3 Strategies Average Investors Should Avoid
While investment tips are a dime a dozen these days, implementing a negligent strategy can cost you years of underperformance. Even worse, it can lead your portfolio away from your retirement goals and individual needs.
The average investor is struggling against almost every major asset class in the world. According to a recent research note from Richard Bernstein Advisors, the 20-year investment performance of the average investor is painfully poor. In fact, the average investor has underperformed every category except Asian emerging markets and Japanese equities. As the chart above shows, even cash managed to perform better, as represented by three-month Treasury bills.
What’s behind the dismal performance? Emotions and poor timing are at the top of the list. Investors often become distracted with a surplus of either greed or fear. When stocks are rising, investors feel too clever for their own good and enter a state of euphoria. When stocks decline, they often hold on in disbelief until they sell at the worst possible moment — the bottom. This type of behavior not only results in buying high and selling low, it results in scary investing strategies that should be avoided.
I recently spoke to Bob Gavlak, a certified financial planner and wealth advisor at Strategic Wealth Partners, to better understand common pitfalls clients make in the financial markets. Let’s take a look at three investing strategies that should be avoided this Halloween and beyond.
1. Living in the past
The most popular disclosure in the investing universe reads: “Past performance is not indicative of future returns.” Yet investors still ignore this statement and use past fund returns as crystal balls. Far too often, investors pile into investments with the highest returns over the past quarter or year when the oversized gains have already taken place.
“We hear a lot of this when we ask potential clients about their current investment strategy. They basically take their 401k statements at the end of the year, look at all the funds, look at which fund is up the most, and put their assets for the next year into that fund,” explains Gavlak. “This is a scary practice because, at the end of the day, what a fund did in the previous year has absolutely nothing to do with whether it will be a good fund moving forward.”
He adds, “It depends not only on the current economic environment, but also what the fund manager did before the prior year. If the manager was down 50% in one year when everybody was only down 10%, they might have a good next year because they have a lot of ground to make up. If you’re only looking at one year or quarter, it really gives you a limited window to know whether it’s going to be a good investment. You can’t just chase returns. The investment needs to make sense.”
2. Listening solely to media personalities
The media plays a major role in financial decisions. Our digital world has investors constantly connected to news like never before. Anyone with a device can stay up-to-date on the latest market events around the world, or tune in to their favorite media personalities. While this does not always hinder investors from good decisions, it can serve as distracting noise.
Before you listen to Suze Orman, Jim Cramer, or anyone else with a microphone, you need to consider your own financial situation. “The television personalities, on-air personalities, radio hosts, whoever it might be, they give very general open-ended advice that doesn’t necessarily apply to everyone’s specific situation. Each individual has different needs, objectives, and balance sheet setups that come into play. While media personalities can be helpful in general schools of thought, you can’t just be all-in when it comes to your own situation,” explains Gavlak.
3. Hiding too much in cash
It’s not hard to understand why some investors keep hiding a large portion of their assets in cash. The stock market has suffered two breathtaking pullbacks over the past 14 years. Between January 2000 and July 2002, the S&P 500 dropped from 1,500 to 815. During the Great Recession, the index plummeted from 1,525 to 800. Looking at the charts and fundamentals, some analysts think another major correction is already past due. Nonetheless, history says cash is a terrible long-term investment.
While holding some cash can provide an opportunity for future investments, making it the foundation of an investment portfolio is dangerous over the long haul. Research from BlackRock shows cash has an average annual return of only 0.5% after inflation, between the period of 1926 and 2012. When taxes are factored, cash has a negative return of 0.8%. In comparison, stocks have an average return of 4.5% after taxes and inflation.
“The only long-term investment strategy that is guaranteed to lose you purchasing power and money is being in cash,” says Gavlak. “We can’t predict what the markets are going to do, whether it be up, down, or sideways, but I can almost certainly guarantee you that over the next 10 to 20 years there’s going to be some form of inflation. By just having your money in cash you’re not going to be able to protect yourself from inflation.”
Gavlak notes that cash is important for liquidity reasons, such as addressing an unexpected financial emergency. However, having more than 5-10% of your investable assets in cash starts to become excessive.
Follow Eric on Twitter @Mr_Eric_WSCS
More from Personal Finance Sheet:
- 10 States Suffering the Most From College Debt
- Are Money Problems the Real Horror Show in America?
- 5 Best Ways for Companies to Improve 401(k) Plans