Here's a three-step investor playbook for 2018

  • Don't make predictions; plan for the unexpected instead.
  • Lay out a long-term financial road map, and don't forget to be stringent when it comes to tax planning and true investment diversification.

The problem with making predictions is that most of the time you're wrong. That's why I don't make predictions. Instead, I plan for the unexpected.

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Who could have guessed all of the things that happened in 2017? Between major changes to the tax code, the market reaching all-time highs and geopolitical upheaval all over the world, the past year has been one of constant change. We're all wondering what new surprises are in store for 2018.

My take: Don't worry so much about it. The markets might go up, or they might go down. The Democrats might take control of Congress, or they might not. And when it comes to investing, a long-term approach is critical.

Uncertainty can be frightening for investors, and it often leads to emotional decisions that might damage your financial future. The best thing investors can do is commit to a long-term strategy designed to weather all market conditions, both up and down. Time after time after time, studies have shown that in the long run, patient investors in well-diversified portfolios outperform heat-chasers who try to time every new fad.

Trying to time the market is about as safe — and as wise — as laying your retirement funds on the craps table.

With that in mind, here is a three-step playbook for the new year.

1. Don't let poor tax planning crush your returns. With tax reform one of the most hotly debated topics of 2017, it's no surprise that investors are worried about minimizing the bite the Internal Revenue Service will take out of their wallets. In fact, according to a recent study we conducted, 46 percent of affluent investors identified tax optimization as one of their biggest financial concerns, and nearly 1 in 4 named it their top financial goal for 2018.

The two most important things to keep in mind in terms of tax-optimizing your portfolio are tax location and tax-loss harvesting. Tax location involves understanding the advantages of different types of investment accounts, then making sure assets are allocated in a way that minimizes one's tax liabilities.

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Tax-loss harvesting works by selling losses to offset realized gains. This can dramatically lower your overall tax bill and increase the amount of money left for retirement or other activities. Tax-loss selling works best with individual stocks held in taxable investment accounts.

Remember: With taxes it's not about the money that you make, but rather about the money you keep.

2. Don't be fooled by false diversification. We've all heard the expression "There's safety in numbers." And while there are no guarantees when it comes to investing, the same mind-set applies in both up and down markets.

Right now affluent investors are optimistic about the stock market's direction, with nearly half expecting the market to perform better in 2018 than in 2017, according to our research. But at the same time, 42 percent are fearful that their portfolio can't withstand a market downturn, and 38 percent are worried that they'll lose their wealth.

So what's an investor to do? Make sure they're properly diversified.

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One common mistake is for investors to rely solely on index funds for portfolio diversification. However, you must recognize that broad market indices are typically weighted by individual companies' market capitalizations, which means they can easily get overexposed to certain sectors that have seen recent run-ups.

This is a serious and rarely understood risk. Consider that the SPDR S&P 500 exchange-traded fund, one of the most widely traded index products on the market, has nearly 10 percent of its holdings in just three stocks: Apple, Microsoft and Alphabet.

If any of those three companies — or the tech sector, as a whole — experiences a decline, the entire fund could plummet in value, taking your retirement accounts with it.

To help protect against this scenario, make sure your holdings are equally distributed across size, sector and style, and commit to rebalancing at least once a quarter. This kind of diversification leads to lower volatility and milder losses during downturns without hurting long-term results.

"How can you know if your financial life is on track if you're not appropriately measuring your saving, spending and investing habits?"

3. Lay out a long-term financial road map. It's always surprising to me how many investors do not appreciate financial planning. According to a recent study, more than a quarter of Americans feel financially insecure, while just half of adult investors say they need to develop a plan that anticipates up and down market cycles. No wonder they feel insecure!

In many ways a financial New Year's resolution to get your finances in order isn't that different from a resolution to lose weight. You can't possibly know if your diet is working without a scale, so how can you know if your financial life is on track if you're not appropriately measuring your saving, spending and investing habits?

I'll make one prediction for 2018: The investors who follow these three steps will have fuller, happier and more confident financial lives.

— By Jay Shah, CEO of Personal Capital

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