When investors take on the ambitious task of managing their own investments, sometimes unknown pitfalls can happen that the investor does not realize may be happening. Below are eight common pitfalls investors should know when managing their own investments.
Not selecting an actual investment fund or ETF
Opening a Roth IRA, Brokerage Account, or some other form of self-directed account that isn’t a 401k is typically a good financial move, but most often I see an individual not actually invest the funds they put into the account. This may be due to a number of reasons
Not understanding the difference between the account and the investment
Thinking it would automatically grow/be invested like their 401k
Simply forgetting to invest.
The Account is the vehicle and the investment fund is the engine that drives the vehicle. Simply opening and funding an investment account does really provide the main benefit of investing in the first place. This can cause one to miss out on potentially significant growth if no investment occurs for several years.
For new investors, selecting an appropriate fund for your investment can be daunting. Utilizing a planner can help educate and clarify these decisions.
Overlap of Investment positions
The opposite of the first main issue and also very common is an account with multiple positions that have holdings that overlap one another. This i see in accounts that have been established for a long time, and may hold a combination of index funds, individual stocks, and mutual funds. Sometimes I may see multiple funds tracking the same index. This can make review and management of ones investments confusing and time consuming, and oftentimes, more funds can tend to impact overall performance negatively.
Typically, keeping no more than 3-5 total holdings per account that encompass the broad stock or bond markets (depending on your goals for the account) can help. This obviously varies based on the investor’s risk tolerance and goals however.
Heavy Concentration Towards one or two positions
This is common with individuals receiving stock options as part of their compensation package. Typically, one’s portfolio should not have more than 10-15% in one position but this can vary based on that person’s unique circumstances. Spreading out to multiple positions through an ETF can help maintain diversification in a portfolio.
No defined rebalancing strategy
A rebalance is defined as an account management strategy where you review your investments and try to keep them at defined percentages. Usually this is completed by selling off some of your funds that have gained significantly, while reinvesting in funds you own that have not gained as much, aiming to keep set percentages of your account to each fund. Defining this is important especially as one nears the point in time where they may begin withdrawals of their investments.
Recurring contributions not getting invested
Similarly to the first issue, you may be making continuing contributions to an account but the money you contribute may not be getting invested even if the original deposit was invested. When self managing your accounts it is important to set up automated investing via dollar cost averaging through your broker’s online portal. This may be completed by reaching out to your custodian directly too.
Market Timing
Oftentimes market timing is a common pitfall in new investors as they may jump in on the hype of a particular security. I see this with thematic investing as well. The problem with this arises not when initially attempting to time the market, but knowing when and how to reinvest your funds if you opt to sell out of your investments. This can lead people to sit out prolonged periods of growth, become defeated, and simply not reinvest their funds (Causing them to not be exposed to even longer periods of market growth).
It is impractical to attempt to time the market as markets can be rather unpredictable at times. This becomes more common during election times. Remember to put your goals at the forefront and not let outside news, media, reports, or other biases come between you and your investing strategy.
Investing all funds in an S&P 500 fund
One of the more common and potentially slightly controversial pitfalls, as the S&P 500 fund by itself has done quite well over the long term. The S&P 500 does not broadly cover international equities and has lower coverage over small cap and mid cap stocks as the majority of the fund is made up of the largest US companies. While these companies have done well, large caps traditionally over very long periods of time haven’t always been the best performer. Ensure you have some coverage over other market classes as part of your investing strategy.
Investments not in fully tax efficient locations
While more advanced, tax efficient investing means understanding the types of accounts available to you and how they are taxed.
For example, a common pitfall specifically I see is an investor having a heavy dividend focus in their brokerage account, when they may also have other retirement accounts such as a Roth. Not always, but frequently, investments generating income may be better suited for accounts with tax advantages like a Roth or IRA, whereas tax efficient investments may be better suited for a brokerage account. This is an area where it can be helpful to consult with a planner to fine tune your accounts for tax efficiency.
Investing can be daunting, but understanding the top pitfalls, especially the ones that deal with investor psychology can help one better manage their investments confidently. As a planner I often help investors validate they are on the right track with their investment plan, and help teach them about these above pitfalls, while empowering them to invest where they want confidently. Even if you feel you have a good handle, it can be valuable to seek additional clarity to double check you are on the right path.
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