Nothing beats the thrill of picking a stock that skyrockets in value. Inevitably, though, some of your investments won't meet your expectations. How you deal with losing investments is just as important to your overall investing success for your retirement portfolio as finding long-term winners.
The dilemma of diversification
Ideally, you would be able to pick investments that never lost value. But the only way to fully prevent losses is through ultra-safe assets like Treasury bills and FDIC-insured CDs. And that security costs you a lot on the return side. To try to earn more on your money, you have to take on more risk.
Most people must moderate that risk with a diversified portfolio of investments. Especially once you've saved a substantial amount toward retirement, you can't afford to put all your money in two or three stocks. If they do poorly, you'll have jeopardized your entire retirement nest egg.
The more different assets you own, however, the greater the odds that at least one of them will lose money from time to time. For instance, picking two or three stocks that go up in tandem isn't impossible. But try picking 20 or 30 without finding a single loser. You can't do it.
Acceptable losses
What that means is that to have a truly diversified portfolio, you have to accept that some of your investments will lose money. That's always frustrating in hindsight; you'll always think to yourself, "If I'd just put all my money in one stock, I could've tripled my profits." The problem is that you can't predict in advance which investment will be the winner.
Take real estate investment trusts, for example. For years, REITs like Boston Properties (NYSE:BXP), Equity Residential Properties (NYSE:EQR), Public Storage (NYSE:PSA), and Vornado Realty Trust (NYSE:VNO) had stellar returns. Yet just this year, they're all down sharply from their highs.
But just because REITs are losing money this year doesn't mean you should get rid of them. Many financial planners believe that REITs have a permanent place in the income-producing portion of investors' portfolios. During the bear market in stocks from 2000 to 2002, rising REIT prices helped offset losses from the stock market. Now, as REITs fall, other types of investments will take up the slack and offset those losses.
There are countless similar examples. If you'd decided to dump stocks like Intel and Cisco Systems after their horrible performance in 2002, you would have missed out on spectacular rebounds. Despite the fact that neither is anywhere near all-time highs, they nevertheless have rewarded investors who didn't sell at the lows.
Don't second-guess
This cycle of rising and falling asset classes is what produces strong returns with acceptable levels of risk. But you have to avoid panicking at the bottom of the cycle. If you decide to sell your poorest-performing asset classes, you'll often miss the subsequent rebound -- and suffer losses in the rest of your portfolio.
To keep yourself from making big mistakes that will hurt your prospects for retirement, you have to accept that not all of your investments will go up all the time. Over the long-term, sticking to an asset allocation strategy that allows for reasonable losses will help you earn the higher returns you need to reach your financial goals.
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Fool contributor Dan Caplinger still wants to win 'em all, but he's made plenty of mistakes. He doesn't own shares of the companies discussed in this article. Intel is an Inside Value recommendation. The Fool's disclosure policy will help keep your portfolio healthy.
