Diversification and attitude are the keys to successful investing

November 21, 2008

Following a planned strategy will maximize the return you receive in the years ahead.

Key Points

What we are witnessing these days is the difficult and emotionally draining part of investing. As we come home each night it seems the news can't get any worse. And then it does. Companies that we have relied on and trusted for decades evaporate in a matter of weeks.

Because of this, our confidence in the government and financial institutions is shaken, causing many of us to naturally want to "do something" to protect ourselves. From an investment standpoint, it is fair to ask, "Is it really worth it to invest in equities and the markets?" Over time, the answer is yes, but the key to this answer is to understand and become aware of our own emotional tendencies as investors.

Over the years, we have come to the conclusion that the key to achieving goals and being a successful investor revolves around two main factors: diversification and your attitude as an investor. Let's take a closer look at both of them.

First, are you proactive in setting your investment strategy, or are you reactive to daily market events? If you are proactive, you have a better chance of building a diversified portfolio for your age, time horizon, and risk tolerance.

I have observed that most people are not proactive in setting their investment strategy, have not tied how their capital is invested to their short- or long-term goals, and are not properly diversified. As many have learned the hard way, appropriate diversification is not defined as 15 tech companies or loading up on investment real estate, nor is it moving all of your assets into bonds and cash.

ATTITUDE

Assuming your portfolio is appropriately diversified, the second-and many times more important-question to ask is "Am I giving my plan the opportunity to succeed?" One of the most informative studies on investor behavior is Dalbar's Quantitative Analysis of Investor Behavior. The Boston-based financial research firm has measured the effects of investor decisions to buy, sell, and switch into and out of mutual funds since 1984.

Dalbar released its latest study in July, concluding that "investment return is far more dependent on investor behavior than on fund performance. Mutual fund investors who hold their investments typically earn higher returns over time than those who time the market."

The study recommends that investors develop a systematic (monthly) plan of investing, a diversified portfolio, and a disciplined buy-and-hold approach. (You can view the latest study at http://www.dalbar.com/)

The bottom line is that your decision-making in times of extreme up-or-down markets is a major factor in growing and maintaining your wealth, and whether you'll achieve your goals in life.

In an ideal world, we would get out just before the market crashes and then get in the day before it rebounds. This is next to impossible. With the amazing volatility in these markets, missing just two or three up days could mean the difference between being down 10 percent or 20 percent. As a long-term investor, it helps to set proper expectations. The reality of investing is that there will be down years as the market goes through periodic self-corrective cycles, and all of these cycles are unique and different.

The greatest value an adviser can provide is devising a realistic plan that factors in, manages, and contemplates risk right from the start. That gives you a better chance of having success and ultimately achieving your goals. As the Dalbar study demonstrates, following a planned strategy will maximize the return you receive in the years ahead.

The author is a fee-only certified financial planner with Preston & Cleveland Wealth Management LLC (http://www.preston-cleveland.com) in Atlanta and Augusta, Georgia, and a member of the National Association of Personal Financial Advisors. The ideas expressed in this column are his alone and do not represent the views of Medical Economics. If you have a comment or a topic you'd like to see covered here, please e-mail meinvestment@advanstar.com
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