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January 4, 2015

14 New Year Investing Resolutions

Do yourself a favor. Find one of the articles discussing how many record highs the S&P 500 set in 2014 (53 as I write this on December 29) and save it. Whenever the next bear market strikes—and it will at some unknown point in time—reread the article to reminder yourself of the upside momentum the market can experience. The record highs are Mr. Market’s way of rewarding those who put up with his temper tantrums.
Last year (2014) was a good year to be in large-cap stocks, with the exception of oil stocks. (We’re just now one slightly better-than-average year away from Dow 20,000!) It was a tough year for small-cap strategies. Early indications suggest that active managers struggled as well.
It was also a good year for those who stuck with higher-quality intermediate and long-term bonds. Yields on the benchmark 10-year Treasury note are ending 2014 approximately 80 basis points below where they started.
When things are going your way, it’s easy to think you’re good at investing. When things aren’t going well, it’s very tempting to change strategies. In between is the reality that the long term lasts beyond the period of time our emotions are willing to consider. Strategies with good long-term performance will falter from time to time. Risky strategies and those with subpar returns will look great when conditions are favorable to them. The key is to avoid being lulled by the events of today and stay laser-focused on the longer term. It’s not always easy to do so, but it is vital to your success as an investor.
For 2015, the calendar patterns give reason for optimism. The third year of a presidential term is favorable for stocks. AAII founder and chairman Jim Cloonan noted in the October AAII Journal that years ending in five have been positive for the market over the last 100 years, and particularly positive when they have coincided with the election cycle—as 2015 will. Market historians also note that stocks do well when a Democrat is in the White House and Republicans control Congress. Federal Reserve forecasts have been projecting a rate hike to occur in 2015 for the past few years, but economists and strategists have continuously been premature with their forecasts of when the first rate hike will occur. (Sooner or later, they will eventually be right…just as a broken clock is right twice a day.) The big influence on this year’s market direction may very likely be something not reflected in current forecasts, however. It’s often the wildcard events that give investors reasons for cheer or grief.
So, rather than orient your portfolio based on what you think might happen, follow these investing resolutions (which I have updated for this year).
  1. Only follow strategies you are comfortable following no matter what the market does. All too often, investors misperceive the optimal strategy as being the one with the highest returns (and often the one with the highest recent returns). This is a big mistake; if you can’t stick to the strategy, then it’s not optimal for you. Better long-term results come to investors who are able to stay with a good long-term strategy in all market environments than investors who chase the hot strategy only to abandon it when market conditions change.
  2. Write down the reasons you are buying an investment. One of the most fundamental rules of investing is to sell a security when the reasons you bought it no longer apply. Take a look at your current holdings and ask yourself the exact reasons you bought them. Do you remember? I personally keep a journal, so I don’t have to rely on my memory to cite the exact characteristics of a stock or a fund that attracted me to the investment. A spiral notebook works great for this.
  3. Write down the reasons you would sell the investments you own. Just as you should write down the reasons you bought an investment, jot down the reasons you would sell an investment, ideally before you buy it. Economic conditions and business attributes change over time, so even long-term holdings may overstay their welcome. A set list of criteria for selling a stock, bond or fund can be particularly helpful in identifying when a negative trend has emerged. A common trait of the AAII portfolios—the Model Shadow Stock Portfolio, the Model Fund Portfolio, Stock Superstars Report and AAII Dividend Investing—is that they all have established sell rules. Again, a spiral notebook works well.
  4. Have a set schedule for reviewing your portfolio holdings. If you own individual securities, you should plan on reviewing the headlines and other relevant criteria weekly (or daily, if doing so won’t cause you to trade too frequently). Those of you who use our Stock Investor Pro screening program can set up custom views to get quantitative feedback on valuations, earnings estimate revisions, price momentum and other key data. If you own mutual funds, exchange-traded funds (ETFs) or bonds, monitor them quarterly.
  5. Rebalance your portfolio back to your allocation targets. Check your portfolio allocations and adjust them if they are off target. (This is a particularly important step now with the large-cap indexes hitting record highs.) For example, if your strategy calls for holding 40% large-cap stocks, 30% small-cap stocks and 30% bonds, but your portfolio is now composed of 45% large-cap stocks, 35% bonds and 20% small-cap stocks, adjust it. Move 5% of your portfolio out of large-cap stocks, move 5% out of bonds and put the money into small-cap stocks to bring your allocation back to 40%/30%/30%. How often should you rebalance? Vanguard suggests rebalancing annually or semiannually when your allocations are off target by five percentage points or more.
  6. Review your investment expenses. Every dollar you spend on fees is an extra dollar you need to earn in investment performance just to break even. Higher expenses can be justified if you receive enough value for them. An example would be a financial adviser who keeps you on track to reach your financial goals. Review your expenses annually.
  7. Write and maintain emergency instructions on how to manage your portfolio. Typically, one person in a household pays the bills and manages the portfolio. If that person is you and something suddenly happened to you, how easy would it be for your spouse or one of your children to step in and take care of your financial affairs? For many families, the answer is ‘not easily’ given the probable level of stress in addition to their lack of familiarity with your accounts. A written plan better equips them to manage your finances in the manner you would like them to.

    Even Warren Buffett sees the value of this resolution. In last year’s Berkshire-Hathaway (BRK.B) annual report, he wrote, “What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit…My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.” Even though it's likely that Mrs. Buffett has learned a thing or two about investing over the years, the instructions given for the bequest are very simple and easy to follow.

    While you are doing this, you should also consider documenting your medical directives. These document your wishes concerning end-of-life medical treatment. Caring Connections has links to advance directives for all 50 states. Even though we are always a day closer to proving that we are immortal, it’s a good idea to cover the bases in case we actually are not.
  8. Check your beneficiary designations. It is critical that all of your beneficiary designations are current and correctly listed. Even if nothing has changed over the past year, ensure that the designations on all of your accounts are correct. Also, make sure your beneficiaries know the accounts and policies they are listed on. Finally, be certain that those you would depend on to take over your financial affairs have access to the documents they need in the event of an emergency (see resolution #7).
  9. Be disciplined, not dogmatic. When you come across information that contradicts your views, do not automatically assume it is wrong. The information may highlight risks you have not previously considered or that you have downplayed in the past. At the same time, don't be quick to change your investing style just because you hear of a strategy or an approach that is different than yours. Part of investing success comes from being open to new ideas, while maintaining the ability to stick a rational strategy based on historical facts. When in doubt, remember rule #1 (optimal strategy).
  10. Never panic. I realize this may seem a like an odd resolution to bring up when large-cap stocks are at record highs, but at some (unknown) point in the future it will be useful to remember it. If you sell in the midst of a correction or a bear market, you will lock in your losses. If you don’t immediately buy when the market rebounds—and people who panic during bad market conditions do not—you will also miss out on big gains, compounding the damage to your portfolio.
  11. Take advantage of being an individual investor. Perhaps the greatest benefit of being an individual investor is the flexibility you are afforded. You are not restricted by market capitalization or investment style. You never have to report quarterly or annual performance. You are also not tied to a single investment style or strategy. This means you can invest in a completely different manner than institutional investors can. Take advantage of the flexibility, because doing so gives you more opportunity to achieve your financial goals.
  12. Treat investing as a business. The primary reason you are investing is to create or preserve wealth, and no one cares more about your personal financial situation than you do. So be proactive. Do your research before buying a security or fund, ask questions of your adviser and be prepared to sell any investment at any given time if your reasons for selling so dictate.
  13. Be a mindful investor. Slow down and carefully consider each investment choice before making a decision. Ensure that the transaction you are about to enter makes sense given your investing time horizon, which may be 30 years or longer, and that it makes sense given your buy and sell rules. A common trap investors fall into is to let short-term events impact decisions that should be long-term in nature. If you think through your decision process, you may well find yourself making fewer, but smarter, investment decisions.
  14. Take a deep breath. Often, the best investing action is to simply take a deep breath and gather your composure. Short-term volatility can fray anyone’s nerves, but successful investors don’t let emotions drive their trading decisions. It’s okay to be scared, but it’s not okay to make decisions that could impact your portfolio’s long-term performance based on short-term market moves. If you find yourself becoming nervous, tune out the investment media until you get back into a calm state of mind and then focus on resolutions #1, #2 and #3. Success comes from being disciplined enough to focus on your strategy and goals and not on what others think you should do.

    Finally, remember that you have a life outside of the financial markets. Investing is merely a means to an end. Put the majority of your energy into activities you truly enjoy, including spending time with family and friends.
About The Author - Charles Rotblut, CFA is  the VP and Editor for American Association of Individual Investors (AAII).  Charles is also the author of Better Good than Lucky.  (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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