When you work hard to invest money, the last thing you want is for your investment portfolio to fail.
Unfortunately, losing money on investments is a definite risk -- and you could increase the likelihood of this unpleasant outcome if you make a few common mistakes.
What are those mistakes? They generally boil down to four P's: performance, price, poor diversification, and paying attention.
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1. Performance
Whether you invest in individual stocks, mutual funds, or exchange-traded funds, you need to make sure your investments perform well.
Performing well doesn't just mean making money, either -- although of course that's a prerequisite. A mutual fund or stock could make you money, but if it makes only a small amount when similar investments perform better, you're losing out.
To determine how well an investment is performing, you'll want to compare it to the right benchmark. Your benchmark could be the Dow Jones Industrial Average or the S&P 500 if you invest in the stocks of larger companies or broad-market mutual funds or ETFs; it could be the Russell 2000 for small-cap investments.
Compare the assets in your portfolio to their benchmarks at least once per year and ideally twice. If an investment consistently performs below its benchmark and there's no reason to believe things will turn around, it may be time to sell so it doesn't impede your portfolio's growth.
2. Price
Investment fees are a fact of life and often can't be entirely avoided. You may have to pay a commission for the purchase and sale of individual stocks, although many online brokers are eliminating these commissions. If you invest in a mutual fund or ETF, you'll have to pay operating expenses, which could include management fees and fees associated with the trading of fund assets. And 401(k) accounts sometimes charge additional administrative fees.
It's important to know the expense ratio of any investment so you'll understand the price of buying it. That's because paying high fees could eat away at your returns and leave you with far less money in the end. In fact, the table below shows just how much fees could affect your final account balance if you invest $5,000 per year for 30 years and earn a 7% return on your investment.
|
Fee |
Final Balance |
Cost of Fees |
|---|---|---|
|
0% |
$472,304 |
$0.00 |
|
0.25% |
$451,583 |
$20,721 |
|
0.5% |
$431,874 |
$40,430 |
|
1% |
$395,291 |
$77,013 |
|
1.5% |
$362,177 |
$110,127 |
|
2% |
$332,194 |
$140,110 |
|
2.5% |
$305,035 |
$167,269 |
|
3% |
$280,425 |
$191,879 |
As you can see, if you don't pay attention to price, you could lose out on hundreds of thousands of dollars because of high fees. You absolutely must look at the expense ratio of any investment you're considering buying. If it's higher than similar investments, steer clear unless it has a proven track record of better performance that justifies its high price.
3. Poor diversification
Investing in the stock market is one of the best ways to grow your wealth, as stocks have significantly outperformed other investments such as bonds and real estate. But there's a risk when you buy stocks because companies you invest in could perform poorly and you could lose money.
You reduce this risk by diversifying your assets. Diversification means you don't put all your eggs in one basket. You don't want to invest every dollar in one particular technology company or even invest all your dollars in different technology companies. If the tech industry or your favorite company tanks, you'd lose too much. Instead, you want a mix of different kinds of investments.
You can easily build a diversified portfolio by investing money in ETFs or mutual funds focusing on different asset classes including large-cap and small-cap U.S. stocks, foreign stocks, bonds, and real estate. Or if you're good at evaluating individual company stocks, you could purchase shares in companies of all sizes in many different industries.
Don't assume, though, that just because funds have different names they provide a good mix of assets. For example, a large-cap growth fund could have too much overlap with a large-cap blend fund, leaving you at risk. Look at what mutual funds or ETFs are actually investing in so you ensure your portfolio is really diversified.
4. Paying attention
With investing, you can't really just set up your portfolio and forget it. While you don't want to react to every market swing by buying and selling assets, you do need to see how your investments are performing and react if investments don't do well. Otherwise, the absence of attention can doom your portfolio to failure.
You also need to make sure you have the appropriate asset allocation based on your age. While you want to invest most of your money in stocks when you're young, this could be a dangerous strategy once you're already in retirement and don't have time to wait out market downturns.
Most financial experts recommend you subtract your age from 110 and put that percentage of your portfolio in stocks -- so a 20-year-old would be 90% invested in stocks while a 75-year-old would have just 35% of his money in the market. Because the appropriate asset allocation changes as you age, you'll need to shift your investments over time to keep the right balance.
Don't let the 4 P's ruin your portfolio
You work too hard for your money to lose it because your portfolio doesn't perform due to lack of attention, high fees, or poor diversification. Make sure you avoid the four P's mentioned here so you can maximize the chances your investments will grow and provide the money you need to accomplish important financial goals.
