5 Tips For the Average Investor

How to keep your cool and make informed investment decisions.

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When it comes to where we are in the economic cycle, expert opinions vary widely. Some experts think the economy could be headed for a double-dip recession, while others say it's headed for a slow but steady recovery. The stock market remains full of uncertainty because of a combination of factors, including worries that the U.S. economy is slowing and doubts about the strength of the Euro. It's times like these when investors should remember a few basic investing rules that can help see a portfolio through uncertain times. To help you wade through all of the noise, here are a few suggestions from a financial adviser about how to keep your cool and make informed investment decisions

[See U.S. News's list of The 100 Best Mutual Funds for the Long Term, and use our Mutual Fund Score to find the best investments for you.]

Be realistic. Investors should know that their portfolios will experience ups and downs. After a decade in which the S&P 500 returned virtually zero, many experts have warned that the stock market may not experience returns that investors grew accustomed to in decades past. In the short term, some experts are concerned that the expiration of stimulus programs throughout the world—including in the U.S.—will lead to a period of slower growth. "The last of the last recovery dollars are being distributed out to the states and [it's] the end of the tax credits for home buyers, which were huge stimulators for the economy and helped it rebound last year," says Rose Greene, certified financial planner with Rose Greene Financial Services in Los Angeles, an affiliate of LPL Financial. "It will not feel good, but it makes sense. This isn't something that just happens when you wake up one day."

[See Home Builders Grow Gloomy As Tax Credit Ends.]

Don't try to time the market. Fund investors tend to enter and exit some funds at the wrong time. Morningstar calculates investor returns, which take into account when fund investors put their money into or pull money out of funds. Investors in volatile funds typically experience lower returns than the published returns of the funds because they tend to get spooked by market volatility and sell. That's why, Greene says, investors shouldn't gamble their money by trying to time the market. "The average investor needs to know that trying to time the market is a fool's following," she says. "We might get lucky once, but it will ultimately bite you."

Stay alert. Whether you're a set-it-and-forget-it investor or someone who favors more active allocation, it's important to occasionally check on the performance of your portfolio. Greene says that her team looks over client portfolios every six months or so to see if any rebalancing is necessary. She determines if changes need to be made by examining how the portfolio has performed over time and whether or not her clients may be over-exposed to a certain asset class. In her opinion, younger investors only need to rebalance about once a year, while older investors who are nearing retirement should do so more frequently because of their shorter time horizon. Often, rebalancing can mean repositioning your portfolio to emphasize asset classes that were beaten up during a downturn. Greene does this for clients. For instance, the high-yield bond market, which is generally more volatile than that of investment-grade bonds, took a huge hit in 2008 during the financial crisis. Recognizing this trend, Greene's team overweighted high-yield bonds in their client portfolios in mid-2009. "It was a perfect place to be," she says. In 2009, the average high-yield bond fund rallied and returned about 45 percent, according to Morningstar.

Consider alternatives. Diversifying your portfolio with a mix of stocks and bonds is important because these asset classes generally don't perform in lockstep. But many advisers, including Greene, believe that it's crucial for investors to look beyond such traditional investments—to asset classes like real estate and commodities—to diversify even further. Real estate funds are an example of an asset class that sometimes zig when traditional investments zag. "Real estate investment trusts (REITs) took it under the chin in 2008 and the beginning of '09," Greene says. "They've not only stabilized, but they ended up having a really solid year in 2009 with still an enormous amount of upside." The average domestic real estate fund outperformed the S&P 500 by about 6 percentage points in 2009, according to Morningstar. Year-to-date, the average fund is up more than 10 percent. Keep in mind, though, that investments like commodities and real estate still remain quite volatile and only belong in a small part of your portfolio—if at all. The average real estate fund lost almost 40 percent in 2008 during the peak of the housing crisis.