My husband looked up from reading the business pages the other day. "The 15-year is under 3.5%!"
Ever since we refinanced our mortgage several months ago, he's been ritualistically checking out mortgage rates, simultaneously kicking himself as they've dropped lower and lower. What seemed like a can't-miss interest rate of 3.875% for our 15-year mortgage now looks senselessly high: Had we only held out, we might have been able to save hundreds over the life of our loan. Refinancing again, unfortunately, will cost us more money and could eat up any savings from securing a lower interest rate.
Stock investors often engage in a similar form of mental masochism. They buy a stock at what they think is a reasonable or even cheap price but then berate themselves if it drops even further after they've purchased. They fixate on not catching the absolute bottom.
But whether you're a rueful mortgagee or a sorry stock purchaser, I say stop beating yourself up. True, the realm of personal finance and investing is a land of numbers, and that might mislead many people into believing that their decisions, too, must be precisely on target. They noodle over whether to hold 5% or 6% in a commodities investment, for example, how to pick a large-cap growth fund that doesn't overlap with their mid-cap growth holdings, or whether they should buy BG Group (BG.) at £13 or wait until it drops to £12.
There's nothing wrong with paying attention to such details when investing. Yet for those with a finite amount of time to devote to their investments (um, everyone?) it's far more important to concentrate their energies on making sure their investment decisions are directionally right rather than precisely so.
Here are some key ways to make sure you get your portfolio heading in the right general direction, even if you're not precisely right with some of your calls.
Put the Odds in Your Favour With an Appropriate Long-Term Allocation
The concept of building a long-term strategic portfolio that's diversified across several asset classes is a perfect example of the "direction, not perfection" concept. After all, you can't know in advance what precise asset-allocation framework will deliver the best combination of high reward with low risk over your time horizon. Instead, the best you can do is to use data on historic asset-class returns and current market valuations, combined with a dash of good-old common sense, to help point your portfolio in a reasonable direction.
For younger people who won't need their money for many years, that means a relatively high weighting in equities, which have historically generated higher returns with higher volatility than bonds and cash. By contrast, people getting close to or in retirement need to shift portions of their portfolios into bonds and cash because stabilising a portion of the portfolio helps the retiree achieve stable cash flows in retirement. Specific allocations might vary, but getting that direction right is essential.
Use Rebalancing Instead of Market-Timing
For an illustration of how even the best investors can't time market calls precisely right, flash back to October 2008, when Warren Buffett wrote a New York Times article saying that he was buying U.S. stocks. With the benefit of hindsight, we know that he was too early: Stocks continued to drop for the rest of 2008 and into early 2009, and early March 2009 would've been a much more attractive entry point than the autumn of '08. But did he make the right call directionally? Yes, particularly if he continued to buy after he said he was doing so.
Instituting a regular rebalancing plan for your long-term portfolio, rather than dramatically shifting your allocations around, is one of the best ways to ensure that your portfolio is leaning in the right direction at big market inflection points. Such a strategy will ensure two important outcomes. First, it will help you maintain the risk/return profile of your portfolio so your longer-term return potential will stay aligned with your objectives while also tamping down your portfolio's volatility. Second, because rebalancing involves trimming winners that have outgrown your target allocations and adding to losers that are underrepresented, you are in effect selling high and buying low. Will you always be selling at a peak and buying at a bottom? Certainly not. But over time those little automated so-called contrarian bets can keep you rolling in the right direction.
Pound-Cost Average to Cover Up a Multitude of Sins
This isn't an option for refinancing your mortgage, but for strategic investors, pound-cost averaging, in which you invest a portion of your money over time, helps to ensure you pay a fair price for your investments by not betting all your chips at one time. Most investors end up pound-cost averaging by default, routinely paying into their retirement accounts by investing a percentage of income out of each pay cheque. But pound-cost averaging is not just for the more passive investor. If you're more inclined to be hands-on and take opportunistic stakes in beaten-down stocks, you can still pound-cost average into your position. If the stock keeps going down but your investment thesis stays the same, the pound-cost averager can put more money to work and lower her average cost basis.
Sweat the Small Stuff You Can Control
I know I said that you shouldn't agonise over not getting the very cheapest price on your stocks or obsess over hitting certain allocations with precision. But that's not to say you should blow off all small details when managing your portfolio. Minding those details you can at least partially control--such as fund expense ratios and how much you pay in tax--can help you offset the other small mistakes that all investors inevitably make on the way to hitting their financial goals.
