Eight portfolio mistakes you don’t want to make

For Virginia's top-earning execs, they’ve already done the hard work of building a successful career. The next step is leveraging and protecting their earnings. For the past few years, they've likely been able to get away with a few mistakes when it comes to managing their money. With the market going basically straight up from 2011 until 2015 with no correction and the Fed on the gas, it was almost difficult to go wrong.

But with stretched stock valuations, the potential for higher interest rates, and of course, an interesting pending election to say the least, the investment landscape has become more challenging. To protect earnings, executives and their families can no longer afford to make mistakes that their portfolio might have easily overcome a year and a half ago.

Unlike a single investment decision gone wrong, these portfolio mistakes typically have a much bigger impact. As a professional portfolio manager, here are the most common mistakes I see top earners make and how to avoid each one.

1. Investing without a financial plan.

Investing without a clear idea of what you want your portfolio to accomplish is the most common mistake. Many executives think, “I just want to make as much money as possible.” But that doesn’t count as a strategy or a viable financial plan, because it doesn’t take into account the risk required to achieve that goal. Without a plan, you have no idea how much risk you can afford to take on, whether you should be in stocks or bonds, or how much you should have in cash. It’s difficult to design an effective portfolio without these details.

2. Having a random collection of investments and calling it a portfolio.

Do-it-yourself investors are the biggest violators of this mistake. They’ve bought different things over the years and end up with a stack of stocks and no sector discipline. There is a big difference between sales people and financial advisors, and a random collection of these one-time purchases is not the same as a cohesive, integrated portfolio.

3. Lack of discipline.

Intelligence should go into where you have money. The ratio of 60 percent stocks to 40% fixed income is a common portfolio structure, but it is not right for everyone. You have to figure out what makes sense for you, and then you have to stay true to that balance. Overconcentrating in one type of equity or one sector is a bad idea. For example, holding a bunch of different mutual funds is not diversifying, because they all hold pretty much the same stocks. You have to be disciplined about avoiding portfolio overlap and make sure that you don’t have a few stocks that could sink the whole thing.

4. Rear-view or momentum investing.

Rear-view investing is an easy mistake to make — you look back at those asset classes that have been showing great returns and want to get in on it. It’s a natural inclination for investors, and very easy to get into risk that you don’t properly understand. If everything in your portfolio is “working,” you are doing something wrong. Rear-view mirror investing over the long-term is a return killer and a risk enhancer.

5. Chasing yield.

In a low-interest rate environment, people often make investments they might not otherwise in an effort to get the returns they believe that they need. Unfortunately, this often involves taking on risk that they don’t properly understand. Be careful trying to generate excess yield in your investments while in a low-yield environment. There is always a reason for the higher yields, and that usually involves increased risk, which is almost always going to be bad for your portfolio over the long-term.

6. Satellite investments with no core.

Similar to that random collection of one-time purchases, many investors make the mistake of building up a portfolio of satellite investments without any real core. These satellite investments might be interesting companies or funds that the investor read about, or heard about from friends and family. These investments can be smart additions to a portfolio, but it’s best to keep them reserved for a section of your portfolio designated for experimentation. They should be separate and complementary to your core investments that keep your portfolio on track towards your goals as defined by your financial plan. Start with your core and diversify from there — not the other way around.

7. Trying to match cash flow to income.

Many investors get caught up in how much income they need their portfolio to earn each year. It is important to remember that portfolio cash flow is different from the income you draw from your portfolio. It does not have to be matched up 1:1 to be successful. You do not need to get all of the income from the cash flow. Instead, focus on staying ahead of inflation and building a portfolio that appreciates over time.

8. Not even knowing what you own.

Not knowing what you own is perhaps the biggest portfolio mistake you can make. If you can't explain the rationale for an investment on the back of a cocktail napkin, you shouldn't buy it. This includes investments such as target date funds and annuities — if you don’t know what’s in them or how they work, you probably shouldn’t add them to your portfolio. When it comes to your life savings, being boring is not a bad thing.

To avoid these mistakes, it all comes down to simplicity. With all the investment options available in today’s market, it is easy to become disillusioned by complexity. The idea that the more complicated an investment is, the better, is a misconception. Keep things simple and you’re more likely to be able to manage risk and avoid making mistakes that your portfolio can no longer afford.

A partner with The Wise Investor Group, Hamilton leads the team’s Portfolio Management department and is an instrumental voice in investment policy, asset allocation and client management decision making. A managing director at the firm with more than 20 years of experience, he is also the frequent host of “The Wise Investor Radio Show” that airs weekly on WMAL 105.9 and AM 630, as well as host of the “Midweek Update” podcast..