One Key Pitfall to Avoid When Building a Portfolio

When building a portfolio, and particularly when building a portfolio based on a group of funds or individual securities, investors engage in different methodologies to rank and evaluate such investments.

In doing so, the goal of most investors should be to build a well diversified group of companies that will perform at least as well as the broader stock market.

Of course, buying a market-based index will replicate the returns of the stock market underlying the fund. This is one of the methodologies I think is most prudent for passive investors seeking to make decent returns over long periods of time and do not want to continuously re-balance or adjust one’s holdings.

For those investors who want to pick stocks, forming recency bias can be one of the key pitfalls that can negatively impact long-term returns. The reason is simple: reversion toward a longer term mean is common, and often results in a situation where the best performing funds over a given time frame (say, five years) will underperform for the next five years.

Investing in funds, indices, or stocks that are built in a fashion that suits one’s investment preferences however, and assigning a lesser weight to recent performance, can prove to be a winning long term strategy.

For new investors looking to start out, I’d suggest focusing on what risk level one is comfortable with, and proceeding from there, looking at defensive vs. growth vs. income names according to one’s needs.

Invest wisely, my friends.