Lessons to take away from the market’s ups
and downs
Consumer Reports Money Adviser August
Issue
Painful memories of 2008’s market
collapse still linger for most people. So lest we forget, Consumer Reports Money
Adviser’s experts listed some common investor mistakes, pre- and post-meltdown,
and how to avoid them the next time around.
1. Following the herd. This emotional
approach to investing often results in buying high and selling low, the opposite
of what most of us want to do. But whether the Standard & Poor’s 500 is up a
certain amount or your neighbor is making a killing shouldn’t matter to you.
Your strategy should be based on your individual goals, time horizon, and risk
tolerance, not those of your neighbor. If you follow the herd into an investment
you run a good shot at buying near the top. Similarly, the greatest volume of
selling is generally near the market bottoms, when the news headlines are the
most dire and a turnaround seems most improbable.
What to do instead.
Put your investments on autopilot. Set up an appropriate asset allocation
and make regular investments at set intervals, regardless of what the market is
doing or pundits are prognosticating. If you’re still some years away from
leaving the workplace, consider target-date funds, which shift their mix of
investments automatically based on your anticipated date of retirement. They
were criticized for their inability to protect investors from losses in 2008,
but the funds performed well for people who stuck with them over the last two
years.
2. Running for safety. In the aftermath
of the 2008 market meltdown, many investors realized that they had too much
invested in stocks and too little in bonds and cash. Some reacted by liquidating
what was left of their stocks and pouring money into Treasury bonds as a safe
haven. Unfortunately, that too could turn out to be a mistake. Should interest
rates rise or the U.S. fiscal situation deteriorate, being locked into
Treasuries, particularly long-term ones, or just having too large a bond
position could mean trailing inflation.
What to do instead. Playing it safe
might make sense if you don’t have a long time horizon and can’t wait for the
market to recover. But if you want your portfolio to grow over time, you should
continue to hold some stocks. If you’re a bond investor, stick to shorter-term
issues until the interest rate picture becomes clearer.
3. Overpaying for past performance. If
you buy a fund because its manager delivered big returns in the past, you could
end up paying management fees for old returns that he or she might not be able
to duplicate. For example, CGM Focus was one of the best performing funds of the
past decade, with an almost 18 percent average annual return through July 31,
2009. But Morningstar’s “Investor Return,” which measures the performance that
people actually achieve in a fund based on the timing of their purchases, shows
that investors lost nearly 17 percent annually during that period.
What to do instead. Hold a mix of index
funds and low-cost managed funds. Index funds are the cheapest ways for
individual investors to build a diversified portfolio and get what’s basically a
market rate of return. Managed funds can fill in niche areas of the market, such
as real estate or high-yield bonds, where a conservative manager can avoid some
of the scarier investments that might be included in an index fund devoted to
that sector.
4. Counting on your home as an
investment. It may be your biggest asset, but you shouldn’t expect to make much
money from your home. Historically, real estate has returned only about half a
percent a year after taking inflation into account. As home prices climbed over
the past decade, many buyers overreached to take on more house than they could
afford, assuming they’d make more profit when the property was sold. The plunge
in housing values has left many with unaffordable mortgages and homes that can’t
be sold.
What to do instead. Don’t base any
assumptions of your ability to retire on how much your home might appreciate.
Look to your home as a place to live, not as a sure-fire investment.
5. Being overconfident. Some investors
tend to ascribe their gains to their own abilities rather than the whims of the
market. And they tend to think that they’re smarter than the average investor on
the other side of the trade. That may not be the case, but you’re not competing
with the average investor—you’re up against investment pros.
What to do instead. Don’t’ let your
confidence lead you to trading more often than you should. Dollar cost averaging
into mutual funds within an IRA or 401 (k) gives you psychological distance from
the market’s gyration.
Consumer Reports Money Adviser is a
monthly, subscription-only newsletter that answers tough money questions and
provides expert financial advice. Its proven information and successful
strategies can make any financial decision an easy one. Each month, CRMA
provides feature articles and helpful investment, savings, and spending advice
that will help prepare consumers for anything life may bring them. For more
information visit: www.ConsumerReports.org.
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