Debunking 5 investment myths
InvestmentInsights BY CAROL M . SCHLEIF
Rewiring Required
Debunking 5 investment myths
Our psyches are simply not constructed to make us wise investors . Blame it on our genetics and the survival mechanisms laid down in the most primitive parts of our brain . When we ’ re scared , rather than calmly assess fundamentals , we want to flee ( sell ) when the more appropriate response may well be to buy high-quality goods that are now on sale . What follows are five of the most common misperceptions about money management we ’ ve witnessed in our 35-year-long career , accompanied by a more helpful possible response .
Myth # 1 : Every event needs a portfolio or trading response . As noted , we ’ re hardwired for action ; it ’ s how our species has survived . But in the investment world , action typically means fees , taxes , and other cost drags , which can reduce overall returns . Study after study reaffirms that average investor returns are typically much lower than those generated by standard market indexes , with the difference caused by the cost and timing drag of more frequent decisions versus just getting in and staying put . One recent study showed that the S & P 500 Index generated an annualized return of 8.19 percent versus the average investor return of 4.67 percent .
Solution : Write a plan and stick to it , especially when markets are unruly ( up or down ). Rebalance intentionally when valuations become extended and / or market action distorts ranges you ’ ve established during calmer times .
Myth # 2 : Market timing works and all or none is the way to go . The implicit presumption most investors bring to their investment programs is that there is some magical signal that indicates market peaks or bottoms , highlighting the precise time to make an all-or-none leap into or out of the market . On average , markets follow the 80 / 20 rule , moving in sideways , range-bound action about 80 percent of the time . Often , sharp up moves come when headlines wouldn ’ t lead one to believe a rally is imminent . ( It ’ s important to remember that the S & P 500 is one of the components used to calculate the leading economic indicators , meaning it moves up before headlines or fundamentals would seem to warrant ). If you are not already invested when these moves come , it ’ s often too late to jump on board once they start . Assuming you can nimbly move all the way in or all the way out is next to impossible and implies you can precisely time both your sell and subsequent buy decision .
Solution : Dollar-cost averaging in or out can help insure that at least some of your assets are at play and / or some of your potential gains are realized on an ongoing , smoothed basis .
Have a firm grasp on where you want to end up — either in saving for specific purchases , or relative to the level of assets and income you need .
Myth # 3 : I must have all the info before I make a decision . We drink from a fire hose of information on a daily basis . This flood of information leads us to try to summarize , categorize , and discern recognizable patterns — even when none could or should exist . The media , in an effort to fill pages and hold reader attention , are forever trying to back into what “ caused ” markets to move one way or the other , an often futile exercise in the short term when even structural factors like illiquid markets , lopsided demand , or large investor asset allocation changes can sway individual securities or entire asset classes .
Solution : The key relationship that matters for individual securities is current market price relative to long-term potential . Is the asset under- or over-priced relative to its income stream now and in the future ? The
vast majority of what feeds the information flow each day is irrelevant toward your ability to outline and execute your long-term investment plan .
Myth # 4 : Market volatility is the same thing as risk . There are many different forms of financial risk , from having insufficient cash flow or assets to support a lifestyle during inflationary times , to not having enough saved for education , retirement , or a home down payment . Day-to-day market swings are typically not considered a risk unless they lead to permanent loss of capital . Daily market swings are part and parcel of the daily interactions of millions of global buyers and sellers , each with their own agenda and goals .
Solution : A firm grasp of reasonable valuation relative to current price , coupled with a clear view of one ’ s long-term goals and funding needs , can turn the view that daily volatility is “ risky ” into the understanding that interim mispricings often represent opportunity .
Myth # 5 : Picking the right individual stocks or bonds is how the big bucks are made . While an inordinate amount of time and energy is spent researching and writing about individual investments , long-term studies have repeatedly shown that the bulk of an investor ’ s return over long periods comes from being in the right buckets to begin with ( stocks vs . bonds vs . cash and types of sub-asset classes within those categories ). Individual securities within those buckets are much more fun to talk about than asset allocation in a macro sense , but statistically they don ’ t matter as much .
Solution : Have a firm grasp on where you want to end up — either in saving for specific purchases or events , or relative to the level of assets and income you will need to fund you during various periods . Regularly rebalance back to these long-term ranges when valuations , market action , or changing fundamentals push the broad categories outside your bounds .
Carol M . Schleif , CFA , is deputy chief investment officer at Abbott Downing , a Wells Fargo business that provides products and services through Wells Fargo Bank and its affiliates and subsidiaries . She welcomes questions and comments at carol . schleif @ abbotdowning . com .
84 MULTI-UNIT FRANCHISEE ISSUE III , 2017