There are a number of investing myths that lead investors astray all the time. Sometimes it’s sound advice that fails under specific circumstances. Other times it’s just plain wrong. Either way, it leads to investors making mistakes and taking unnecessary losses.
Safety In Cash
There is safety in cash or so the saying goes. A good online brokerage account includes money market rates on any money you don’t invest. If rates weren’t so low, this investing myth would be sound advice.
Cash not growing at a rate equal to or above the inflation rate is a losing venture. You may not lose money in the sense of having less dollars, but you will lose purchasing power. If you don’t believe me, toss $100 in a mattress and in twenty years see how far it gets you compared to now.
When investing there are only two reason to have cash in your portfolio. Either you’re planning to withdraw it soon or you’re waiting to put it to work. By that I mean you’re waiting to take advantage of an opportunity. So if you’re not active looking for investments or planning to spend it, put that cash to work already.
Bonds Are Safe
Far to often investors view bonds as a safe asset. When the market tanked in ’09, the flight to safety was bonds. In turn that flight drove bond prices higher. The Fed has helped that effort, giving bond funds a nice return for the past couple years. But it wasn’t in the yield department. In fact, bond yields are at all time lows.
If you still think bonds are safe or safer than other assets. You’d be wrong.
The past few years there has been a push to invest in shorter term bonds and bond funds. The hope is to avoid interest rate risk and falling bond prices. It’s hard to get a decent return with interest rates so low. To get around this investors are stretching their risk a bit with either higher yield junk bond funds or longer maturity bond funds.
The general rule is every 1% change in interest rates equates to a 1% change in bond prices (in the opposite direction) for every remaining year of maturity. So a 1% rise in rates on a 10 year Treasury will be about a 10% drop in bond price.
The idea that bonds are safe is one of the bigger investing myths today.
Diversify As Much As Possible
Diversification is a way to lower to your investment risk. Like many things we tend to take this to the extreme. The Super Size Me belief that more is better doesn’t translate well to investing and portfolio allocation. Peter Lynch calls it diworsification and investors suffer for it.
More funds do not mean you’re more diversified and unlike poker having two or more of a kind is a bad thing. Diversification done wrong only leads to under performance on a good day and big losses on a bad one.
In most cases, using a less is more approach is better. If you feel you need something more complex or you’re not sure what to do, you should find a financial planner to give you a hand.
The Stock Market Is Efficient
The Efficient Market Theory is right some of the time. Unfortunately, its wrong too. This investing myth has been argued to the hilt. The theory states the stock market always reflects all the information available. To that end, stock prices should always be perfectly priced based on that information.
This doesn’t mean stocks are accurately valued.
Stock prices are largely subjective since price is a function of future earnings. Depending on the company and available information those future earnings can be a very accurate guesstimate or a complete shot in the dark. You only have to look at analyst estimates to see the wide array of guessing going on.
Once you add irrational exuberance, flash crashes, and other random events the efficient market seems rather inefficient at times.
You Can’t Beat The Market
This is one of the investing myths out there. It goes something like this – the safe investment is index funds since you can’t beat the market. With one exception. Research has shown that a value investing strategy can consistently beat the broader market over the long-term.
So if you want to beat the market, you need the knowledge, time, and discipline to hand-pick undervalued stocks, bonds, and other assets that will consistently outperform the market over the long-term. Easy enough, right?
It is certainly possible. but not probable, since most people fall short of those three requirements, usually in the discipline area. Which happens to be a great reason to invest in index funds.
This makes the saying “you can’t beat the market” a successful marketing ploy for the fund companies. Most people end up making the right decision to invest in index funds based on the wrong information.