Emotional involvement with your investments often leads to costly behavioral investing mistakes. You can’t control the market but here are some ideas on what you can do.
In a Tumultuous Market Investors Need to Focus on What They Can Control
Big, sharp market swings like we have seen this year can be unsettling if not downright scary for many investors. Lulled into complacency by a nine-year bull market and more than two years without a serious correction, it’s likely that many investors started paying attention once again to their portfolios and 401(k) plans, which, studies have shown, is not good your financial health.
Checking Your Accounts Frequently Can Hurt Investment Performance
Research has shown that, the more investors check their investment accounts, the more likely they are to want to tweak their portfolios, which typically leads to underperformance.1 It’s this type of emotional involvement with one’s investments that often leads to costly behavioral investing mistakes, such as panic selling near a market low, exuberant buying near a market top, chasing returns, or simply trying to time the market.
The same study found that investors who don’t regularly check their investment accounts generate higher returns because they are more likely to stick with their long-term investment strategy and less likely to make any forced errors. What these investors seem to understand is that, while this month’s market performance or calamitous economic event may seem consequential to our lives at the moment, the impact on the markets and, therefore, our portfolio over the long-term is so minimal as to cause nothing more than a tiny blip on our long-term investment performance. That and the fact that there is nothing we can do to control which way the market moves tomorrow or next week, so why bother?
How to Gain Control Over Investment Performance
However, that is not to say there is nothing you can do to improve your investment performance. There are several aspects of investing you can control and actions you can take to reduce portfolio volatility, minimize risk, reduce investment costs and minimize taxes all of which can lead to a better investment experience.
Create an investment plan to fit your needs and risk tolerance
If you expect your investment strategy to be successful, it should be based on a complete assessment of your needs, objectives, and risk tolerance. You must have clearly defined goals that are achievable and measurable, factoring in life’s uncertainties and changing economic conditions. That becomes your target to focus on regardless of market fluctuation.
Asset mix is critical to long-term investment returns
Understanding the fundamental relationship between risk and returns, it’s critical to create an asset allocation with the optimum mix of assets to generate the returns needed to achieve your investment objective. The purpose of asset allocation is to reduce portfolio volatility by investing in different assets that have low correlation to each other. For example, when stocks are performing well, bonds tend to underperform, and vice versa. Because it’s difficult to know which assets will outperform at any given time, you hold different types to capture returns when they occur.
Broad diversification reduces risk
Broad diversification seeks to capture the returns of different types of investments over time but with less volatility at any one time. Since it is very difficult to know who the winners will be before the fact, a reasonable investment approach is to keep your portfolio well-diversified among various asset classes, market segments, and company market capitalization. That way, your portfolio can capture returns while managing the risk-return tradeoff according to your risk profile.
A sound investment strategy not only seeks to generate returns on your capital, it also seeks to preserve as much of your capital as possible to keep it working for you. One of the surest ways to preserve your capital is to reduce the amount of taxes you pay on investment income and gains. By incorporating tax-saving strategies into your investment plan, you can minimize the impact that taxes have on your long-term investment performance.
Taking advantage of tax-favored qualified retirement plans and the more favorable tax rates of long-term capital gains; avoiding mutual funds with high portfolio turnover in non-qualified accounts; diversifying your retirement income sources for optimum tax efficiency and minimizing required minimum distributions are just some of the components of an effective tax strategy that can allow your money to grow faster and last longer.
1ETF.com. The Cause of Myopic Loss Aversion. August 2016
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