Stocks: The worst ways investors go astray

Investors are often their own worst enemies, said Ben Steverman in Business­Week. The past few years of market turmoil have emphasized the “high cost of doing the wrong thing” at the wrong time. Yet investors continue to make the same mistakes over and over again. They fall for “fads,” try to use politics as a gauge for the direction of the market, and are “notorious for selling stocks when markets have already dropped and buying after they have risen.” If you panic-sold last March, when the market hit bottom, that’s a pretty good indication that you took on more risk than you could handle. “People who jump in and out of the market probably shouldn’t be in the market,” says Susan Elser of Elser Financial Planning.

One of big mistakes that mutual fund investors make is placing too much emphasis on recent returns, said Chuck Jaffe in MarketWatch.com. “You can’t just buy funds that did reasonably well yesterday; you need to invest in parts of the market that are likely to do well going forward.” While that’s no easy task, it helps to know exactly how each fund invests. “Too many investors can’t explain what their funds do and why.” That’s probably because they rely heavily on rankings and ratings. “More than 90 percent of all inflows into mutual funds goes into issues that carry Morningstar’s four- and five-star rating.” Yet even Morningstar itself calls its ratings system “more ­‘descriptive’ than it is ‘predictive.’” Past performance, in other words, is no guarantee of future results.

Don’t get so caught up in scrutinizing individual investments that you ignore the big picture, said Jeff Sommer in The New York Times. Research shows that how you allocate assets is a better predictor of returns than what stocks you pick or how you time the market. “People spend all their time looking at the trees and not the forest,” says Gary Brinson, a Chicago asset manager who helped pioneer asset allocation theory. “It’s the forest that’s important.” In fact, the most prudent way to invest is pretty simple. Assess your needs and risk tolerance. Design a diversified, low-cost portfolio. Rebalance it annually, and make regular contributions through dollar-cost averaging. This method may not be exciting, but it’s practically foolproof.

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