The Capital Group, one of the nation’s largest mutual fund companies, recently released a study of the most common portfolio mistakes they encounter. To be sure, investing isn’t simple, and there are many mistakes investors can make, so it’s always helpful when leading firms share their insights. What are Capital Group’s top three portfolio mistakes? 1. Inadequate International Exposure, 2. Risky bond portfolios, 3. Over-reliance on recent performance.
1. Insufficient International Exposure
With the U.S. market outperforming international stocks by a substantial margin over the past year, it is easy to see why investors would be underweight international stocks. However, international diversification is as important as ever, particularly when international stocks offer better valuation that those in the U.S. The idea behind diversification is to invest in positions that provide exposure to different economic factors, and investing globally helps do just that, providing exposure to markets other than the U.S. In 2017 international markets reminded investors of why this type of exposure can matter, when the European and Japanese markets rose 26% and Emerging markets rose 37%, beating the S&P 500. Over the next 10 years international markets are generally expected to outpace returns in the U.S. and investors shouldn’t neglect these markets.
2. Risky Bond portfolios
Typically, the role of bonds in a portfolio is to provide stability, countering the movement of stocks while providing income in the form of interest. However, with interest rates falling to record lows, it has been tempting for investors to ‘reach’ for yield by buying lower quality bonds. The problem with this approach is that low quality or ‘junk’ bonds often behave very much like stocks, falling in price when the economy falters and rising in price when the economy expands. When the bonds in a portfolio act like stocks, the whole portfolio becomes risky, negating the benefits of diversification. The solution is simple, but sometimes hard to do; make sure that the majority of bonds in the portfolio are high quality so that the bond portfolio behaves like a bond portfolio.
3. Over-reliance on recent performance
A common mistake when choosing funds in a portfolio is over-reliance on recent performance. The capital group study for example, found that investors over-weighted funds with managers with a solid three track record, but underweighted funds that had outperformed over a decade or longer. Unfortunately, managers with strong recent performance are often poised for a period of underperformance. There are many reasons for this, but one very intuitive (and somewhat ironic) reason is that successful fund managers often receive a strong influx of new investors. As a result, a successful manager with a growing fund must expand the list of investment ideas, often beyond the best ideas to the second-best ideas or third-best ideas, potentially diluting the performance of the entire fund. Investors should focus on long-term performance and fees when selecting fund managers.
If you have been reading this and wondering how your portfolio stacks-up, feel free to give us a call. We would be happy to analyze your portfolio and give you some recommendations on how to improve your investments.
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