| |
Common Mistakes |
Things You Should
Know |
Pretty Good Answers |
| 1. |
Mistake price inflation for real investment returns. |
Real returns are provided by economic growth.
Inflation and even stock price changes don't create value for the investors
as a whole. |
Remember to subtract inflation and taxes from your returns.
Don't expect to be able to spend more than about 3% of capital without its
erosion. |
| 2. |
Think that it is easy to earn above-average returns, and
that you are a wimp if you just invest in the market averages. |
If you want more, someone just as intelligent
as you must give up the difference. On average, they will willingly
pay you only a risk premium. |
Invest in stock index funds or ETF's. Add enough bonds and cash
equivalents to fit your risk tolerance and tax
profile. |
| 3. |
Buy stocks of only well-managed growth companies. |
The stock is not the company. The
difference is the price you pay for a share. Besides, you need more
diversification. |
Buy broadly diversified stock index funds or ETF's, or hold
many different stocks and let most gains accumulate without trading. |
| 4. |
Think that stocks, money managers, or investment letters
that have done well will continue to do well. Pay fees for active
management based on past performance. |
The movement of stock prices is a game in
which players in competition convert predictable economic events into
unpredictable price movements. |
Allocate assets to stocks according to
your risk management needs, not based on your short-term forecasts or on
your ability to identify superior skill by money managers. |
| 5. |
Make decisions on isolated individual securities rather than
on their impact on your portfolio. Hold more than 10% of your
portfolio in the stock of your employer. |
The cross-relationships among returns across
different elements of your portfolio determine much of what you will
experience. |
Diversify holdings between stocks and bonds, and within
stocks, among various industries, across big and small, growth and value, US
and international. |
| 6. |
Think fees, trading costs, and taxes are unimportant. |
An extra 1% reduction of expense or
effective tax drag can dramatically affect compounding of wealth over a long
period. |
Start with plain vanilla, low-cost index funds or ETF's,
stock or bond, and US government bonds as your base case. |
| 7. |
Avoid the stock market entirely. |
People will pay you to bear hard-to-diversify
risk. |
Keep a risk-appropriate fraction of your wealth invested in
a broadly diversified stock portfolio. |
| 8. |
React with emotion when the stock market rises or falls a
lot. Conversely, freeze in place, even when your risk tolerance has
changed because of a substantial change in wealth. |
Expected return for the market has minimal
relationship with past performance. |
Make modest adjustments in stock-bond proportions as your
financial circumstance, not the apparent return of the market, changes. |
| 9. |
Spend lots of time reading the financial press, financial
TV, and Internet news sites. |
Risk, tax and fee knowledge retains its value
even if widely shared. Ideas for extra return do not. |
Forget picking stocks or timing the market. |
| 10. |
Rely on advisors who can do well only by getting you to
churn your portfolio. Pay high fees for unproductive management. |
Most financial service companies are
structured in ways that produce powerful conflicts of interest. |
Consider fee-only financial planners, brokers who want
lifetime relationships, or money managers with low costs who emphasize risk
management and reduction of any tax impact. |
