Friday, April 1, 2011

Are you sabotaging your own portfolio?

Individual investors' returns typically fall short of those for the stock market as a whole. Why? Because their returns are affected by their own behavior. Man studies have shown that individual investors tend to buy and sell at the wrong times. When the market goes down, they panic and sell. When the market rebounds, many gun-shy investors are reluctant to invest again and postpone getting back into the market. As they watch prices rise, they get increasinly anxious about missing out on those returns. However, by the time hese investors are comfortable with buying again, prices often have risen to the point that they're almost ready to turn down again.

That kind of behavior can by costly over the long term. Dalbar's Quantitative Analysis of Investor Behavior for 2010 compared the performance of the average mutual fund investor between 1990 and 2009 (as measured by fund inflows and outflows tracked by the Investment Company Institute) to that of the average index fund based on the S&P 500.* The company found that returns for the average investor trailed the S&P over that 20-year period by 5.6% because of investor behavior. Though there's no guarantee that the patterns of the past will continue in the future, previous studies also reached the same conclusion: that investors often earn less than a mutual fund's reported returns because of their own behavior.

How can you prevent self-inflicted portfolio sabotage? A disciplined approach to investing helps. Some techniques that can give you a framework for decisions that aren't based solely on emotion include establishing a target price based on fundamentals, dedicating specific pools of money to specific goals with defined time horizons and re-balancing investments periodically. Also, understand you true risk involved in each of your investments and understanding how each has behaved relative to the overall market can help you stand firm despite losses.

*Based on the average return for all funds listen in Lipper's U.S. Diversified Equity Fund category.

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