Money Matters: 3 common investing pitfalls to avoid

By David G. Wilson Jr.

The Daily Record Newswire

It's easy to get caught up in worries over the European debt crisis, massive government spending, high unemployment and weak economic activity. Many investors today are tempted to go to cash until the future looks a little clearer. Investors can't control the markets, the economy or the government, but they can control their actions and behaviors to try to avoid the following pitfalls:

Pitfall No. 1: improper asset allocation

A strong foundation is the most important part of home construction, and the same rule holds true for portfolio construction. The foundation of any well-built portfolio is asset allocation, which should be aligned with age, goals and risk tolerance.

For example, a working 50-year-old with a fairly strong stomach and 15 years until retirement may have an asset allocation of 70 percent stocks. However, at age 70 this same person may be retired and drawing an income stream from the portfolio. At this point, the asset allocation should, perhaps, be only 30 percent stocks.

While appropriate asset allocation does not ensure a profit or protect against loss in declining markets, it can help investors stay focused on a strategy through volatile periods. Because of the two 50 percent corrections we sustained in the last decade, many investors are improperly allocated between stocks and bonds. They have, in many cases, under-weighted stocks to reduce risk and protect capital. This is understandable, but they may have over-weighted bonds as an unintended consequence.

Many investors feel much safer over-weighting bonds, but they are doing so just when bonds are paying record-low interest and a 30-year bull market for bonds is probably ending. Their portfolios are probably riskier than they think, but they won't realize so until there is a sudden rise in rates and bonds depreciate in value.

Pitfall No. 2: not understanding the cost of investments

It is amazing how little transparency there is for total fees that investors are paying for money management. When speaking with an adviser or investment company representative, ask the person for a detailed summary of all fees and charges. This includes adviser fees, manager fees, and miscellaneous expenses.

Many advisers today are moving to a business model where they are paid based on a percentage of assets, usually ranging from 1 percent to 3 percent. Typically, there is a sliding scale, and asset management fees fall as the asset level rises.

When the onion is peeled back, many investors are surprised to learn that there are additional charges for the investment manager as well. If the adviser is charging 1 percent and the investment manager is charging 1.25 percent, that's 2.25 percent annually.

In the end, it's important for an investor to understand the fees and believe they are reasonable, given the value received from the client/adviser relationship.

Pitfall No. 3: buy and hold ... forever!

"Until death do us part" is great in marriage, but it can be devastating for investors. They too often fall in love with a stock -- usually because it has performed well in the past. These smitten investors take on a buy-and-hold mentality -- and won't let go. But this can be dangerous and ultimately very costly.

At the peak of the technology bubble, there was a well known company that was trading for more than $80 a share. An investor had a sizable profit and was unwilling to diversify, take some profits and reduce his exposure to this stock, which represented a large portion of his net worth. With almost $1.5 million of value at the peak, his stock position is now worth slightly more than $234,000. In addition to this loss in value, the stock has paid no dividends over the last 10 years, and the future doesn't look bright.

While this won't happen to every stock, investors need to be diligent in assessing each stock position. That means evaluating the quarterly earnings, management outlook and industry forecast, and making sure the reason the stock was purchased is still intact.

Too often as time passes, less and less attention is given to the stock holding and the company's future prospects. Lost market share, management departures and a changing competitive environment can all gradually weaken an otherwise strong holding.

In many ways, a stock portfolio is like a garden. In order to thrive, a garden needs to be watered, weeded and cleared of vegetation so that sunlight can nurture its growth. The same goes for stocks: without periodic care, investments can slowly die.

Investors who keep these principles and potential pitfalls in mind can help them control what they can -- their behavior -- and cope with what they can't control -- the government, economy and markets.

Published: Thu, Aug 25, 2011