Most investors lag the results of the overall stock market because they make one or more of the following mistakes:
1. Overconfidence: Stock-picking is difficult yet many people believe they can select winning stocks or stock funds.
2. Constant surveillance: Many investors check the results of their portfolios frequently. The more often they check, the more likely it is they will experience losses and decide to abandon whatever long-term plan they might have had.
3. Trend-following: Some people buy the stocks or market sectors that have done well recently while avoiding those that have done poorly. Others invest with managers who have beaten the market recently. Either way, it’s unlikely that today’s trends will continue much longer.
To avoid these errors, put together a well-diversified portfolio and stay the course, long-term. If you invest through funds, pick managers who have delivered consistent results over extended time periods.
Asset allocation is just step one, though; step two is regular re-balancing, to maintain that allocation.
Suppose, for example, your basic allocation is 60 percent to U.S. stocks, 20 percent to international stocks, and 20 percent to bonds and international stocks posted strong gains, U.S. stocks were up a smaller amount, and bonds were flat. Therefore, the value of the stocks in your portfolio would have increased while your bond allocation has dropped. To re-balance and get back to your original asset allocation, you should sell some stocks and put the money into bonds.
The need to rebalance—and the unfortunate habit of many investors not doing it—is one reason to consider lifecycle, or target date funds such as are offered by the TSP and many mutual funds.