This is the time of year when investors start to review their portfolios and try to figure out what's in store for next year. As you go about counting up your investment winnings, selling your losers and rebalancing your portfolio, keep in mind these six key lessons.
1 . For most investors, mutual funds or exchange-traded funds are the best investments. Nobody should own the stock of an individual company unless they know the company inside and out. You need to read the annual report, understand the income statement and balance sheet and have an informed view of the future of the company. Most people do not have the time or resources to really analyze a company, and so the best way to participate in the market is through a widely diversified ETF or mutual fund.
2 . You cannot predict the market, but you can control fees. Research has demonstrated time and again that higher fund fees do not bring higher returns for investors. In fact, it's quite the opposite: on average, the lower your fund fee, the better your return. If your mutual fund charges a 1 percent or 1.5 percent management fee, you are being overcharged. If the stock market goes up 5 percent a year and you pay a 1 percent management fee, you are handing over 20 percent of your profit to your fund manager. Compare that to low cost index funds from Vanguard, Fidelity or elsewhere. They have expense ratios of less than 0.2 percent, which will slice off just a negligible fraction of your profits.
3 . But if everything is in an index fund, you are not diversified. If all your investments are in a S&P 500 index fund, then your entire future is tied to the S&P 500. The S&P has more than doubled in the last five years, but what if it gets cut in half in the next five years? I'm not saying that will happen, but it could happen and has happened before. So make sure your low cost mutual funds reflect different markets. In addition to an S&P 500 fund, you should have a small cap index fund, an international fund and some bond funds. You might want to put just a small portion of your portfolio into more exotic investments, such as an actively managed value fund, a fund of preferred stocks or even gold. But remember, gold is not a safe haven. It is a speculation.
4. Keep it simple. Many fund managers claim to have a secret sauce -- usually couched as some kind of mathematical econometric model -- that promises higher returns. Don't believe them. Just as you should understand an individual company if you're going to invest in it, you should understand where your mutual fund is invested and how it performs over time. You don't want to buy a problem, and you don't want to buy what you don't understand. For example, some managers recommend master limited partnerships, correctly pointing out the relative stability and high dividends of these investments, but conveniently forgetting to tell you about all the tax complications.
5. Beware the marketing machine. Fund managers, along with the financial media, tend to focus on what is new, different and hot. These days all you hear about is technology and social media. But there is more to the stock market than smart phones and Internet services. If you buy into a trend, you may do well in the short term. But watch out when the next new thing comes along and turns the current trend into last year's sucker's bet.
6. Defend against your worst enemy : yourself. A little bit of knowledge can be a dangerous thing. Just because you read the "Wall Street Journal" and watch CNBC, that doesn't mean you're an expert. The daily gyrations of the stock market can be deceptive, and it's tempting to jump on the latest tip or try to game the latest geopolitical issue, employment report or inflation number. But here's the reality: If you spot a new trend, chances are the Wall Street insiders have already spotted it and traded it. If you think you can time the market, you're just kidding yourself. Your enemy is your ego. Your friend is a solid, long-term plan that does not waver with the latest financial or political winds.
Tom Sightings blogs at Sightings at 60 .