| Top Ten Portfolio Pitfalls continued... |
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| 5. Owning too many funds |
| Many investors know they have this problem--they just don't know what to do about it. Start by evaluating where the fund fits into your portfolio. Is it a core fund or not? It's critical that your core funds be strong performers, so if they lag behind their peers for three years, make a change. Try increasing the assets in your core funds and cutting out a few of the poorer-performing noncore funds. |
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| 6. Poor choices within categories |
| Morningstar's star ratings may get a lot of press, but Morningstar's category ratings are more important in my book. |
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| Here's an example. Two large-cap blend funds, Principal Growth PRGWX and Goldman Sachs Capital Growth GSCGX, earned 4-star ratings through the end of July. They may seem like equally worthy funds. But their category ratings tell a different story. The Goldman Sachs fund has been a far better large-cap blend investment on a risk-adjusted basis than Principal Growth over the past three years. The Goldman Sachs fund's category rating clocks in at 5 versus a 2 for Principal's fund. |
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| Evaluate your portfolio's performance at least once a year, comparing your funds' risk and returns against those of their peers. If a fund hasn't kept up with its peer group over the past three years, it's time to think about dropping it. |
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| 7. Inefficient use of tax strategies |
| Is your portfolio making the most of tax strategies? Some funds work better in tax-deferred accounts than in taxable accounts. In future columns, I'll discuss how to avoid penalties if you retire early, when to consider a Roth IRA, and other tax-related topics. |
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| 8. Paying too much in fees |
| Given two similar funds, I'd take the one with lower costs. Over time, the difference in performance between a fund with a 0.5% expense ratio and a 2.0% expense ratio can be dramatic. |
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| Let's take an example. Say you invested $10,000 in a fund that gained 12% per year before expenses and carried a 0.5% expense ratio. Your brother invested $10,000 in a fund that also gained 12% per year before expenses, but his fund carried a 2.0% expense ratio. Twenty-five years later, you'd have nearly $45,000 more than your brother, simply because your fund's annual fees were lower. No matter what anyone tells you, costs matter. |
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| 9. Excessive stock overlap |
| I've seen many cases where someone owns a significant amount of their employer's stock in their 401(k) plan, unexercised stock options in their company, and mutual funds that also own that same stock. There's nothing wrong with holding some of your employer's stock, but do balance that investment with diversification in the rest of your portfolio. |
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| 10. Not knowing when to seek professional help |
| Morningstar has always appealed to the do-it-yourself investor. But there are times when it pays to get professional guidance that focuses on your individual situation. Complex tax issues or estate planning can necessitate a trip to a financial specialist. |
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