6 Common Misconceptions About Investing

6 Common Misconceptions About Investing

investing

With something as important as our financial security, investing myths pose a serious threat to your future wealth. And as long as investors believe in harmful myths, they run the risk of damaging their way of life.

While determining the truth as it relates to investing strategies, tactics and advice can be difficult, this article debunks six myths that may have harmed investors and their financial wellbeing.

 


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Myth 1: Investing is the Same as Gambling

Perhaps in a way to oversimplify their view of investing, some people believe that “playing the stock market” is no different than gambling. But strategic investing is hardly a gamble.

Yes: when you purchase a stock, you expect that it will increase in value. But even if it the stock declines, the asset has the potential to rise again. The most important distinction between investing and gambling though, is that when you purchase a share of a company’s common stock, you’re buying a percentage of ownership in that business.

Conversely, when you exchange your money for chips at a casino and place a bet, your bet does not provide something of value in return. If your bet is a winning one, you’re given more money back. But if you lose, you’ve lost that money forever – You have no potential gain from that initial “investment.”

One of the reasons people relate investing and gambling is because some believe that investing is a good way to make quick money. But that too is a poor approach that leads to trouble. Anyone who’s consistently made returns on the stock market has had to observe investing truths in action – including tenants such as diversification and proper risk management.

 

Myth 2: Picking Individuals Stocks Can Consistently and Predictably Add Value

Many individual investors hold a belief that they can choose stocks they believe will perform well in the future. Whether based on a report they read, a strong belief in a company itself, or intuition, an investor mayfeel that that company’s stock will appreciate. However, picking stocks has proven to be a losing game over the long term. Sure, some assets will do well, but others will inevitably go in the opposite direction.

Consider the history of the average U.S. mutual fund versus the stock market as a whole over the past 45 years. As a mix of “selected” assets, mutual funds all differ at least slightly based on the goals or directive of each individual fund. And while funds are a diversified mix of securities, they don’t approach the level of diversification of a stock market – the S&P 500, for example.

If you had invested $100,000 into the average U.S. mutual fund in 1972, by the end of 2016, it would have grown to roughly $3.5 million. Had you made the same investment in the S&P 500 at the same time, however, you would have earned nearly $7 million over the same time frame.

Data representing the average of all US equity mutual funds is from the Survivor Bias Free Mutual Fund Database created by CRSP (12/31/2016); the S&P 500 Index and the CRSP Market Index were extracted from returns software provided by Dimensional Fund Advisors (DFA). The referenced indices are discussed in more detail in the endnotes. Average fund performance results and comparative indices assume reinvestment of dividends and income. Average fund data also includes fund expense ratios associated with active management, but does not include sales commissions; however, the indices are unmanaged, cannot be invested in directly and their returns do not reflect any management fees, transaction costs or expenses. This graph does not reflect actual investor results and no representation is made that your portfolio would experience similar results. Past performance is no guarantee of future success.

 

Myth 3: Taking on Greater Risk Will Yield Greater Return

While there is a fundamental relationship between an asset’s risk and itsexpected return, greater risk has never guaranteed greater returns. Investing tools and analysis of historical data enable investors to predict a wide range of potential outcomes for a security. With this information, investors can also better understand the risk exposure of a stock – how wide a range of outcomes they can expect.

Studying this data helps uncover durable patterns of risk and return based on valuations, economic conditions, and geopolitical factors. With an understanding and consideration of the probability of potential losses and gains, you can invest more wisely. But you can never know if the past performance of a security will conform to risk/return expectations over any period of time.

 

Myth 4: Historically-Successful Funds Will Reliably Perform Well in the Future

As just noted, past performance does not indicate future success. Finding funds or securities that performed well in the past is a faulty “strategy” some investors have used to try to identify funds that would do well in the future.

Track Record Investing, as it’s known, has hardly been proven to provide greater returns. Consider the table below, depicting the performance of three sets of securities over different time periods:

Avg Annual Return

  1997-2006  

  2007-2016  

  2007–2011  

  2012-2016  

S&P 500

8.42%

6.95%

-0.25%

14.66%

All U.S. Equity Funds

8.07%

6.20%

-0.12%

12.04%

Top 30 U.S. Equity Funds

17.74%

5.35%

5.07%

4.35%

Per compliance, source must be in writing, but does not need linked to Source:For illustrative purposes only. Mutual fund data provided by CRSP Survivor Bias Free Mutual Fund Database, includes funds that are U.S. Equity mutual funds. The S&P data are provided by Standard & Poor’s Index Services Group. CRSP data provided by the Center for Research in Security Prices, University of Chicago. Indices are not available for direct investment, therefore their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not actual investor results.

Whether using ten-year timeframes (columns two and three) or five-year timeframes (columns four and five), none of the three sets of securities provided the same returns in the second period as it did in the first. And in many cases, the returns were drastically different. Historical success and appreciation simply doesn’t indicate the same level of success in the future.

 

Myth 5: Investing is Only for People with Money

Thanks to the high cost of investing in the 1900s especially, many people have concluded that only those with plenty of money could truly make money in the stock market. And that may have been the case when investors were charged high broker fees. But since online trading became a staple of investing, the cost of investing has diminished considerably.

Anyone with an internet connection can create an online trading account, and it only takes a little bit of money to get started. The internet has also made it far easier to find and analyze financial information  that was once primarily reserved for professional advisors and stockbrokers. Now, anyone can do their own stock research and monitor their investments.That being said, having the necessary knowledge to make strategic investments is incredibly important.

 

Myth 6: Working with Professionals Isn’t Worth the Cost

Most people don’t spend their lives studying investing and the stock market. It’s a career just like engineering is a career. Coincidentally, many engineers work for investment institutions and trading platforms.

What separates a good financial advisor from an amateur is their ability to understand and assess your long-term needs, challenges, and goals and determine a strategic path to that end. A financial advisor can guide you through retirement planning, investing strategies, tax issues, and many other financial scenarios. And that professional support is incredibly valuable.

According to the 2017 Retirement Confidence Survey, roughly one in four employees reported having less than $1,000 saved for retirement, and more than half of surveyed employees had saved less than $50,000.

Most Americans need hundreds of thousands of dollars when they reach retirement, if not millions. The value of having a strategic plan and sound guidance to reach that point is more than worth the cost.

 

What does a strategic wealth creation strategy look like? Download a copy of The 5 Greatest Wealth Creation Strategies to learn some of the best ways to build wealth

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About Greg Hammond, CFP®, CPA

Greg Hammond is the chief executive officer of Hammond Iles Wealth Advisors, and co-founder of Planned Giving Strategies®. Greg leads a team of professional financial advisors providing customized wealth management and investment solutions for high-net-worth individuals, families, companies, and charitable organizations across the U.S.