Many of the investors who visit Peter Mallouk’s offices in a Kansas City suburb have one big request—don’t let me make a fatal financial mistake. That’s especially true lately, as investors worry about whether the stock market will continue to set new records or will plunge off its lofty heights. Mallouk, who was named by Barron’s as the top independent financial adviser in the US this year and last year, tells investors that he can’t predict where today’s market is headed, but he can make sure that they never make a terrible investment decision again.
Here, Mallouk talks about the biggest mistakes investors are making today as they maneuver through challenges ranging from low interest rates and high unemployment to global terrorism and regional conflicts. Some of these mistakes may sound familiar to you—but amid today’s challenges, they are trapping even sophisticated investors…
DON’T LET TODAY’S CONDITIONS RATTLE YOU
I began my career 15 years ago as an estate attorney working with stock brokers, financial planners and their clients. What astonished me was how many people—including investors and advisers—let themselves make certain mistakes even when they probably knew better. That’s happening again today.
Human beings have powerful biases—to do what other people are doing…to panic and run from danger…and to always want more no matter how much they have. To be a successful investor and protect yourself, you need to be aware of these impulses as you experience them and create practical steps to override them.
Four of today’s big mistakes…
MISTAKE #1: Dumping stocks when you think the market has peaked.
What’s happening now: Some of my clients are clamoring to exit stocks now because they believe that many obvious red lights are flashing. For instance, the Standard & Poor’s 500 stock index has hit new highs more than 20 times in 2014 and there hasn’t been a so-called correction—a pullback of 10% or more—since the summer of 2011. The problem with market timing is that you don’t need to be right just once. You need to be right twice—when you get out and then again when it’s time to get back in. To beat the long-term returns of the broad market, studies show that you actually need to make the right call 70% to 90% of the time, depending on market conditions.
What to do instead: Don’t try to time this market. You likely will see many more bear markets and corrections in your lifetime. You may be able to sidestep some of them, but trying to do that is highly likely to do great damage to your portfolio in the long run.
MISTAKE #2: Buying or selling investments based on today’s relentless onslaught of news and opinions.
What’s happening now: Many investors overreact to articles, to “experts” on TV and even to tweets—all supposedly explaining what’s going on in the world and how it might affect investments. For example, I have a client who watched the market drop because of Russian president Vladimir Putin’s moves against Ukraine, and he was convinced that another Cold War was about to unfold. He wanted to sell stocks and buy US Treasuries. Another client saw the market spike in reaction to comments from the latest Federal Reserve meeting about raising short-term interest rates—and she wanted to sell US Treasuries and buy stocks, exactly the opposite!
What to do instead: Do not make big investment changes based on daily events in the world. You cannot predict how those events will affect your portfolio. The only news that should cause you to alter your long-term investment plans is a big event in your own life—you retire, you want to change careers, etc.
MISTAKE #3: Rebalancing your portfolio based on the calendar.
What’s happening now: Investors have been “brainwashed” to follow the conventional wisdom that they should trim or add stocks and bonds on a set timetable, such as every year or quarter, to get their portfolios back in line with their long-term asset-allocation plans. However, rebalancing on a set schedule often creates unnecessary transaction fees and/or generates unneccesary tax bills…and if you sell winners too early, you might dampen your long-term returns.
What to do instead: Use “opportunistic rebalancing.” When any stock or bond fund in my portfolio drops by at least 5%, I buy enough additional shares to return it to its intended allocation level. To make these purchases, I use cash from new contributions or from income the portfolio produces. For winning funds, I wait to take profits for a minimum of one year (to avoid short-term capital gains taxes) and continue to hold them until the fund has risen 5% above its intended allocation in the portfolio before I trim the investment.
MISTAKE #4: Choosing a mix of mutual funds that is not tied to your long-term goals.
What’s happening now: Even with the S&P 500 outperforming most funds today, people still think that they can beat the index by selecting a few big winners among stocks and/or mutual funds. But extensive studies have shown that the mix of asset classes that you choose is what’s responsible for about 88% of your returns.
What to do instead: Don’t try to win the mutual fund lottery by banking on a few supposedly extraordinary funds. Instead, decide what your goals and risk tolerance are and choose an asset mix—and a mix of funds—based on that. For examples of smart fund portfolios based on various goals.
4 Great Portfolios
Here are four portfolios with the best allocations to achieve common goals…
Goal: Beat historical market gains averaging 9% to 10%. Very aggressive investors who want to outperform the S&P 500 over a 10- or 20-year period require big allocations to volatile stock categories. Allocations: 25% US small-caps…25% foreign stocks…25% emerging-market stocks…25% US large-caps.
Goal: 7% annual returns. This is very achievable for moderately aggressive investors. Allocations: 60% stocks (25% US large-caps…20% foreign stocks…15% US small-caps) and 40% bonds (25% US bonds…15% foreign bonds).
Goal: 5% annual returns with low volatility. Keep enough assets in bonds to take monthly or annual distributions without being forced to sell stocks in down markets. Allocations: 40% stocks (20% US large-caps…10% US small-caps…10% foreign stocks) and 60% bonds (40% US bonds…20% foreign bonds).
Goal: I just want to grow my portfolio modestly with the least volatility. If you already have a big enough nest egg, you can draw down 3% of your assets each year without ever touching principal. Allocations: 10% stocks (all in US large-caps) and 90% bonds (70% US bonds…20% foreign bonds).