Sue Stevens

Most investors are interested in finding an appropriate mix of stocks and bonds that reflects their risk tolerance. In other words, they want to be able to sleep at night. Portfolio peace of mind is about choosing an investment strategy that minimizes mistakes and keeps returns on an even keel. Here are ten pitfalls to watch out for as you plan your investment strategy:

1. Being Overly Aggressive
If you are looking for a smoother ride in the stock market, take a look at your asset allocation--your mix of stocks and bonds. This is how you balance risk and reward. Don't take more risk than you need to. Once you have analyzed your portfolio from this broader perspective, you can move on to examining each of your individual holdings to see if they are aligned with your overall goals of consistency and steady performance.

2. Investing Too Narrowly
In the search for a low-anxiety portfolio, one of your best bets is to spread your assets (and your risk) to a wide variety of investments. You should start with "core" holdings in the major asset classes to anchor your investment line-up. Broad-based index funds and exchange-traded funds are prototypical core investments--even the most sophisticated pension fund and endowment managers use them as such. Each goal you have identified should be supported by a group of core funds--think of them as your portfolio's foundation. They are primarily responsible for achieving your objectives. Core funds typically cover large-cap domestic and foreign stocks, taxable and tax-exempt bonds.

Once your core is built, it's fine to seek a bit more diversification, but it's also easy to go too far.  Adding exposure to asset classes like mid- and small-cap stocks, emerging market stocks and alternative assets can provide a useful dose of diversification to your portfolio, but it's important to keep them in check. These asset classes are historically much more volatile, and investors are most likely to fall in love with them only after they've provided spectacular short-term performance--just in time, in many instances, to catch the downside.

3. Being an Under-Informed Investor
Part of finding peace of mind is knowing what to expect. You can't do that unless you've taken the time to educate yourself about the financial markets. Find some way to continue learning about personal finance. Perhaps a subscription to the Wall Street Journal or Radiant Wealth (www.financial-happiness.com).

4. Being Undisciplined and Overly Emotional
Don't fall in love with your investments. You need to have discipline and set your expectations. The best way I know to do that is through an Investment Policy Statement (IPS). Creating an Investment Policy Statement is a great way to establish beforehand how you'll deal with the inevitable tough questions and minimize the impact of emotions.

You'll need to think about questions like: What is my risk tolerance? What range of returns should I expect? Which asset classes should I choose and how much should I allocate per asset class? What risk reduction techniques will I use? Thinking through questions such as these is the difference between having a cohesive investment program and just a collection of funds and/or individual securities.

5. Being Impatient
Peace of mind comes with patience. One thing I've learned over the years is to not react too quickly to market conditions. It's tempting though isn't it? Sometimes you just want to do something when you're feeling anxious.

One of the best ways I've found to avoid doing this is to simply try to tune out the noise about the market's day-to-day gyrations. Once you have your portfolio in place, you'll be far better served by ignoring the screaming and shouting on cable shows, which will help you avoid jumping in or out of the market and learn to persevere through the inevitable market drops. Stick to the discipline of your IPS.

6. Getting Greedy
Did your folks ever tell you to keep your eye on the ball? That was good advice. When times are good, lots of people get distracted by the "high" of making money and lose sight of their true goals. They fall into the trap of always wanting more. There's a famous story of Kurt Vonnegut talking with Joseph Heller while at a party thrown by a billionaire. Kurt commented on the wealth of their host, and Joe Heller responded that he had something their host never would. "Enough." That's the title of one of Jack Bogle's latest books, which is well worth a read.

If you're meeting your objectives, don't get greedy and think the grass is greener by taking on unnecessary risk. The vast majority of the time, it's just not worth it.

7. Ignoring Tax Efficiency
There are differing opinions on where you should hold your stock and bond investments. Some feel that it's better to own stocks in taxable accounts (thus taking advantage of the current low tax rates on dividends and long-term capital gains) and bonds in tax-deferred accounts (thus shielding the income they provide that would otherwise be taxed at ordinary income tax rates). Others feel that stocks, particularly stock mutual funds, are best held in tax-deferred accounts to maximize their long-term growth. This discussion of where to hold assets for tax advantage is known as "asset location."

The reality is that what's best for you depends on where you hold the bulk of your assets, your personal tax situation, and how willing and able you are to make adjustments based upon tax law changes. Once you've set your asset allocation and your Investment Policy, go back over the types of assets you hold (taxable and tax-deferred) and think about where you might have a tax advantage. For example, if you are in a high tax bracket, you may want to hold municipal bonds that aren't taxed federally (and sometimes state too) in taxable accounts. You'll also need to give thought to the tax effect of what you plan to sell. With some planning, you may be able to net out capital gains and losses (perhaps over several years) and pay less tax.

8. Paying Too Much
Other than perhaps your asset allocation, nothing will impact your total long-term growth more than the fees you pay. It's really quite simple--the more you pay, the less you keep. Even seemingly small differences in annual expenses can have a dramatic impact. For example, let's say that you invest $10,000 in a fund with annual expenses of 0.5 percent, and your friend chooses one with expenses of 2 percent. If you each earn an annual return of 8 percent before expenses for 40 years, your final balance will be $180,400. Your friend's total? $102,900, or just 57 percent of yours. Yes, costs matter. If anyone tells you any differently, smile politely and make a mental note to never take any investment advice from them. 

9. Rebalancing Too Often or Too Little
Even the most finely tuned portfolios will see their asset allocation drift over time, as some asset classes do better than others. While relatively minor changes (plus or minus a few percentage points or so) aren't necessarily worrisome, it is possible that your allocation has shifted dramatically if you haven't given it much attention over the past several years. If that's the case, you might be taking on more risk than you intend.

Recent studies show that the optimal time between portfolio rebalancing may be as long as six years. Now some people are going to get very nervous waiting that long, so we'd recommend that you try to limit any major rebalancing to once a year. If you find yourself out of alignment you may want to dollar cost average (systematically moving money over a longer period of time) back to your target allocation.

When rebalancing your portfolio, consider the type of accounts you hold. If you invest primarily in tax-deferred accounts, you can rebalance back to your original allocation without any harmful tax consequences. If, on the other hand, you need to rebalance assets that have appreciated in a taxable account, you should try to bring your portfolio into balance by investing new money in underweighted asset classes instead of selling something else. 

10. Forgetting to Put Your Money Where Your Heart Is!
Finally, one of the most important rules of finding portfolio peace of mind is to choose investments that reflect your own personal ideals. This connection to what your money is invested in will help you through the hard times.

For example, let's say you love music. Perhaps you can build in a special category for music when you do your budgeting. As your portfolio grows, perhaps you take a certain percentage of profits to use to enjoy concerts. Or if your profits allow, to contribute to an arts organization. Because you are using your money to enjoy life, you will find the inspiration to save and invest even more money in the future. It's a self-fulfilling prophesy.

Your money needs to work hard for you to achieve the things you want in life. There is much you cannot control, but by following these guidelines you'll avoid many of the pitfalls and move closer to attaining Portfolio Peace of Mind™.