True or False
Myths about investing are costly. They can lead you to take too much risk, or too little, or avoid investing altogether, which likely is the most costly mistake of them all. Here are some common investing myths — from the belief that investing is the same as gambling to assuming you must have a lot of money to make money — and the truths that can set you free to build your wealth.
The Myth: Investing is basically just gambling.
There are definite similarities between the stock market and casinos. People hope to make a fortune, but the risk of loss is great. The only party sure to profit no matter what is the “house” — the casino that supplies the chips or the Wall Street firm that handle the trades.
The big difference is in the odds. They’re against you in Vegas, but with you in stocks. In every 30-year period since 1928, stocks have averaged an annual return of at least 8 percent, and often more. You can lose money in any individual stock, and you can lose money in sustained downturns, but over time, a diversified portfolio makes investors richer.
Because, bottom line, you’re investing in something real. Instead of betting on cards, or spinning reels or dice, you’re betting on the productivity of the businesses in which you invest. As a shareholder, you’re a part owner of the company. You may be entitled to a share of the profits in the form of dividends, and you can share in the growing value of the company if increasing productivity leads to increased market value (as it often does). Here’s what billionaire Warren Buffett had to say in his most recent letter to Berkshire Hathaway shareholders:
“In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts),” Buffett wrote.
He pointed out that the Dow Jones Industrial Average grew from less than 100 points early in the 20th century to more than 17,000, “paying a rising stream of dividends to boot.”
The Myth: There are “secrets” to successful investing that most people don’t know.
You can make a fortune with secret investing or trading strategies — as long as you’re the one peddling these strategies to people gullible enough to pay for them!
Investors who try to beat the market consistently fail to do so. Most so-called “active” mutual fund managers not only fail to justify the higher trading costs their strategies impose, but typically don’t even do as well as their market benchmarks (in other words, the returns they’d get if they just sought to match rather than beat the market).
The secret to successful investing is no secret, at least according to Buffett, one of the world’s most successful investors. It’s diversification at low cost. And that means index funds.
“The goal of the non-professional should not be to pick winners — neither he nor his ‘helpers’ can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well,” Buffet explained to shareholders. A low-cost S&P 500 index fund will achieve this goal, he added.
In fact, Buffett revealed in the letter that he’s put his money where his mouth is: at his death, he wants his trustee to put 10 percent of his estate in short-term government bonds and 90 percent in a very low cost Standard & Poor 500 index fund. “I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals — who employ high-fee managers.”
The Myth: The older I get, the less risk I can take.
Financial planners have long known that people need to keep a substantial chunk of their retirement funds invested in stocks, even in their 50s and 60s. Pioneering studies by financial planner Bill Bengen in the 1990s (subsequently confirmed by other researchers) found that stocks offer inflation-beating returns and actually improve the odds you won’t run out of money in retirement.
That’s why target-date mutual funds, which start out aggressive and grow more conservative as your retirement age approaches, typically keep more than 40 percent of their portfolio (and sometimes more than 50 percent) in stocks even for investors at or beyond retirement age.
In fact, recent research has found that instead of getting more conservative once you’re in retirement, you should consider getting more aggressive. An approach known as the “rising equity glide-path” can reduce the chances of running out of money in retirement, according to researchers Wade Pfau, professor of retirement income at The American College and financial planner Michael Kitces, partner and director of research for Pinnacle Advisory Group.
This approach assumes you’ll draw from various “buckets” in retirement: one with cash equal to three years’ worth of expenses, another with bonds to fund the next five to seven years and the third bucket invested in stocks. As money is withdrawn from the first two buckets in sequence, it isn’t replenished, so your equity exposure as a percentage of your portfolio rises — and along with it your portfolio’s chances of staying healthy over time (assuming you’re well-diversified).
The Myth: If there's a lot of hype about a company, it's time to buy stock in it.
By the time you start hearing about a hot company, its best days — at least as an investment — may already be behind it.
Even if you get in on a hot “initial public offering” or IPO, you’re not getting in on the ground floor. Before going public, a typical private company has several rounds of financing by individuals or companies. These “angel” investors, venture capitalists and private equity firms are the ones who likely get the most value for their investment.
Once the company goes public, there might not be a lot of upside left. Prices may soar that first day, thanks to the hype, but University of Florida professor Jay Ritter found that after that first day of trading, IPOs are a worse investment than their peers in subsequent years. Ritter found that IPOs from 1970-2011 underperformed other firms of the same size by 3.3 percent during the five years after their stock is first issued. (There are exceptions, of course, like Facebook, but picking the winners is tough.)
The Myth: You need a lot of money to invest.
You need to be able to leave your money alone if you’re going to invest. Money that you’ll need within 10 years shouldn’t be invested in stocks, since the market could hit a downturn and you wouldn’t have time to wait for your investment to recover.
But you don’t need a huge cash pile to start. Workplace retirement plans such as 401(k)s allow you to start investing immediately with as little as 1 percent of your pay. If you don’t have access to a workplace plan, you can start an IRA. The minimum investment for that Vanguard 500 fund is usually $3,000, but it drops to $1,000 if you open an IRA.
And small investments, made consistently, can really add up. Investing just $1,000 a year (or $83.33 a month) for 40 years, and you’ll wind up with over $250,000 if you get the 8 percent average annual return that stocks have historically offered over long periods. Boost your investment to $5,000 a year, and you could have over $1.2 million.
Liz Weston is an award-winning journalist and author of several money books, including the best-selling “Your Credit Score.” She writes about personal finance at her site AskLizWeston. You can like her on Facebook and follow her on Twitter.