Common Investor Mistakes From Real-Life Portfolioshttp://www.fool.com/investing/brokerage/2014/07/13/common-investor-mistakes-from-real-life-portfolios.aspx Hal M. Bundrick, CFP, NerdWallet
July 13, 2014
We've all heard about the power of compound interest. Compounding mistakes can have the reverse effect: Rather than helping to build wealth, they can cause an erosion of riches. Small errors in judgment today can result in significant portfolio damage when magnified over time. Reviewing real-life portfolios held in an online account-aggregator service, analysts found some common investor errors. See if your portfolio contains the same faults.
Saturated with liquidity
"Looking at a sample of Personal Capital dashboard users, we found that our users on average hold three times more cash than they need in their investment portfolio," Ruderman says. "The average user keeps 14% of their portfolios in cash. For nearly 10% of our users, we found that cash in brokerage accounts represented over 50% of their entire investment portfolio value."
Bank accounts were excluded from the analysis. Considering that cash or cash equivalents are low-yield investments typically held in money market funds, short-term bank CDs or Treasury bonds, Ruderman thinks the cash allocation is "alarming."
"Our investment committee generally believes that no investor should hold more than 5% cash in a long-term investment portfolio," he says. "There can always be an exception depending on a specific investor's situation, but we think that is just that -- an exception. Imagine how much more those individuals could be earning in the markets if they put that money to work!"
Too many mutual funds
Although ETFs generally have lower expense ratios, there are still some situations where mutual funds can be a more attractive option. For example, many mutual funds are available with no transaction fees, whereas investors often must pay transaction fees when buying ETFs. Depending on the investment, the transaction fee might counteract the lower expense ratio. The lesson that investors should take away is that when making investments, they should be aware of all costs.
Nobel Prize-winning economist William F. Sharpe has long been an advocate of low-cost investments as a method to enhance potential returns. He revisited that theory last year in research published by The Financial Analysts Journal, quaintly titled "The Arithmetic of Investment Expenses."
His conclusion after all of these years was the same as his original thesis. "Under plausible conditions, a person saving for retirement who chooses low-cost investments could have a standard of living throughout retirement more than 20% higher than that of a comparable investor in high-cost investments," Sharpe wrote.
The prevalence of mutual fund investments in portfolios analyzed by Personal Capital warrants another important consideration, according to Ruderman:
A risk mismatch