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Investment Action Plans

If you've ever made poor investment decisions, you're not alone (and if you haven't, congrats! But keep reading). If you understand why you made them, you may be able to find ways to avoid making the same mistakes or others like them in the future. To help you get started with your action plan, define a personal risk policy, develop an effective investment strategy, and maintain a long-term perspective.

None of this may seem radically different from the approach you've been following. But there is a clearly defined purpose that may not have been a focus before: overcoming your biases to improve your investment performance.

Create a Risk Policy

Instead of trying to define your risk tolerance, which can be hard to nail down, you may want to try creating a proactive risk policy that makes sense for your age, goals, financial situation, and the way you tend to respond to the uncertainties and opportunities of investing.

A risk policy can guide you as you create a core portfolio of broadly diversified equity investments you choose for their long-term promise. Once that portfolio is in place, you can add in other types of investments that supplement or enhance that core.

For example, if you feel a sense of panic when markets are volatile, you may want to add investments to reduce risk exposure even if it means limiting the potential for gains. Or, if you need an above-average return to reach a specific goal with a short time horizon, you can choose promising investments while recognizing that they will increase your exposure to risk and potentially delay reaching your goal if they don't go as planned.

Develop a Strategy

With a risk policy in place, the next step is defining your investment philosophy. In other words, understand why you're investing. When you set goals to know what you want to achieve, you can develop an investment strategy that includes choosing securities, constructing a portfolio, and, importantly, determining when to sell.

The first two are undoubtedly part of the advice you've received in the past. But the third is something you may not have thought about in an organized way. The truth is that it's essential to give as much attention to what and when to sell as to what and when to buy.

With rational and consistent criteria for these decisions, you can help head off subjectivity and bias, streamline your decision-making process, and you might even improve your bottom line.

A Plan to Sell

Deciding when to sell before you buy may seem strange at best and maybe even irrational. But having a plan can counteract the common tendency to hold onto poor investments too long and sell good ones too soon. Typically, pride and regret, rather than logic and rationality, are the hallmarks of poor decisions. Analyzing the actual impact of keeping disappointing investments and selling profitable ones (in dollars and cents) will give you a useful weapon to fight your instinct to do the wrong thing.

One way to do this is to look at a historical performance chart for a solid but volatile stock in your portfolio. Analyze what you think the continuing pattern of price fluctuations is likely to be. If it's a poor performer, ask yourself how you feel about having chosen it and what's making you keep it. If it's a strong performer, be honest about why you want to sell it. Candid answers may help you resist the urge to take quick profits at the expense of the potential for long-term gains.

When you craft a selling strategy, remind yourself that limiting the amount of trading you do not only helps to limit transaction costs (which can wipe out small profits), but it can also reduce the high cost of too many short-term capital gains. A small victory over the IRS can be more satisfying than the highs that may be triggered by constant trading.

Putting Things in Perspective Another thing: you shouldn't be surprised if your portfolio drops in value from time to time or if a security turns out to be disappointing. Instead, think ahead about how you'll respond to these inevitable setbacks. Also, be alert to the difference between losses that are the result of a falling market and those that are the result of poor choices.

Your intuition is probably not all that reliable as a guide to making good investments. Intuition has its place, but it can also be shortcut that interferes with sound decision making.

Nothing feeds fear, exuberance, panic, or greed - or the mistakes those emotions generate - more intensely than checking the market day-to-day or even hour-to-hour. You might find value in redirecting short-term attention to a long-term perspective, especially if you have the time to spare. Along an arc that extends ten years or more into the future, even a substantial loss in portfolio value from one month to the next can be a minor blip, and not the end of the world.