Even passive investing has pitfalls. Here are the most common errors — and how to avoid them.
The most common and costly mistake. Investors pull out of index funds during downturns ("I'll reinvest when things stabilize") and often miss the fastest recovery days. Missing just the 10 best trading days of any decade dramatically reduces long-term returns. Stay invested, always.
Market downturns of 20–40% are normal and occur regularly. The S&P 500 has experienced over a dozen bear markets since 1950 and has fully recovered from every single one. Selling at the bottom locks in losses and prevents participation in the recovery. The investors who did worst during the 2008 and 2020 crashes were those who sold.
The top-performing fund category of any given year is statistically unlikely to repeat the following year. Investors who rotated into technology funds in 1999, real estate in 2006, or oil in 2014 right after those sectors peaked experienced significant underperformance. Broad market index funds sidestep this trap entirely.
Investing in a taxable brokerage account before maxing out a Roth IRA or 401(k) is a costly order-of-operations mistake. The tax savings from these accounts compound significantly over decades. Always exhaust tax-advantaged options first.
Any expense ratio above 0.20% deserves scrutiny for an index fund. There are excellent options at 0.00%–0.03%. The difference of 0.97% compounding over 30 years on a large portfolio can represent six-figure losses. Check the expense ratio of every fund you hold.
More funds does not mean more diversification. A portfolio of 15 different U.S. equity index funds is still essentially a U.S. equity portfolio — just more complex and harder to manage. One or two funds often provides all the diversification most investors need.
After a long bull market, your portfolio allocation can drift significantly from your target. A 60/40 stock-bond portfolio left unmanaged through 2017–2021 might have become 80/20 by 2022 — exposing a conservative investor to far more risk than intended. Rebalance at least annually.