Special Report

13 Ways to Avoid Investment Distractions

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The world of investing is not simple. There are many pitfalls and traps that can destroy an investor’s portfolio instantly or over time if you invest based on emotion. Still, if you want to save for a rainy day, it will be hard to do without investing in the stock market.

More wealth has been created in the stock market since it bottomed in March 2009 than in any other eight-year period. The only way to have benefited from those great gains was to be in the market. Yet, even this expansion of more than eight years will not last forever, and investors could get burned.

If the fear of losing money is preventing some people from saving and investing, keeping in mind a few basic points could help prevent significant losses and will keep you from losing sleep.

You have to start with a goal or plan. Before looking at the many instruments available for investing — from stocks, bonds, mutual funds, exchange-traded funds (ETFs), and more — new investors should have a plan and learn how to invest with your head and not your heart.

It is also important to understand how to minimize risk. For example, diversification helps soften the blow if markets turn bearish. And avoiding timing the market — no matter how tempting — is also the safer option

These are lessons and strategies that can help investors from losing their head and shirt.

Click here to see 13 ways to keep your head investing.

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1) Have a goal.

Investors should have a plan in mind, determine the number of years of investment, set realistic goals, and don’t be swayed by emotion.

Regardless of your age and income, investing can help you afford large items such as a house and college tuition. It is important to keep realistic expectations in mind. The stock market may be up 200% from the panic-selling bottom in March 2009, but stocks generally average total returns (gains and dividends) of 5% to 10% over time. Bond funds used to average 5% or more, but in this era of low interest rates their return is now lower. When you think about realistic investing goals, thinking about returns of 6% to 7% is generally realistic. If you are 50 and think you should expect the same 200% gains eight years from now, you will most likely be off by a wide margin.

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2) Save early.

Investors and savers will do better over time if they start learning about — and start — investing as soon as possible and avoid impulse purchases. People who start investing in their 20s should have an advantage over those who start in their 50s or 60s. It is important to invest in retirement funds if you want a successful retirement. Investing outside of retirement is also crucial if you understand that life is full of unexpected events and emergencies that will require unplanned spending. Though it helps to start saving early, it is never too late to start investing.

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3) Diversify.

One of the most crucial investment principles is diversification, which aims to minimize the risk of investing. Generally, it means don’t be too concentrated in any one asset class or invest in a specific sector for sentimental or emotional reasons. And within asset classes, investors can diversify across different sectors and geographical regions to further helps minimize risks.

The U.S. Treasury is not really at risk of default, but municipal issuers, corporations, and foreign governments have occasionally defaulted. Some investors will diversify by owning mutual funds or ETFs that track stocks or bonds. Owning bonds may seem boring compared with stocks, but those bond funds generally rise in value during periods when stocks are selling off. If you cannot stomach a major loss in the stock market, diversifying into these unexciting bond funds will keep you from losing as much as you would have with just stock investments.

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4) Avoid high fees.

One issue that will eat into your investing plan and cause anxiety is excessive fees and high commissions. If you consider 6% to 7% returns as a realistic investing goal over time, imagine what will happen if you are paying 3% or more in management fees and commissions. That’s half of your expected returns. If you are buying ETFs, stocks, or bonds through a traditional brokerage firm and pay $25 or $50 as a minimum commission for even a $500 investment trade, that translates into a fee of 5% to 10%. High commissions and fees will erode your investment over time.

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5) Hire a money pro.

Going to a registered financial adviser and not your drinking buddy for advice can help keep your portfolio afloat and reduce stress. A financial adviser generally charges a fee to manage your money and to help you determine the best-suited asset allocation for you. It is important to avoid high management fees here, too. One tool that is becoming popular and that can help minimize fees is the so-called robo-adviser that major banking and investing firms have been allowing investors to use.

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6) Don’t time the market.

As the saying goes, “Time in the market is more important than market timing.” It is important to understand that there are many years where almost all of the stock market gains are made in just a few, ebullient days. Take the example of the recession. At that time, some despairing investors sold out of stocks in late 2008 as markets were in freefall and they did not return to equities until they felt comfortable in 2014 or 2015 — after long years of a bull market. For these investors, chances are that “timing” locked in losses of up to 50% and prevented gains of 100%. Improper timing can lead to losses or to missing out on gains.

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7) Avoid fads.

Some investors love to invest in the hottest growth stocks or in big fads. This is where bubbles can burst your investing efforts. Investors also have to understand that some ETFs and mutual funds may have too high an exposure to investing fads, particularly in a world where there is an ETF strategy for almost every market sector and style of investing. Chasing internet stocks in 1999 and 2000 destroyed the portfolio of impetuous investors. Imagine a loss like that coupled with the realization that former prices and valuations may never come back. Buying all biotech in 2015, purchasing speculative oil stocks when oil was more than $100 a barrel, chasing gold or gold miner stocks when the metal was nearing $2,000 an ounce — all these impulsive investment decisions led to heavy losses for many investors.

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8) Study great investors.

It may be hard to be a financial market wizard, but there are valuable lessons to learn from great investors. Great investors know that the current bull market will not last forever. They also knew the last recession and bear market would end. Savvy investors such as Warren Buffett and Peter Lynch did not act like a dog chasing its tail every time the market went up or down. Getting caught up in the excitement of a bull market or the panic of a bear market can make you lose your head and lead to bad decisions. Buffet says to be greedy when others are fearful and to be fearful when others are greedy. Peter Lynch made great strides in helping investors to think about the things they know and like and to use their knowledge to build on investing. Billionaire investors such as Carl Icahn, Ray Dalio, George Soros, and John Paulson did not become billionaires by panicking. Chances are high they knew a thing or two about staying calm and deciding where to invest during periods of uncertainty.

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9) Never go all in.

Some investors change strategies over time or they may suddenly get a large (windfall) amount of cash (inheritance, house sale, business sale, stock option vest) at once or over a short period that alters their long-term planning. It is easy to lose your head this way, and maybe your shirt, too. There is a strategy called dollar-cost-averaging in which investors buy into stocks or bonds gradually over a period of weeks, months, or years. This approach will keep you from buying at the top, and if you use the same method for selling, it may help you avoid selling at the bottom.

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10) Reinvest dividends.

Don’t underestimate the power of dividends. Almost half of all total returns in stocks over time can be attributed to dividends. Many companies raise their dividends over the years, generating more payments to investors each year. These dividends can be reinvested back into the same company or fund/ETF as another form of dollar-cost-averaging. The dividends can also be used to reinvest elsewhere as new opportunities arise. Some investors even use dividends to supplement their income in retirement. And it’s not only stocks that pay out dividends. Mutual funds and ETFs that own bonds earn interest payments, and these ultimately get paid out the same as dividends. This is where the compounding of interest or dividends works in your favor over time. Having slow, steady dividends or interest payments rather than just owning growth stocks won’t raise your heart rate, but they should help you sleep at night when the next bear market comes.

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11) Allocate assets.

Understanding asset allocation is also critical. Asset allocation means portioning your portfolio between the main three asset classes: stocks, bonds, and cash. Asset allocation largely depends on your goals and investment horizon, as well as the amount of risk you can tolerate. Having a proper allocation in stocks and bonds is crucial over the course of your life. Investing all in stocks might be appropriate when you are 25 and have a lifetime to grow assets. But what if you are 55? Once you grow assets to a certain size, or if you are fortunate enough to accumulate wealth, it is imperative that you know how to hold on to it. Asset allocation is not just about saving for retirement either. If you are saving for your kids’ college education or for that 20% downpayment for a house, your investment horizons change. If you are close to the time of that expense, you will want to avoid being entirely invested in stocks.

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12) Be wary of irrational exuberance.

If you look through enough Wall Street research reports covering individual stocks over a decade or more, it should be evident that most analyst reports come with Buy or Outperform ratings and very few come with Sell ratings. The financial media can also stoke investors’ mood. Did you notice how lively the media becomes when markets are at all-time highs or on days when the equities market makes huge gains? If analysts and the media thrive mostly on positive developments, perhaps they are not your best source of advice.

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13) Know your investments.

If you want to minimize your risk when investing, you better understand your investments. If you are invested in a mutual fund or ETF, you need to think about what the fund really owns rather than just looking at the name of the fund. Does the fund use leverage to buy more assets than it would without leverage? If you invest in an individual stock, you better know what that company does, how it really makes its money, and how it plans to reward investors. If you own a bond fund, you need to understand what the fund really invests in. Having this deep knowledge and understanding of what you own will help you keep your cool the next time the markets sell off.

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