4 million-dollar investing myths you need to stop believing
Reprinted courtesy of MarketWatch.com
Published: June 27, 2018
To read the original article click here
I’m continually amazed at the investment misconceptions that lure people into cheating themselves out of long-term returns.
Some are little more than plausible-sounding rules of thumb passed from person to person without much careful thinking taking place.
Let’s look “under the hood” at four examples.
These million-dollar investing myths prompt investors to effectively rob themselves of hundreds of millions of dollars they could otherwise have.
Myth 1: The S&P 500 index SPX, -1.57% is riskier than the stock of the company you’re working for
Why this seems plausible: After all, the S&P 500 contains 499 other companies about which you are likely to know relatively little. You know your own company and at least something about the folks who are running the show.
If there’s some major risk to your company, you’ll probably get wind of it in time to make an informed decision.
Why this doesn’t hold up: If you’re the chief executive or on your company’s board of directors, that argument might have some limited validity.
Otherwise, it’s bunk. This line of thinking implies that you will have insider information of some sort. Even if your company (illegally and improbably) shares such information with employees, if you were to sell shares based on that information, you’d be breaking securities laws.
On the contrary, your company’s top management will almost certainly try to put a positive and hopeful spin on everything that might lead investors to dump the stock.
If you think your company stock is likely to be a better investment than the broad average, you’ll be ignoring more than 90 years of data.
A study recently published by Hendrick Bessembinder found that since 1926, the returns on stocks of the majority of public corporations (roughly four out of seven) have been less than the returns on essentially risk-free U.S. Treasury bills.
That’s right: Statistically, your company’s stock has a less-than-even chance of returning as much as T-bills.
It’s even worse: In terms of lifetime dollar wealth creation, the returns of just 4% of all public companies explain most of the entire net gain for the U.S. stock market since 1926.
Collectively, the other 96% of public companies matched the rate of T-bills.
Are you willing to stake your financial future on your belief that your company is one of the 4%? If you are, have you asked your spouse if he or she feels the same?
The good news is that over the past 100 years, the S&P 500 has produced a compound return of approximately 10% — about 400 times as much as T-bills.
Myth 2: Investing in stocks is essentially gambling
Why this seems plausible: See the previous discussion about individual stocks. If only 4% of stocks really pay off in the long run, the odds must certainly be stacked against investors.
Young people may have seen their parents’ investments take a huge beating 10 years ago; at the same time, they’ve undoubtedly seen real-estate prices skyrocket in recent years.
Why this doesn’t hold up: First, you should think about the meaning of the term “gambling.” This is generally a wager in which you learn the outcome fairly quickly, and that outcome is either a very high — but highly unlikely — windfall or a much-more-likely total or near-total loss.
Reno and Las Vegas are fine places for entertainment, but the gambling industry has spent billions of dollars to make sure you’re very unlikely to make your fortune there.
Investing in equity funds for retirement is quite different.
You won’t learn the outcome for years — perhaps decades. You’re unlikely to make a killing, and you’re very unlikely to lose everything.
This insidious myth is leading many young people to put their money elsewhere, such as residential real estate, which lacks the long-term record of well-chosen equity asset classes.
Young people also put far too much credence in recent short-term history.
They are much more likely to trust the stock market with their lifetime financial futures when stocks have been rising for a few months or years (despite the fact that the price of admission has risen substantially) than during times of normal corrections (which ironically present the best bargain prices for long-term investors).
Myth 3: The way to make money in the long run is to cut your losses and let your profits run
Why this seems plausible: Really, what could be more reasonable and obvious? If only 4% of stocks are long-term winners, then you’re going to have to weed out lots of losers over the years.
Why this doesn’t hold up: If you are a stock trader, this rule of thumb could make sense (if you ignore the costs of trading).
But for long-term investors making lifetime choices among asset classes, this is counterproductive at best.
If you have chosen wisely (it’s really not hard to do) and invested in a handful of asset classes, then selling every time one of them is in a slump will make your portfolio increasingly concentrated – and increasingly risky.
Every equity asset class goes through periods of corrections, and successful long-term investors are those who can persevere.
If you have really done your homework, chosen well and you are looking for long-term results, you should be able to follow this alternative rule of thumb:
If it goes down, buy more of it.
(Hint: That’s what happens when you rebalance a portfolio.)
Myth 4: I’m young. There’s lots of time before I need to start seriously investing for retirement
Why this seems plausible: Well, lots of reasons.
You’re young and there are many pressing demands on your money.
You may have student loans to pay off, a young family to support, a household to establish, destination weddings to attend.
Besides, no matter what your current age, in 10 years you will probably be making more money and setting some aside will be easier.
Why this doesn’t hold up: Well, lots of reasons.
For starters, as I wrote in a recent article, time itself is the greatest asset for a long-term investor.
Just as important (and I know this might sound shocking), the stock market doesn’t actually care about what you want or need.
It’s true that the S&P 500 index has a long-term return of 10%. It’s equally true you can figure out when you want to retire, then count back to the number of years it will take to reach your goal assuming a 10% return.
But that 10% return doesn’t happen in every year, every decade or even every 25-year period.
For the 25 years ended in 1999, the S&P 500 compounded at 17.2%. But from 2000 through 2017, the index compounded at less than 6%.
In order for the first 25 years of the 21st century to match that 17.2% compound return, the S&P 500 index would have to do something it’s never done before: grow at a rate of 39% for the seven years 2018 through 2024.
One lesson every investor should understand is pretty simple: The stock market does indeed produce great returns from time to time, but you never know in advance when it will happen. And once you do know, you can’t invest retroactively.
To learn about nearly a dozen more myths about investing, check out my related podcast.
Richard Buck contributed to this article.
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