In reviewing physicians' portfolios, I see many of the same investment mistakes over and over. Here are six of the most common, and how you can avoid them.
In reviewing many physicians' portfolios, I see many of the same investment mistakes over and over. Here are six of the most common, and how you can avoid them:
1. Under-diversification. It has been said elsewhere that a portfolio that does not have at least some positions losing value while others move up is under-diversified. A plethora of studies have established the worth of having a portfolio full of asset classes that are “non-correlated.” That is, they don’t all move in the same direction at the same time. Adequately diversified portfolios have greater returns with less volatility.
There are two major ways that portfolios can lack diversification. It is common to still see portfolios that have 80 percent or more of assets limited to domestic markets. With more than 50 percent of the world’s stock market capitalization outside of the U.S., this is a mistake. A “hidden” way this occurs is when a variety of mutual funds exist in a portfolio, but the funds all invest in the same places. This was a common mistake in the great technology stock crash of 2000 to 2002. Obvious under-diversification exists when a portfolio has a concentrated position of one or two stocks.
2. Over-diversification. I see many brokerage “wrap accounts” with literally dozens of stock and mutual funds, sometimes in a relatively small portfolio. The monthly statements can run for dozens of pages, requiring a great deal of thought and work on the part of the broker/adviser. These “investments” are chosen from a list or handed down intact from above, and represent a complicated and expensive way to build an index fund performance, when just buying the fund at a low cost is usually a better move. But of course, there is no “sizzle” in just buying an index fund.
3. Costly investing. The total cost of investing is inversely proportional to most investors' long-term returns. Reasonably, advisory costs over 1 percent annually can rarely be justified, and portfolio costs outside of adviser fees should run well under 1 percent as well. Larger portfolios should cost even less, as advisory fees should go down as portfolios get larger (but they do not always do so). Charging a flat advisory/expense fee regardless of the size of a portfolio is very hard to justify. It is not much more work to invest $10 million than to invest $1 million. This is a big fault of even "no load" actively managed mutual funds and many brokerage “wrap accounts.”
4. Short-term outlooks. Lack of a long-term outlook often leads to frequent buying and selling, usually at the wrong time. A now famous study of investors buying and selling only an S&P 500 index fund between1994 to 2013 revealed a return of about 3 percent to 4 percent annually despite the index’s return of over 8 percent to 9 percent annually. A short-term focus leads to selling when the market is going down, and vice versa. A disciplined approach involves the opposite behavior.
5. Buying overvalued Assets. Usually, these asset classes announce themselves loudly as “things that everyone” is making a lot of money on. Think tech stocks in 1998 to early 2000, or real estate until 2006. Sometimes understanding that an asset class is overpriced takes a bit more thought. If interest rates return to "normal" in the United States (even without inflation), then intermediate and long-term domestic bonds will lose value.
6. Trying to “beat the market.” Investors often compare their returns to some benchmark like the DOW 30 or S&P 500. But a well diversified portfolio contains foreign stocks, some fixed income, commodities, and other asset classes. How can one compare that portfolio to an index of just some American stocks?
Consider the idea of relative performance. If the Dow 30 is down 15 percent and your portfolio only lost 10 percent in the same time period, is that a desirable outcome? A well-designed portfolio should capture the general upwards momentum of global equity markets, while having less volatility than any single index. A reasonable goal is to avoid losses and accept moderate gains in most years. Expecting more than this leads to mistakes.
These are not the only mistakes you can make, but they are the big ones. Avoiding big mistakes and being disciplined might be the key to long-term investment success for most of us.