Investing in stocks and bonds and having adequate insurance coverage is essential to any comprehensive wealth accumulation plan. The stock market has historically grown at a faster rate than inflation. So why do so many people have such poor results in their portfolios?
Stock markets are cyclical. When one category of securities falls (such as large US company stocks) investors get nervous and make an emotional decision to move to another category that may be moving up at the time, (such as government bonds, for example). We instinctively want to move away from what seems painful. The mistake is that your investments often don’t respond the way you hope from this type of behavior.
In actuality, if you keep moving your investment from one type of security to another, it will erode the potential return because it will likely be in a market that will experience a down turn when the original US company stocks experience its next big move up! Truth is, no one really knows which sector will bring the best results and jumping around rarely produces positive results. Patience does.
It seems logical to pick mutual funds and other managed investments by how well they have performed in the past. It feels comfortable and looking at the data gives us the sense that we can predict how it will perform in the future.
Truth is, predicting future performance based on past performance has created loads of unhappy investors. Studies show the vast majority of funds DO NOT out-perform the market. Picking 100 or 150 stocks out of a stock market that has thousands of choices results in a very small chance of outperforming the broader market returns.
LACK OF DIVERSIFICATION
If you have 10 different mutual funds you may think you have good diversification. After all, you hold so many different funds, right?
Maybe not. These funds could have the same individual stocks in them, which means duplication – plus, there could be gaps in the portfolio – and the next good return is in a category you don’t even own! The next cyclical downturn in stocks could weigh heavily on your portfolio if you aren’t balanced among several markets.