Portfolio killers: 5 common investing myths
Reprinted courtesy of MarketWatch.com.
To read the original article click here.
You might think that people old enough to be preparing for retirement — to say nothing of those who are already retired — would have learned at least the basic facts about successful investing. But in far too many cases you would be wrong.
I’ve identified five common beliefs — actually they are more myth than reality — that trip up investors of all ages. If they don’t apply to you personally, I can almost guarantee that they’re true for somebody you know.
Myth No. 1: I can choose — or my adviser can help me choose — a money manager who will beat the market.
Reality: There is no evidence that any money manager has been able to beat the market every year. A very small fraction of them somehow accomplish this feat for years in a row. But nobody — and I really mean nobody at all — has found a reliable way to determine in advance which managers will do this.
Perhaps the most famous example is Bill Miller, formerly of Legg Mason Value Trust LMVTX +0.17%. In 2006, Business Week named him one of the “Best Fund Managers.” Miller had just finished an extraordinary streak of managing that fund to beat the Standard & Poor’s 500 Index SPX +0.32% for 15 consecutive years.
You can be sure that a lot of investors pumped a lot of money into that fund based on those results. But Miller’s performance quickly turned sour. For the 10 years ended April 30, this fund’s compound rate of return has fallen into the bottom 1% of all funds in its category.
Oh, how fast the worm can turn.
Miller’s case illustrates a basic fact of life for investors: You get no benefit from knowing who beat the market last month or last quarter or last year. If you and your money weren’t there at the start, it’s just academic history.
These facts are obvious to anybody who is paying close attention. Yet year after year, hope springs eternal. Wall Street does its best to cash in on that hope, promising a parade of experts eager to manage your money.
Advice: Focus on what you need instead of the returns of the vaguely defined “market.” Then invest in a way that increases the probability that you’ll get what you need without taking undue risk. What “the other guy” is making doesn’t have anything to do with your own success. One simple way to steer clear of the performance chase is to invest in index funds.
Myth No. 2: It’s hard to beat the S&P 500 index.
Reality: This is only true if you’re making this attempt by selecting individual stocks from among those that are in the index. In that case you are essentially betting that your picks will do better than all 500 of them together. There’s some slight chance that will work, but statistically this is an almost sure way to underperform.
If you diversify widely in a mix of large and small, growth and value, U.S. and international stock funds, you will most likely beat the S&P. Although this won’t happen every year, if you give this strategy some time, you may be surprised to learn how easy beating the index actually is.
Myth No. 3: I work for a company that I know well. Its stock is a good investment to hold in my retirement plan, especially since I can buy it at a discounted price.
Reality: Unless you’re allowed to sell that stock for the market price right after you buy it (this is highly unlikely), this is a bad idea. No matter how good your company is, you cannot really know its future. Nobody can.
The expected return of any individual stock, including that of your company, is no greater than that of the entire asset class of which it is a part. Yet the risk of any single stock is relatively high.
This myth essentially says something like “In my case, history and common sense don’t apply to me. I don’t need diversification.”
Advice: The overconfidence represented by this myth has ruined the future for far too many investors and their families. Don’t let that happen to you. Instead, follow the advice in item No. 2 above.
Myth No. 4: Technology companies are creating the future, and young investors should own technology funds.
Reality: Tens of thousands of investors who suffered major losses after the technology bubble of the 1990s burst would love to talk some sense into anyone who still believes this myth. Early in the year 2000, Microsoft MSFT -0.05% was leading the pack of technology superstar companies into the bright technology future known as the 21st century.
Just when investors thought they couldn’t lose, the bottom dropped out of the market. Microsoft stock lost more than half its value in a few months. Even now, 14 years later, it hasn’t regained its peak price of the year 2000.
Technology is an important sector of the economy, but it’s only one sector among many. This sector is represented by the Nasdaq Composite IndexCOMP +0.29% ; you may not know it, but the Nasdaq has a lower long-term return than the S&P and about 50% more risk.
Advice: Do yourself a big favor and follow the advice above by diversifying widely.
Myth No. 5: Young investors should protect themselves from bear markets, either by pulling out of the market when things look dicey or by owning fixed-income funds.
Reality: First of all, pulling out of the market when things look bad is a rotten idea, as I described recently. It’s an almost certain way to lose money.
Second, the small percentages of fixed-income funds typically recommended for young investors won’t provide much protection in a serious bear market. But they will reduce the long-term return available from owning stocks.
Third, what young investors need most is long-term growth, not relatively stable values of assets they are unlikely to need for many decades. Fixed-income funds just get in the way of that growth.
Advice: Young investors — indeed anyone with a long investment horizon — should welcome bear markets as opportunities to buy more stock when it’s “on sale.” This isn’t necessarily comfortable, but it’s an important way to maximize the greatest asset that young people have: Time.
Now that you have reached the end of this article, you may have learned some things. I hope so. As Ben Franklin said, “An investment in knowledge pays the most interest.”
Richard Buck contributed to this article.