Compound your gains, not losses
Market sell-offs are bad enough. By fixing these common investing mistakes, you’ll make sure difficult times aren’t made worse.
(Money Magazine) — Hoyt Cory doesn’t know quite what hit him. The 61-year-old holistic wellness practitioner in Sonora, Calif. expected steep losses in his $890,000 retirement funds, given the market crash. But when he added up the damage at the end of last year and saw that he had only $542,000 left in his stock and bond portfolio – nearly a 40% decline – the former corporate training and development consultant couldn’t believe it.
“I thought I did everything right,” says Cory, who is about to get married. “I read up on this stuff, I diversified, I even got help from a financial adviser. I just didn’t see the writing on the wall.”
There are plenty of people who share Cory’s disbelief – and pain. The typical long-term 401(k) investor ages 45 to 64 lost about 20% in 2008, according to the Employee Benefit Research Institute. If, like Cory, you suffered steeper losses than that, it’s probably a sign that you had problems in your portfolio. That means you got pounded twice – first by the crash and then by your missteps.
While you can’t do much about the market, you can correct your errors
Mistake no. 1: You invested too aggressively for your age
The very young can invest almost all of their money in equities, since they have time to make up for losses. But the same isn’t true for boomers. Yet an alarming number of workers nearing retirement are too heavily weighted in stocks.
Among 401(k) savers 56 to 65, nearly two in five recently had 80% or more of their retirement assets in equities, according to EBRI research director Jack VanDerhei. Cory was one of them, though he didn’t realize it at the time.
While virtually all assets (stocks, corporate bonds, real estate and so forth) were hit hard by this downturn, a higher fixed-income allocation would still have prevented Cory from losing so much, notes Plymouth, Mass. financial planner William Driscoll.
For instance, had Cory invested 65% of his money in an S&P 500 stock index fund and 35% in a diversified bond index fund, he would have lost 22% last year. That still would have hurt, but it’d be better than his actual 39% decline.
Solution: Sit down and figure out your proper allocation. Take into account your financial standing, expected retirement date and tolerance for risk. Based on these factors, Colorado Springs financial planner Allan Roth recommends that Cory put 65% of his portfolio in equities – not the nearly 85% he currently has – with the rest in bonds and cash.
To figure out the best strategy for you, check out the asset-allocation tool (http://cgi.money.cnn.com/tools/assetallocwizard/assetallocwizard.html). Even if you work with a financial planner, run the calculation. If your adviser recommends a different strategy, ask why.
Mistake no. 2: You forgot to keep your plan in check
It’s tempting to let your portfolio run unfettered when stocks are rollicking. But failing to routinely monitor your investments will make you more vulnerable to market crashes.
Take Cory. It was never his intent to have nearly 85% of his retirement funds in stocks. When he was in his mid-fifties, an adviser recommended that he be 75% in equities. Cory took the advice. But he never reset his portfolio to that initial mix of stocks and bonds. Since his equities grew faster than his bonds between 2003 and 2007, his 75%-stock strategy morphed into a more aggressive plan on its own.
Solution: Reset your mix to your desired allocation at least once a year. In a rising stock market, rebalancing forces you to take some profits. It also ensures that your portfolio won’t be too aggressive when the next bear strikes. Conversely, when equities are falling, rebalancing forces you to buy shares when prices are low. And it ensures that your portfolio won’t be too conservative when the next bull rolls around.
What’s the best way to rebalance? Driscoll suggests that Cory set triggers. If his stock weighting changes by more than five percentage points in either direction – in other words, if his 65%-stock allocation shrinks to less than 60% or grows to more than 70% – rebalance then and there. An easier solution: Pick a date on the calendar and just rebalance annually.
Mistake no. 3: You picked some real dogs
Sometimes it’s not your overall strategy that’s flawed. It’s the individual funds you picked to implement your plan.
Yet investors often struggle psychologically with the idea of selling their underperformers. Part of the problem is that many investors “feel the pain of taking a loss twice as much as the pleasure of realizing gains,” says Michael Pompian, author of “Behavioral Finance and Wealth Management.”
It could also be the fear of triggering long-term capital-gains taxes. That’s not as big a concern now, with 52% of U.S. stock funds down over the past 10 years and 91% underwater for the past five. Yet with so many funds down, it’s also hard to figure out which funds are the true losers.
Solution: Separate your real laggards from funds that are simply down – and take this opportunity to sell. Start by comparing apples with apples. “If the stock portion of your portfolio did worse than the S&P 500’s (.SPX
) 37% plunge, that’s telling you something,” says Daniel Moisand, an adviser in Melbourne, Fla.
Then dig deeper. Check how each of your funds has done over the past year and the past five years compared with peers that invest in a similar style. So if you own a large-cap growth fund, see how it ranks against other large-growth portfolios. It doesn’t have to be the absolute best, but make sure it’s at least close to average. To look up average performance figures for all fund categories, visit Morningstar.com, click on the Markets tab and then scroll down to Fund Categories.
After looking over his portfolio, Cory found that many of his funds were under-performing – and that he was losing too much to fees and commissions. So he is simplifying his strategy by replacing his dogs with low-cost index funds.
That may not be the approach you ultimately select. But whatever you do, don’t wait too long to fix your portfolio. Who knows if the next rebound – or sell-off – is just around the corner?