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Learn from experience: Avoid costly investment mistakes

According to Francis Bacon, Histories make men wise, because studying the mistakes of others allows us to learn from the mistakes they made. This is particularly true when investing, because mistakes can be costly. By avoiding the following common investment errors, you may be able to improve your portfolio’s performance:

No comprehensive investment plan.

For too many people, an investment plan consists of a few stock holdings purchased over the years, a CD or two, and maybe an IRA. Unfortunately, this haphazard approach to investing may not provide the results you need to reach your financial objectives. Instead, you should have an overall investment plan that incorporates your investment time horizon, objectives and risk tolerance, within an asset allocation framework. Also, a firm investment plan will help you avoid another common error, procrastination. Your money will generally grow faster if you invest on a consistent basis and maintain a steady, long-term focus.

Overlooking inflation.

Lower-risk investments, such as bonds or money market accounts, typically do not have the same growth potential as investments with a higher degree of risk. Historically, only stocks have consistently outpaced both inflation and taxes. Past performance is not indicative of future returns, but if you invest only in fixed-income securities like bonds, you risk letting inflation and taxes erode the buying power of your investment’s interest payments and principal. Even retirees need to allocate a portion of their portfolios to growth investments to keep ahead of inflation. Of course, you need to choose growth investments that fit within your risk comfort level.

Ignoring or overemphasizing taxes.

Tax-deferred savings programs, like IRAs, 401(k)s and some annuities allow funds to accumulate more quickly than taxable plans. These plans defer taxes until withdrawal, allowing all of your interest and dividends to accumulate without being depleted by taxes each year. However, many people do not take full advantage of the benefits of tax-deferred investing.

On the other hand, some investors let taxes drive all their decisions and seek only tax-free investments, without comparing the net return with that of alternative investments. For example, if your tax bracket is 30 percent, a tax-free yield of 5 percent is equal to a taxable yield of 7.14 percent. If an alternative taxable investment yields 8 percent, choosing the taxable investment may yield better results in the long run.

Insufficient diversification.

It’s important to make sure you invest in different types of assets, such as stocks, bonds and money-market securities. Different asset types perform better under various economic conditions. By spreading your investments across these asset classes, your losses in one area may be offset by gains in another. This reduces your overall investment risk

Failing to balance your portfolio.

Once you’ve made an investment, you and your financial advisor should regularly monitor it, and you should examine your entire portfolio each year, and make sure your assets allocations still match your time frame and risk tolerance. Sometimes changes in management or the market can turn a strong investment into a below-average performer, and your portfolio may become over- or under-weight in a particular asset class. You may have to move some assets into another area to keep your portfolio balanced.

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