Christine Benz, Morningstar.com's Director of Personal Finance, deconstructs four investment "rules" that tend to lead individual investors astray. As she points out, a blind adherence to these rules could negatively impact your portfolio:
"The investment realm is full of conventional wisdom, advice that some investors and financial professionals repeat and act upon without checking up on its validity. Some of this guidance is just fine, such as the notion that diversifying among asset classes can help reduce your portfolio's risk level. Other investment chestnuts, meanwhile, don't stand up to closer scrutiny. Some kernels of investment wisdom are more effective as sound bites than portfolio-management tools; others were perhaps valid at one point but new data have cast their validity into question."
So, without further ado, here are the four investment rules of engagement that Morningstar.com highlights:
(1) Consistency is king, especially when choosing which stocks to add to your investment portfolio
(2) If an investment has under-performed over the past three to five years, it's time to cut it loose
(3) Your "risk tolerance" should be a key factor in asset allocation and invesment portfolio decision-making
(4) It's OK to move your money into cash when you're nervous about the market.
This last point is especially tricky, especially since many experts advise investors to have "dry powder" available for the next big upswing in the market. Christine, however, disagrees:
"I've recently been hearing from investors who have moved a lot of their portfolios into cash because they've been nervous about the spillover effects of the subprime crisis and stocks' losses in this year's first quarter. When everything's headed down, shifting into cash can have the immediately gratifying effect of shielding your portfolio from losses. Yet, that sense of relief is often short-lived and immediately replaced by another nagging worry: Is it time to get back in? Was yesterday's 200-point rally in the Dow a head fake or the beginning of something big? No one knows the answer for sure, of course, so my experience is that big cash-holders find themselves in just as big a predicament as they started with. According to a recent study, a market-timer who missed the 10 best days of global stock markets' returns over several decades would be 50% poorer than a buy-and-hold investor at the end of the period."
The bottom line: while it's OK to follow certain rules-of-thumb, there are no rules of the market that are ironclad commandments.
[image: The Rules of Engagement]
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