VOICES FROM THE INDUSTRY: Investors would be wise to avoid these four traps

May 14, 2007

Advice on investing is a lot like advice on caring for a newborn-there's no shortage of it around and everyone believes they have just the right answer.

Eventually, parents learn that they must sort through all the help offered by TV shows, books, magazines, Web sites, and even friends and relatives, to find the tips that work best for their baby. The same thing can be said for investors. Being successful requires tuning out all the noise and knowing what advice to take and what to pass up.

Here are four traps that are wise to avoid when it comes to weighing advice on how to invest:

1. Investing without a plan

If you don't have a destination, any road will get you there. So before jumping to act on a piece of advice, have a solid understanding of what you're trying to achieve with your portfolio.

First, the right questions have to be answered. What are your goals? How long do you have to reach them? And how much risk of loss are you willing to take? Your answers will lead you to develop an overall investment plan upon which you should weigh any advice.

The framework of your plan will be your asset allocation-the mix of stocks, bonds, and short-term cash reserves that offers the potential for growth and degree of risk control that best fits your unique situation.

Without a plan, any suggestion you hear will sound good. Your uncle might tell you it's a great time to invest in inflation-protected securities. But if you're investing to buy a house in three years, that information should be totally irrelevant to you.

2. Trying to predict the future

Often, investment advice that's offered starts backward by looking forward. Pundits focus on what investments or areas of stocks or bonds are the best and worst to invest in and why, based on predictions of the markets' direction.

General statements about future market conditions are enticing. People hear that a large investment company is adjusting its strategic allocation from 60-percent stocks to 80-percent stocks and say, "I'm putting 80 percent of my money in stocks." But that's one company's strategic allocation based on its own evaluation of stocks compared with bonds at that particular time.

Another company may have a completely different viewpoint and allocate differently. Plus nothing about the individual investor-risk tolerance, time horizon, or tax bracket-is taken into account.

That's where a good investment plan proves its worth. A well-thought-out asset allocation doesn't need to be adjusted from market cycle to market cycle and provides just the right balance of risk and reward to help you achieve your goals. The most important decision investors make isn't what investment to buy, but what's the right asset allocation for them.

To be a successful investor, forget about predicting where the market is headed, which is out of your control, and instead control the things you can, like maintaining the right mix of investments, their costs and taxes.

3. Focusing on the short term

Financial news is focused on the here and now, which is helpful for keeping up with what's going on in the world but unhelpful for making sound long-term investment decisions.

It's easy to get swept up in the day's chatter of which stock or industrial sector is hot and which one is not. But recognize that the story will probably change tomorrow or it wouldn't be news.

Investments typically make news when they rise or fall dramatically, something that happens on a regular basis. Headlines and top stories work well at grabbing investors' attention but make for poor advice. Buying or selling because monthly, quarterly or even annual performance is in the news ignores basic investment reality.

The cars out at the Indianapolis Motor Speedway this month are some of the fastest, most highly-engineered cars in the world. Yet, the setup they use for their four qualifying laps is much different than the setup on race day.

If they used the qualifying setup on race day they wouldn't make it to the end of the 500 miles. The motor would give out or the driver would crash the car trying to keep it under control for all 200 laps. The goal of the race-day setup is to stay in the hunt all day long so you can be there at the end to make a run for the win.

It's usually not the car that led the most laps that ends up winning the race-and you don't get your face on the trophy for leading the most laps.

With this long-term focus in mind, choose investments that fit into the overall context of your investment plan. Focus on the portfolio, not the investments' past short-term performances. Do that and you should have a portfolio that will get you to the retirement finish line, not one that blows up on you halfway through.

4. Forgetting about risk

Last year and this year (so far) have been pretty good for financial markets. Anticipations are high. This is not a time to get complacent about risk. We only need to look back to the period of 2000 through 2002 to be reminded about it.

To better manage investment risks, you should seek to avoid large losses. Think more about three years from now than three months from now, invest with experienced managers and the investments they manage, and focus on your goals.

Avoiding large losses is simple math. A 50-percent loss requires a 100-percent gain to get back to even. To recoup a 10-percent loss only takes an 11-percent gain.



Snyder is co-owner of Oaktree Financial Advisors Inc. in Carmel. Views expressed here are the writer's.
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