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10 "truths" that aren't
There's no shortage of conventional wisdom about investing, and some of it can help you make smart decisions. But certain rules of thumb and widely held beliefs are outdated, or simply wrong. Follow them blindly and they can undermine your portfolio's performance. Here are 10 to beware.
1. Your stock allocation should be 100 minus your age.It's true that your exposure to stocks should shrink as you get older. But this equation comes from another era, when people died a lot younger on average. If you're 65 today and follow this rule, you should have 35 percent of your assets in stocks. But you might easily live 25 more years, and 35 percent in stocks might not be enough. The exact percentage you should hold in stocks will depend on your risk tolerance and financial situation, but for most people, it should be at least 50 percent.
2. Buy the mutual funds with the best recent records. Today's winners may have benefited from a hot sector or industry that will soon become cold. Moreover, an outperforming fund will likely receive huge cash inflows that could make it difficult for the manager to invest all of that money wisely and extend the fund's good record. Play it safe and buy funds that demonstrate consistently good long-term performance vs their peers, not vs the overall market.
3. Concentrate your investments in a few good ideas. This is a big part of Warren Buffett's approach. And if you're wired to outperform the market as he is, it's a good one. Unfortunately, the typical investor's idea of a great investment changes all the time and he doesn't have Buffett's connections. Your strategy should be to create a diversified portfolio that can weather all types of markets.
4. Buy blue-chip stocks and forget them.This is a very popular approach to investing. It works until it doesn't. While you generally don't have to monitor blue chips as closely as small companies, you shouldn't neglect them. (Kodak and Sunbeam, for instance, were blue chips not too many years ago.) If prices drop, it may be time to sellor to buy, if the company is still financially sound but currently undervalued.
5. Value-oriented investors buy junky companies.Wrong. A true value-oriented investor buys companies that are temporarily unpopular or that have assets Wall Street hasn't yet recognized. For example, few people would call drug stocks "junky companies." Yet at today's depressed valuations, many value-oriented mutual fund managers have overweighted certain pharmaceutical companies in their portfolios. For instance, when this column went to press, Bristol-Myers Squibb, GlaxoSmithKline, and Merck all had price-earnings ratios that were well under the average for the industry.
6. It's smart to buy more of a stock that's doing well. Unless you know of a strong, fundamental reason for the gain, never load up on a stock assuming that its price will continue to rise. The investment landscape is littered with stocks whose prices soared primarily on hype, only to come crashing back to earth.
7. A great company is always a good bet. Not necessarily. A company can have great fundamentals but its stock may be too richly priced. If you pay too much, you could suffer years of underperformance or lose money outright. Depending on your timing, that could have happened in recent years with a multitude of stocks, including familiar names like Cisco Systems, General Electric, Microsoft, or Wal-Mart, to name a few.
8. Hold a loser until you get your money back. People keep their losers because they believe a sale would force them to acknowledge that they did something stupid. But it's best to sell your loser stock and find something else. Not only will you be rid of a drain on your portfolio, you may get to deduct your losses to boot.
9. Don't buy a long-term bond when you're old. You may die before the bond matures, the theory goes, or if you need the money early it'll be tied up and unavailable. The reality is that while you might lose money if interest rates rise, most bonds are liquid and you can sell them if necessary. Long-term bonds, particularly tax-free ones, can be attractive for people of virtually all ages when the bonds' yields are high and interest rates aren't expected to rise. (Rising rates cause bond prices to drop.)
10. The husband should handle the investments. Like many generalizations, this one doesn't have a sound basis. I've seen great and poor investors of each sex. Moreover, a study published in the February 2001 issue of The Quarterly Journal of Economics found that women's stock returns were slightly better than men's. I believe the reason is that men tend to pull the trigger on their lagging stocks more quickly than women, who seem to have more patience. Also, men sometimes feel that it's their primal duty to personally manage their portfolios, whereas women are more likely to delegate to a financial adviser if they don't have the time or expertise to do the job well.
The author, a fee-only financial planner, is president of L.J. Altfest & Co. (www.altfest.com), a financial and investment advisory firm in New York City, and an associate professor of finance at Pace University. The ideas expressed in this column are his alone, and do not represent the views of Advanstar Medical Economics. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also fax to 973-847-5390 or e-mail to firstname.lastname@example.org.
Lewis Altfest. Investment Consult: 10 "truths" that aren't. Medical Economics Sep. 17, 2004;81:18.