There are 3 keys to every disciplined investment program. The 3 keys to disciplined investing are to implement a diversified portfolio, rebalance the portfolio on a regular basis, and to avoid responding to the hype in the media.
Implementing a diversified portfolio should not be a problem for most people. Unfortunately, too many 401(k) investors let their balances accumulate in money market funds or something called a stable value fund. Stable Value funds are another name for a money market-like investment. In either the money market or the stable value fund approach, investors are taking on large amounts of inflation risk. These types of investments tend to lose purchasing power over the years. While using a stable value fund may look disciplined from the outside, it is a very bad idea over the long run.
Rebalancing is another problem for most investors. People tend to want to hang on to their winners thinking the good times will continue. And, people will hang on to their losers hoping for a turnaround. The concept of rebalancing is not difficult, but people tend to want to time the markets instead of letting the markets work for them. Rebalancing ensures you sell some of you investments at a high price while buying into investments at a relatively low price. This helps you to attain the investor's holy grail, buy low and sell high. But it is difficult for most investors to rebalance on a regular basis. We recommend quarterly rebalancing.
Avoiding the media hype is certainly difficult for anyone to be completely successful at. The media is omnipresent and the messages keep getting louder. The current hype around hedge funds is an excellent example. Now that hedge funds are being reported in the media as huge winners (some big losers, too), the price for most investors is just too high. Most of the gains have already been achieved. There may be some gains ahead still, but most investors jumping into these tools will be taking on the chance for much more downside than upside.
The 3 keys for discipline are to implement a diversified portfolio, rebalance it, and avoid the media hype machine.
In our next entry, we will discuss portfolio monitoring.