Exchange traded funds (ETFs) have a ton of advantages, but like any good thing, not understanding the rules, not knowing the limits and lacking a strategy can hurt more than help you. Here are six ways you can help avoid those pitfalls.
Jason Zweig, the author of Your Money and Your Brain, recently sat down with Rachel Heig at Morningstar to discuss different ways to sidestep your mental hang-ups and start investing smarter. We threw in a few of our own ideas, too. [Other things to avoid when investing.]
- Do not trade too often. The more you look at your portfolio, the more you will be tempted to change something. Monitor it and understand where you are in relation to your buy and sell points, but don’t react to every bump and hiccup. [How to invest in ETFs with ease.]
- Failing to rebalance. The opposite extreme is also problematic. If you don’t check up on your portfolio and rebalance when necessary, you can end up with a substantially different risk profile than you intended. Remember that the markets are always changing, so what worked six months ago may not be what works today.
- Be willing to sell. This error can happen with either a stock or ETF that is performing well or a stock or ETF that has underperformed. When stocks are rising, it’s understandable that you want to hold them in case they continue going up. But when you’ve hit your sell point, know when it’s time to let go.
- Buying what is “hot.” Do not buy something that is all the rage, in other words, all the articles and topics of investment are focused on this company or sector. Investors tend to pour money into funds after they’ve performed well and rush for the exits after they underperform, resulting in much lower returns.
- Ignoring expenses. ETFs are cheaper than mutual funds on average, but they still cost money. The more you trade ETFs, the more fees you rake up. Although ETFs do tout lower fees than mutual funds, they can add up quickly. [ETF fees are becoming less of a factor as competition increases.]
- Looking at accounts individually. Of course, different accounts may serve different purposes, and you may be more aggressive in some than others. But holding dozens of investments in several different accounts earmarked for the same goal can be an issue. Your overall allocation may be different than you realize, and you will probably have overlap between funds and stocks. Consider 401(k), IRAs and taxable accounts together for the best outcome.
- Failing to plan. You know the adage: When you fail to plan, you plan to fail. Understand your goals, your buy point and your sell point before you spend a cent. More importantly, be sure to stick to your plan when the time comes, because no plan will work if you’re not using it. [How to follow trends.]
For more stories about ETFs, visit our ETF 101 category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.