One of the most critical elements to achieve the goals and objectives in your financial plan is making the right investment choices.
Making the wrong choices can be costly and result in failure in achieving your
long-term goals. RubinBrown Wealth Advisors share the most common mistakes investors make, as well as provide guidance to avoid them.
1. Not understanding the all-in cost of your portfolio
Fees can include transaction costs (commissions, mark ups and loads), ongoing investment advisory fees charged by advisors, embedded fees contained in investment products (mutual funds, annuities, exchange traded funds, separately managed accounts, etc.), custody fees and the like.
Fees can have a significant impact on the performance of your portfolio. Ask your broker or investment advisor to disclose the “all-in cost” of managing your portfolio, including all the fees you see and especially those you do not see.
2. Investing without identifying goals or assessing your risk tolerance
Quite frequently, RubinBrown Wealth Advisors find individual investors take on more risk than they need or can tolerate. As a result, when markets are volatile, they panic, sell at the wrong time and often do not get back into the market until it has recovered.
It is important to know and clearly articulate what you are saving money for. This will enable your advisor to create a plan, and design a portfolio as part of that plan with an appropriate asset allocation. This approach will help you achieve the long-term return you need to achieve your goals and objectives at a level of risk you can tolerate.
3. Chasing returns
Many investors look at the past performance of an investment and mistakenly assume that the same performance is repeatable in the future, only to be disappointed when the investment does not meet their expectations.
Because the performance of different asset classes (stocks, bonds, real estate, commodities and cash) fluctuates at different times in the business cycle, and the timing is not easily predictable, investors shouldn’t chase returns. Our experience has shown this is the primary reason that past performance is not necessarily a good predictor of future performance.
4. Not rebalancing your portfolio
It is important to review your portfolio periodically to be sure that its asset allocation is consistent with your plan. Left to its own devices, a portfolio can quickly get out of balance as different asset classes move in and out of favor over the course of the business cycle.
Especially after a period of volatility, you can easily find your portfolio over weighted to one or more asset classes. This change in asset class weightings can result in a portfolio with a different risk/return profile from the one your advisor originally designed.
Look at the portfolio asset class weighting periodically with your advisor and make adjustments to the allocation as needed to maintain your desired risk/return profile.
5. Portfolio lacks diversification
Many Noble Prize winning studies have demonstrated the primary driver of the risk/return profile of an investment portfolio is the asset allocation. Many investors believe investing in different stocks or mutual funds means their portfolios are diversified.
Upon further analysis, RubinBrown oftentimes finds many of the stocks or mutual funds owned are in the same asset class or sub asset class (e.g., large/mid cap growth or value, small cap growth or value, etc.)
and will likely fluctuate similarly as the business cycle progresses, thereby mitigating the risk reduction benefits of being truly diversified. It is important to understand exactly what you own.
6. Not investing in a tax efficient manner
Many investors don’t think about the tax implications of where their investments are held. It is important to remember that it is not what you make that matters, but what you keep after taxes. Pay attention to taxation.
Different types of accounts and investments have different income tax implications. Capital gains and dividends are taxed at preferred rates, while interest can be either taxed at ordinary rates or tax exempt. Also, any earnings in a traditional IRA or 401k account can be deferred until withdrawn in retirement and are then taxed at ordinary rates, including dividends and capital gains on stocks.
Earnings in a Roth IRA or Roth 401k account are tax exempt, even when withdrawn after retirement. Therefore it makes sense, if you have a diversified portfolio containing tax inefficient assets that generate ordinary income (e.g., taxable bonds, commodities and real estate investment trusts) to hold these in tax deferred accounts, such as traditional IRAs and 401k’s.
Doing so will allow you to defer any income tax without giving up any tax preference when the returns are withdrawn in retirement.
For those assets that generate returns that are taxed at preferred rates (e.g., capital gains and dividends on stocks), consider holding them in taxable accounts so that the tax preference is not lost, or hold them in a Roth IRA or 401k account where none of the returns will be taxed.
Also, if a portfolio has trust accounts that are not included in an investor’s estate, it may make sense to consider holding growth assets like stocks in them since the appreciation will not be included in the investor’s estate.
7. Not monitoring your managers
Many investors buy a fund or invest in a separately managed account and never look at it again. Many portfolio managers managing mutual funds and separately managed accounts come and go. The investment philosophies, strategies and organizations they work for can change or be bought and sold over time.
Portfolio management fees and costs can also change. Manager performance can lag versus a peer group or benchmark. It is important to pay attention to the investments you buy and the portfolio managers you hire. Sit down with your advisor periodically and review the portfolio managers you are using. Make an informed decision based on whether they are still meeting your goals and objectives and whether they should be retained.
Also, understand how your advisor evaluates the portfolio managers recommended to you and what each investment’s role is in your overall portfolio strategy.
8. Lacking an overall strategy
Our experience is that many investors have accounts spread out with several advisors and custodians. Because the accounts were opened at different times, each contains different investments or strategies. As a result, the investor has no overall strategy at all, making it difficult to know if his or her goals and objectives are achievable. Typically, all of the accounts are there to serve the same purpose – meet your needs in retirement. Therefore, it makes sense to have one overall investment strategy.
Keep things simple and work with one advisor that can create a plan for you, and as part of that plan, develop an overall investment strategy to help you achieve your goals and objectives at a level of risk you can tolerate.
Your advisor can recommend different portfolio managers to use in your portfolio to achieve proper diversification, avoid overlapping services and reduce costs.
9. Fearing instead of embracing volatility
Investors have been conditioned over the years to fear volatility (risk). However, the reason that stocks have higher returns than bonds is because they are more volatile. To get the required returns from your portfolio needed to achieve your goals, you will likely need stocks in your portfolio.
This is why it is important to work with your advisor to create an investment strategy with the right returns at an acceptable level of risk. Your advisor anticipates volatility will occur from time to time in the future, and creates your strategy with that in mind.
When the market volatility does come, you may have the opportunity to rebalance your portfolio and buy stocks when prices are lower. Embrace volatility as a means of achieving your goals. After all, isn't it better to buy when assets are on sale rather than at full price?
10. Not knowing what you own
Many investors are sold investment products without really understanding what they bought, the cost and their role in their portfolios. Because of this, investors can be more anxious about holding on when the markets are volatile.
Ask your advisor to clearly explain what each investment in your portfolio is, how it works, how much it costs and how it fits into your overall strategy. In our experience, the simpler the investments in a portfolio are to understand, the more likely an investor will stay the course during periods of market volatility.