It is common for investors to express uncertainty over their ability to manage their portfolios during prolonged periods of market volatility. But prudent investors understand that making sound investment decisions shouldn't be based on the market's twists and turns.
Rather, these decisions should stem from an understanding of investment fundamentals and an awareness of the mistakes others have made. Keeping a few common mistakes -- and tips for avoiding them -- in mind may help you achieve better results.
Maintaining unrealistic expectations
There's nothing wrong with hoping for the best from your investments -- it's human nature. However, you could encounter serious long-term cash flow problems if you base financial plans for the future on unrealistic assumptions.
According to an August 2004 Gallup poll, nearly one-third of 800 investors surveyed expected to generate profits of 10 percent or more in their portfolios during the next year.
How does that anticipated return compare with actual historical returns? Based on data from Standard & Poor's and the Federal Reserve, from 1926 to 2003, a hypothetical portfolio divided equally among stocks, bonds and cash would have had an average total return of 7.3 percent annually. While the composition of your portfolio may be different from the portfolio in this example, it's important to maintain realistic expectations in order to have the best chance at reaching your goals.
Familiarize yourself with the historical performance of appropriate investment indexes -- or appropriate benchmarks -- and use their average long-term returns to help maintain realistic expectations for your own investment returns.
Chasing "hot" investments and overtrading
Investors tend to convince themselves that recent investment performance represents the future. The problem with chasing today's winning stocks or mutual funds is that by the time you hear about the latest "hot" performers, you may have already missed out on all or most of the opportunity to participate in that price appreciation.
Chasing past winners is closely correlated with another potential investment mistake -- overtrading.
Shuffling your investments too often increases the chance that you'll buy high and sell low -- a worst-case scenario for investment success. Overtrading also generates more transaction costs and fees that cut into investment gains.
One potential solution: work with a financial adviser. An experienced professional may be able to help you stay focused on your goals and avoid the urge to trade frequently. In fact, studies have found that investors who work with a financial adviser tend to hold on to their investments longer and realize better returns than do-it-yourselfers.
Failing to keep your balance
You might be surprised to find that strong -- or weak -- returns in one area have caused a shift in your overall investment strategy that could affect your ability to reach goals or manage risk. Work with your financial adviser to review your asset allocation once or twice a year to make sure that it remains in line with your investment goals.
Of course, investment mistakes do happen, but many are avoidable. Learn from the missteps of others, start applying these lessons to your investment strategy, and make a point of working with a qualified professional.
Wilsey is a registered principal with Linsco/Private Ledger, a member of the SIPC. "Smart Investing with Brent Wilsey" can be heard Saturdays at 8 a.m. on KFMB AM 760 and Tuesdays at 12:30 p.m. on Channel 8 news.