Avoiding pitfalls in active investing

What do you have to know before you start active investing? Sheyna Steiner, investing editor of Bankrate.com, has some ideas before you decide make the leap. 

"It's going to cost a little bit more. You should know why you're paying more, says Steiner. "Sometimes it's worth it, a lot of the time it might not be."

As Justin Fox pointed out, a booming market can make everyone look like a skilled investor. When the market as a whole is gaining, how do you find the right actively managed fund?

It's all about research, Steiner notes. "Go back and see how the fund has done in varying economic situations. What happened in 2008? Did the fund lose as much as the broad market? Did it lose more? Did it lose less?" Seeing how a fund handled booms and busts can be a good way to decide what to invest in.

What if you don't want to pay someone else to handle your money, and instead want to choose your own stocks? Steiner says a good way to get into the market is by researching companies you know of already. You can also research the holdings of other funds to get a sense of what a portfolio should hold. "Look at what a large-cap mutual fund might hold. They'll hold really big companies, and you can look in their top 10 holdings and start investigating what companies you see most often."

But individual investors can end up in trouble. "They end up timing the market really poorly. They buy high and sell low, chasing performance, and maybe over waiting one particular investment rather than diversifying," Steiner says. "It's really risky to bet the farm on one stock, and buying a bunch [of stocks], whether it's through a mutual fund or individual stocks is much less risky."

Steiner learned that lesson the hard way. When she first built her 401k, she put all of her money in an aggressive growth fund and one technology stock. "This was in the tech boom, and then it all crashed, and I sold and cashed out my 401k. I ended up leaving that job, and I did exactly what they say not to do, cashed out my 401k, paid off some bills and started [my retirement fund] over with nothing."

One thing you should do before investing is figure out your risk tolerance. Here’s a classic risk tolerance test for investors. 

"If you're the type of person that's going to stay awake and fret over your 401k balance, regardless of how much time you have, then it should somewhat guide you," says Steiner. "But other things are important .. how much money you want to have at retirement, or how much money you need to have at retirement."

One thing an active or passive investor should do? Steiner says start early. "If you just leave money alone and you save a few thousand dollars in your 20's, by the time you retire at 60, you're going to have so much more money than someone who starts when they're 35."

About the author

Adriene Hill is the senior multimedia reporter for LearningCurve.

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