portfolio, some come with high fees, little transparency and strategies that are difficult to understand. As Warren Buffet once said, “Never invest in a business you don’t understand.” Keep this in mind when you chose investments for your portfolio.

Rebalance on schedule

As a tool that may be effective in helping to manage risk, portfolio rebalancing is a critical component of the investment management process. Without it, the diverse mix of investments that make up an investor’s portfolio will fall out of alignment over time as values fluctuate. As this occurs, the original target portfolio changes, which in turn, can alter the amount of risk you are being exposed to.

Consider rebalancing your portfolio every six months to a year or when any one holding increases or decreases by 5 percent, as this may help to keep your portfolio from deviating too greatly over time from your target allocation.

Remember to pay close attention to the tax implications and transaction costs associated with any rebalancing, as they can have an impact on its effectiveness.

Past-performance trap

While past performance is no predictor of future results, investors often make the mistake of relying too heavily on it to make investment decisions. Last year’s best performing asset classes will not necessarily be this year’s winners. For example, in 2007, emerging market stocks were one of the best performing asset classes but turned out to be one of the worst the following year. Looking in the rear-view mirror to choose your portfolio may prove costly in the long run.

Consider visiting www.callan.com/research/periodic/ for a chart that highlights the unpredictability of various asset classes during the last 20 years.

Avoid excessive fees

Performance may be the singular focus of investors when constructing their portfolio, but expenses should also be a factor when implementing any investment strategy. While nothing is free in life, you do not want to overpay for investment management.

Since fees can place a significant drag on portfolio results, they should be closely monitored.

There is no shortage of hazards when it comes to managing your investments. While the pitfalls noted above are just a few, implementing a strategy that avoids them may help you in the long term. Because everyone’s situation is unique, consider speaking to your adviser to determine the most appropriate investment strategy for you.


Kurt J. Rossi, MBA, is a certified financial planner practitioner. He can be reached for questions at (732) 280-7550 or kurt.rossi@Independentwm.com. LPL Financial Member FINRA/SIPC.