Most people understand that a key to achieving retirement success is to become a prudent investor. As a result, they study the markets and acquire investment advice. Most people become pretty good at discerning the smart advice from the bad in the process, but there’s a danger here. Some seemingly prudent strategies can sometimes wreak havoc on your long-term returns unless you completely understand the strategy inside out. Here are three investment strategies you should think carefully about before following.
Tilting your portfolio for higher returns. Some investors tilt their portfolio to overweight stocks in certain categories. For example, studies have shown that adding small cap and value stocks to an investment portfolio has helped these portfolios to outperform the standard S&P 500 index with similar volatility in the past. And with the ease of adding these investments to a portfolio these days, more people are making the trade and boosting the allocation to specific asset classes higher than they have in the past. There is some evidence that you might be able to benefit by tilting over the long haul, but there’s also the possibility that there could be a decade or more of underperformance. Not everyone will have the conviction to hold on to an investment that subsequently underperforms a S&P 500 index fund for years. If you can’t stick with the strategy over the long term, it’s not a good idea to implement it because selling and then paying the capital gains taxes will make your underperformance even more pronounced.
Bonds belong in taxable accounts now. The standard advice is to put bonds in tax-deferred accounts and stocks in taxable accounts because dividends and capital gains are taxed at preferential rates. But due to an increase in tax rates on dividends for high earners, much lower bond interest rates and the possibility of selling bonds at a capital loss in a taxable account, some people are now saying the opposite is true. To decide which type of account is the best place for you to hold bonds you need to consider your tax situation as well as what type of bonds and stocks you own. Make the calculation yourself, and keep the long-term picture in mind. The low interest rate environment likely won’t last forever, so you don’t want to be caught with a ton of bonds paying higher interest rates in a taxable account later. If you are in the accumulation phase you need to think about future bond interest rates as well as current ones.
Reduce bond duration due to the imminent rise in interest rates. Pundits have been warning for years that interest rates will rise, but it hasn’t happened yet. People who chose bonds with shorter durations have lost out on the solid returns longer-term bonds have generated for the past few years. By shortening the duration, you are essentially implying that you are better than the market at predicting the direction of rates, the magnitude of rise in short rates versus long rates and the time it takes for the rates to rise. After all, the yield curve already reflects everyone’s best guess as to what is going to happen. And if you are attempting this feat in a taxable account, you also need to worry about tax consequences from the interest and capital gains.
Seemingly prudent strategies are suggested all the time, but that doesn’t mean you can reap the benefit. Before you make any portfolio adjustments, make sure you understand the strategy completely. If it’s a short-term strategy, decide when you switch back to the tried and true and pay attention to any tax consequences. If it’s a long-term strategy, then you have to resolve to stay the course even if it doesn’t work immediately. Decide if your time horizon is long enough to wait it out if the outcome goes against you for a while.
David Ning is the founder of MoneyNing.com.
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3 Investment Strategies to Think Twice Before Following originally appeared on usnews.com
