The 10 toughest investment decisions
Reprinted courtesy of MarketWatch.com.
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Investing money isn’t necessarily easy. All of us face some hard decisions as we confront (and prepare for) a future that is inevitably unknown.
Here are, in my opinion, the 10 toughest decisions we have to make.
1. Perhaps the most fundamental investment decision is determining whom to trust. If you trust advisors who put their own interests ahead of yours, you can quickly lose half of your retirement savings. I’ve seen it happen more than a few times.
Brokers and other advisors are trained to be likeable and to seem authoritative. But in too many cases, their understanding and knowledge are shallow. Instead, put your trust in academic researchers, whose interests don’t conflict with yours.
2. We all make investing mistakes, and admitting them can be really hard. Selling the “dogs” in your portfolio can be painful, because the mistake is right there in black and white. But often cutting your losses is the best thing to do.
3. Equally challenging is giving up the notion that you can beat the market. Far too many investors shoot themselves in the foot by trying to get the jump on everybody else.
Beating the market is the wrong objective. Much better: Seek either the lowest-risk way to meet your needs, or the highest return you can reasonably expect within your risk tolerance. (See my next item.)
Instead of hiring the smartest manager you can find to try to outfox the market, the smartest investors adopt the simple solution of investing in index funds.
4. It’s hard for most investors to know how much risk to take. Take too much, and you can be wiped out (or at least lose sleep). Take too little, and you can be left in the dust by the silent, cumulative forces of inflation.
One good guide is historical data showing losses that have occurred with various equity/bond combinations. You’ll find some useful information in this article.
5. If you have a chunk of money to invest, it’s really hard to know when to commit. Do it right now? Wait for better prices or market conditions? Some people struggle with this for years.
In bull markets, you can be afraid of paying prices that are too high, so you keep money in cash when it could be earning gains. In bear markets, you may keep waiting for prices to drop further in order to get a better deal.
One solution is dollar-cost-averaging. This automatically has you buy more shares when prices are low and fewer shares when prices are high.
6. When you’re accumulating savings, it’s often hard to choose between saving more money for the future or using it for things you really want or need now.
Young investors can often double their retirement income by increasing regular savings by as little as 10% to 20%. If you can train yourself and your family to live on a little less, you’ll likely have more to spend later. And you might be able to retire earlier.
7. Likewise, retired investors often have a tough time determining how much to withdraw from their savings. Most of us would like more money to spend. At the same time, few of us want to risk running out of money.
There’s no magic formula that fits everyone. But if you can get along by taking out 4% every year instead of 5%, other things being equal, your money is sure to last longer. To learn more, check out these tables.
8. It can be really tough to give up trying to time the market. Countless times I have asked investors whether they are market timers or buy-and-hold investors. More than nine out of 10 tell me they buy and hold.
But their stay-the-course resolve often disappears in a flash when they realize the risks they embraced so willingly during a bull market have come home to roost in the form of actual losses. I think of these people as closet market timers who follow the “I can’t stand it any more” timing system.
The solution? Control the level of risk you’re taking, then adopt an attitude of infinite patience. That’s easy to say, but often tough to do. My final two items may help with this.
9. In the 21st century, we are constantly bombarded with news, information and commentary. Plenty of it is aimed at investors. When everybody seems to be connected and “in the know,” it can be very hard to manage your exposure to the financial media.
Yet this is a crucial step if you’re going to adopt that “attitude of infinite patience.” Like the weather, much of what you read and hear about the markets is completely outside your control. If there’s nothing that you can do about something, how much of your time and energy is it really worth?
I have seen too many cases in which the financial news made people so upset that they started abandoning their carefully laid plans in order to try to protect themselves from some imaginary boogeyman.
Often, the best answer is simple: Turn off the TV and spend your time on something else. The final item in this list is closely related.
10. How often should you check the prices of your stocks, your funds or your portfolio? If you have carefully invested on the basis of your needs and tolerance for risk, I think the answer can be as little as once a month or even once a quarter.
If that shocks you, that may be a warning sign. Study after study has found that people who watch their investments frequently are likely to trade more frequently, and those who trade more frequently are likely to achieve lower returns.
Take it from somebody who has followed the market closely for half a century: Whatever happens to your investments this week won’t matter at all in five, 10, 20 or 30 years from now. That’s where your focus should be.
Richard Buck contributed to this article.