Investors should be wary of these 5 bits of Wall Street ‘advice’
Reprinted courtesy of MarketWatch.com.
Ernest Hemingway once said: “The best way to find out if you can trust somebody is to trust them.”
(Try telling that to Homeland Security these days.)
However, investors who trust everything they hear from Wall Street won’t be successful. Ironically, those who trust nothing they hear from Wall Street won’t be successful either.
Wall Street is a huge industry that’s focused on profiting from individual and institutional investors. Many of the companies and individuals in this industry are honest and trustworthy.
But when trillions of dollars change hands every business day, the potential for profits is huge. Often, the honest truth is not enough to satisfy the Captains of Wall Street. And just as often, the truth winds up on the cutting room floor.
In navigating such waters, I think investors can get a big head start by avoiding the most dangerous untruths that are common. Today we will look at five of the bigger untruths and half-truths that Wall Street wants investors to believe.
1. The economy is recovering, and that means stocks will do well.
Reality: It may indeed be true that the economy is recovering. But so what? That doesn’t mean the stock market will boom. You should always remember this: Stock prices reflect anticipation, not accomplished facts. And investors have a pretty dismal track record trying to correctly forecast the economy.
From 1968 to 1982, the economy grew nearly 300%, but during that time, the stock market essentially went nowhere.
2. Stocks go up 10% a year over the long term, and you can make your financial plans based on that.
Reality: It’s true that the S&P 500 Index SPX, +0.50% has a very-long-term track record of appreciating about 10% a year. But I’m almost certain that your return will be something else. Every year is different, and every decade is different.
In the real world, the long-term return you get will be determined largely by two factors: How well you diversify your portfolio (see below) and when you begin putting money away for the future (and, of course, when you start taking it out in retirement).
Those times depend on when you enter the work force, when you start saving seriously, and when you need to start withdrawing your money for retirement.
If you study the performance of the S&P 500 during every 40-year period from 1928 through 2015, you’ll discover that the worst annualized return was 8.4%, the best was 12.4%, and that nearly one-third of the time, the annualized return was less than 10%.
If you look at all the 15-year periods from 1928 through 2015, you’ll find that in approximately 40% of the 15-year periods, the S&P 500 compounded at less than 10%.
3. The best way to beat the market is to pick the best stocks.
Reality: That’s true. It’s equally true that the way to live forever is to never get older. In each case, it’s a nice idea, but impossible. (I devoted a chapter in my 2011 book Financial Fitness Forever to the myth of beating the market, and I recommend it to you.)
Don’t pick stocks, pick asset classes. Academic studies say that will determine more than 90% of your long-term return.
“The market” is usually considered to be the relatively thin slice of stocks represented by the Standard & Poor’s 500 Index, a blend of large-cap growth and large-cap value stocks.
The best way to outperform that index is to diversify by investing in asset classes that, for the past 90 years, have done better than the S&P 500. You can easily do that by adding large-cap value, small-cap blend and small-cap value stocks. Just adding those three asset classes makes a huge improvement.
Even better returns have been available to those who ventured into real-estate stocks and international stocks. This article gives the details.
4. You can’t manage your own money because investing is a complicated process. You need someone who understands how to do it right.
Reality: I’ve been involved in the investing business for more than half a century, and yes, that statement might once have been true. But it’s not true today.
Yes, it’s vital to understand how to do it right. And yes, it can be complex if you want to get involved in the details. (That applies to just about every aspect of life I can think of.)
But today’s investors have so much good information and so many good products from which to choose that there’s no reason to throw up your hands and give up.
Armed with some readily available disinterested guidance and a bit of time, first-time investors can make excellent lifelong choices from among no-load, low-cost index funds and ETFs, including target-date funds. In addition, IRAs and employee retirement plans such as 401(k)s make it easy to defer taxes on investment gains, and in some cases to eliminate them entirely.
This was the focus of a presentation I made as the keynote speaker at the 2016 Retirement Conference.
5. Our advisors are working with your best interests in mind.
Reality: Sometimes that is true, but often it’s not. You will have to look out for your own interests to make sure. Fortunately, it’s not hard to determine whether this is a con or the truth.
A University of Chicago study found that 7% of Wall Street’s financial advisors — that’s about one out of every 14 — have been disciplined by regulators for misconduct with investors’ money. In one major firm, the number was closer to 20%.
The abuses are most often conducted by advisors who earn their pay via sales commissions. That makes it easy to protect yourself: Refuse to do business with any advisor whose pay is based on commissions.
There’s an excellent alternative: Choose an advisor who is paid only by fees and who assumes a fiduciary legal responsibility in dealing with you.
You can vastly reduce your chances of being defrauded by asking your advisor two questions, and asking for the answers in writing:
- Is part or all of your compensation based on commissions? (The best answer is no.)
- Do you have a fiduciary responsibility in the advice you give me? (The best answer is yes.)
I can’t offer a blanket guarantee that you won’t ever be hoodwinked by Wall Street. But if you understand these five common bits of “advice” and act accordingly, you’ll be on the right track to avoid becoming a victim.
For more about navigating the sometimes treacherous waters of Wall Street, check out my podcast, “How to make a million dollars with your smartphone.”
Richard Buck contributed to this article.