30 Myths Investors Choose to BelieveSubmitted by Cornerstone Investment Services, LLC on April 15th, 2015
"Acknowledge the complexity of the world and resist the impression that you easily understand it. People are too quick to accept conventional wisdom, because it sounds basically true and it tends to be reinforced by both their peers and opinion leaders, many of whom have never looked at whether the facts support the received wisdom. It's a basic fact of life that many things "everybody knows" turn out to be wrong." - Jim Rogers
In my 30 years of industry experience, I have seen too many investors fall prey to these popular misconceptions. Performance, Risk, Investment, and Retirement myths are perpetuated in the media, circulated in print and shared online. Take a moment to consider the other side of these 30 myths.
- John Riley
Chief Investment Strategist, CIS
1. An Index Fund is the best performer.
"Share prices fluctuate much more widely than values. Therefore, index funds will never produce the best total return performance." -Sir John Templeton
An Index fund gives "index" performance. If that is what you are looking for - with all of the risks associated - then you should utilize an index fund. According to StockCharts’ data, since the market low of 2009 to February 17th 2015, the S&P 500 is up 214%. However, from the peak of 2000, the S&P is up only 34.85%, about 2% per year.
So what happened? The long term return from 2000, included 2 major bear markets. One dropped 50% and the other 42%. The purpose of an Index fund is to be long term and ride out the ups and downs, to get market returns. The 2000 – 2015, return of about 2% per year, is what the long term investor would have gotten.
(Of note is the fact that according to Morningstar’s data, the much heralded Vanguard 500 Index fund placed 2832 out of 5,945 funds with a 10 year track record. 47% of US Equity funds beat the Vanguard Index 500.)
"But I wouldn’t have stayed in the Index fund during the bear markets." Is the claim of the Index fund buyers. This leads to the next myth.
2. I will get out before things get bad.
"Men, it has been well said, think in herds. It will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." - Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds, 1841
Studies (found in myth 13) show that investors tend to buy at tops and sell at bottoms. If you were to get out, on what would you base your decision? What are the triggers you are watching? What indicators will tell you when to get out? Would you wait for it to be officially a bear market? (Which is a 20% decline.)
"Market tops and bottoms are rarely recognized for what they are at the moment they are happening. Almost always, there's a popular perception that whatever has been happening recently -- [stock] prices going up, prices going down -- will continue happening in the years to come." - Jim Rogers, CNBC guest host, May, 1997
3. I should expect a min 10% return, with a 15% target.
"Games are won by players who focus on the playing field -- not by those whose eyes are glued to the scoreboard." -Warren Buffett
This is fine if you expect the market to return almost triple its historical average annual return since 1871. Your odds of getting a 15% annual RoR are not good. Since 1871, Shiller’s market data shows the market has averaged between 5% and 6% consistently. This is why we believe active money management is so important, to try to enhance the return, especially during the years when the market is performing below average.
4. It’ll come back…
This is the battle cry from the speculator turned buy n’ holder. If you have a long enough time frame, just about anything will eventually come back. But the time frame is pretty long in some cases. Yahoo! Finance shows that the Japanese market is 26 years into a bear market. TWENTY SIX years. Eventually their market will get back to its highs in 1989… eventually… maybe. As per the NASDAQ, the NASDAQ went 15 years without surpassing its all-time high.
Some stocks go down and never come back or go bust.
It has been our experience that this myth is mostly believed by investors that over-paid for a hot stock, only to see it come crashing back down to earth. The company may be just fine and the business go on for years, but the stock may never see the heights it once saw during the mania phase. Crocs is the poster child for these investors.
5. A good portfolio/mutual fund is a top performer over the long and the short term.
Many investors think that if you string a bunch of successful quarters together, you will have good long term performance. That is not how it works. Short term shooting stars usually fizzle. The averages are "averages" for a reason. Few money managers/mutual fund mangers have ever been able to string together top 10% short term performances for the long term.
To prove this, using Morningstar data, we looked at the 100 best performing US Equity mutual funds for the past 10 years (ending 2014). We will call them the Top 100. These were the best of the best long term performers; the top 100 out of thousands of mutual funds. If it were true that short term performance translates into long term performance, then the 1 year performance of the Top 100 should be well above average. It was not.
The average 1 year performance (2014) of the Top 100 was not in the top 5% of all funds. Not in the top 10% of all funds. Not even in the top 20%. The average performance was dismally in the middle of the pack. The average position or ranking of the top 100 was 4,054th out of 8,360 US Equity Funds. They averaged in the middle of the pack. But it gets worse.
There were only 5945 Mutual funds with a ten year track record, so placing 4054 is not very impressive. But that is the point. The 1 year track record was not important. These were the Top 100 US Equity funds over a ten year period - including the poor placement in 2014.
A fund manager I knew told me once that his company frowns on placing the fund in the top quintile for the year, because they knew, if it was in the top this year, it would be towards the bottom next. They wanted consistent annual returns in the second and third quintile because they knew that over time, the performance would rise to the top.
Our small test with the Top 100 shows this to be true. The short term performance was not great, but the long term performance was. Which would you rather have? Top 100 performance for a year or over a ten year period? We think a smart investor would choose the ten year period.
"If you are not willing to own a stock for 10 years, do not even think about owning it for 10 minutes." - Warren Buffet
6. Fees are critical to performance.
You get what you pay for. Fees are the third rail of the investment industry. Study after study tries to correlate low fees with high performance. Our own study using Morningstar data of over 21,000 mutual funds showed some surprising results. We compared all mutual funds, (except sector funds), over 3 and 5 year periods ending December 31, 2014. We compared the most expensive funds (Total Net Expense Ratio), those over 2.00%, with the least expensive, under 0.65%. Over a 3 year period, the most expensive funds OUTPERFORMED the least expensive by almost 18% - the expensive funds had an average annual rate of return of 10.48% compared to the least expensive with an average annual rate of return of 8.89%. At 5 years, the most expensive and least expensive are almost a tie, 7.79% for the most expensive, 7.78% for the least expensive.
Here’s the upshot - The funds with fees in between 0.65% and 2.00% outperformed both the most and least expensive funds. So while everyone is pushing a faulty maxim, that low fees mean out-performance, the funds in the middle, with fair fees, outperformed both the most and least expensive.
Fees are important and, while you would obviously not want to over-pay, we believe the data shows that it is okay to pay a fair fee. To put it into perspective: just like athletes, good performers can request a higher fee. Think of it this way: if your child was in legal trouble, would you hire a cut-rate lawyer to help him out? Or if you needed medical services: would you shop for the lowest priced surgeon, or would you look for the best?
When investing you are placing your financial future, savings, retirement in someone else's hands. As the research shows: a fair fee in the right hands can make all the difference. Fees are a way to pay your financial advisor for all of the things not directly related to the investment that he does for you. Maintaining and training a qualified staff, keeping investors updated through emails and newsletters, and monitoring the investments and/or portfolio managers all have costs associated with them. Just giving advice on the phone has costs associated.
So yes, fees are critical to performance, but we believe performance needs to be measured in broader terms, not just the rate of return of the investments. The overall performance of the financial advisor should be taken into account. Is it worth x% to have such and such person working with you?
" A professional, competent, caring financial advisor is always worth much more than he or she costs. Any investor can look up the past performance of a mutual fund in a magazine or read it in an advertisement. Returns, in that sense, are very easy to understand. On the other hand, it is more difficult to get an accurate, objective idea of the risks the fund took to get those returns. …A superior financial advisor is always mindful of risk and works very carefully to construct a portfolio… They match investment managers to your true risk tolerance." - Marty Zweig, Zweig Securities, Maintaining Perspective, 1/99
7. My portfolio should go up every month or at least it shouldn't ever have a down month.
"When an investor focuses on short-term investments, he or she is observing the variability of the portfolio, not the returns - in short, being fooled by randomness." -Nassim Nicholas Taleb
Expecting your portfolio to go up each month or never have a down month is an unrealistic expectation. The very nature of the stock market is that it has ups and downs. Sometimes a good portfolio will go up for several months and sometimes a good portfolio will go down. Just because a portfolio goes down, doesn’t mean it is bad or that the strategy is wrong. ANYTHING CAN HAPPEN SHORT TERM. If the market goes up and your portfolio goes down, it may not be a sign of a bad portfolio but one where the securities are not correlated to the market, possibly a defensive posture by the money manager.
The short term moves are more a function of volatility than rate of return.
If you want an investment that goes up every month, put your money in the bank. You won’t make much, but at least it will go up every month.
"It isn't a manager's job to outperform quarter by quarter, or even year by year. A manager's job is to stick to what's worked in the past - so long as the manager is convinced it still works. This is no more or less true for a defensive manager like us than for a fully-invested, momentum-driven manager. Don't mistake a fund manager's consistency and discipline for underperformance…" - Marty Zweig, Zweig Securities, Maintaining Perspective, 1/99
8. Everybody has an opinion. One opinion is as good as another. For every opinion, there is an opposing one.
While it is true that everybody has an opinion, not everybody is right. To equally weight all opinions is like listening to the opinion of your 5 year old nephew regarding which car to buy. He has an opinion, but no knowledge, experience or understanding of cars or your needs.
Rarely are opposing opinions both correct. Usually only one is right. Facts and evidence are usually the deciding factor. Dismissing an opinion that is based on facts and evidence, is a mistake investors seem to make over and over again. It has been our experience that investors would rather hear a good story than comprehend and understand the evidence of a well founded opinion. But this is not new. In Reminiscences of a Stock Operator, written in 1923, Jesse Livermore says:
"…the average man doesn’t wish to be told that it is a bull or a bear market… He wants to get something for nothing. He does not wish to work. He doesn’t even wish to have to think."
And that is why so many investors believe the myths.
9. The Media offers great financial insight.
There are investors that watch the business news channels religiously, as if they are going to get some unique insights from a channel that is broadcast to millions at a time. Understand this about the Media: they are not giving specialized investment advice because they do not know you; they cannot know you and so they cannot give specific investment advice.
In our view, they give hot tips to dupes. They feed bread to pigeons, who then swoop over to the markets and buy whatever they have heard. Thanks to the "Sportification" of the financial industry, financial news shows are more like sports reports. They talk about earnings as if they were batting averages. They promote business owners like they were hot quarterbacks and Wall Street analysts as if they were superstar sportscasters. They make some economic numbers or pieces of market data the most vital and potentially market moving number, until tomorrow’s all-important number.
In our opinion much of it is hype and pabulum for the masses who eat it up, as if it were manna from Heaven. We jest that if the media were required to give disclosures and disclaimers, as is done in the actual investment industry, a half hour business news segment might be 5 minutes of news and 25 minutes of regulatory required disclaimers and disclosures.
10. You cannot trust big Wall Street research: they have the game rigged.
"If you don't study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards." - Peter Lynch
Wall Street firms take their research very seriously. They invest millions into these departments, full of the best of the best from the best business schools. The analysts themselves compete for coveted awards, such as the Institutional Investor magazine All-America (All-Asia, All-China, All-Europe…) Research team.
The idea that big firms are pump and dump shops, shows a lack of understanding of the compliance supervision these days. They take the Chinese Wall, separating the Research departments and Investment Banking, very seriously.
However, we believe there still is a problem with recommendations being heavily weighted towards "Buy." This could be less a function of the analysts and more the reality of the lack of cooperation and insight that would be forthcoming from a company on which an analyst has rated "Sell." Companies do not like to be rated "Sell." So if a
research analyst gives a stock a "sell" rating, in our experience, he can expect not to be invited to that company’s investment road shows or conference calls, and would likely be the last analyst notified about any company news. So it behooves an analyst not to give out a "Sell" rating, unless he really means it!
11. Investing is just gambling.
Gambling is a zero sum game. There is a fixed pot that can be won by one or several people. The pot is funded by those playing the game, so nobody can win more than the total of the deposits into the pot.
While some may approach investing as gambling, true investing is not gambling. If you are betting on the daily price of a certain security, you may be gambling. If you are buying a company, at a good value, with good long term business prospects, with the intention of owning it for years - that is investing.
The media may make the markets out to be a sporting event or gambling casino, but in our opinion that is strictly for the short attention span crowd. Serious investors do not get caught up in the day to day noise of the market nor do they get caught up in the mania when a shill comes on CNBC hawking this or that security.
12. "XYZ" is the best investment.
There is no single "best" investment. Times change, the cycle changes, and the economy changes. A great investment during the 1980’s might have been terrible during the 1990’s. Market leadership is constantly changing, so a sector that is on top today might be the laggard tomorrow. Look at oil for the past several years. It was hot and then it was not.
13. I can manage my portfolio better myself.
"The investor's chief problem - and even his worst enemy - is likely to be himself." -- Benjamin Graham
This myth of the prowess of the individual investor has been promulgated by the no-loads and the discount brokers for decades. Unfortunately, studies show it is not true.
Evidence shows that individual investors tend to do the wrong thing at the wrong time. So much so, there are accepted market indicators based on the behavior of individual investors. They are inverse indicators. In other words, whatever the individual is doing, do the opposite. AAII sentiment, odd lot purchases and mutual fund net inflows are all inverse indicators based on individual investor behavior that pros follow.
Investing is a very tough business. It is one where you have to keep on top of many different variables and understand how they interact with each other.
It is the big leagues. Someone trying to manage their own portfolio is like the guy that hits .750 in his Tuesday Night Softball league and thinks he could do the same in the Majors. Not quite. It is not even the same game. It looks the same, but it is not.
Individual investors tend to buy the highs and sell the lows. Morningstar data shows that at the bottom of the bear market in 2009, investors were selling US Large Cap Funds and ETFs more than ever before. Today, with the market at all-time highs, mutual fund investors are buying US Large Cap Funds and ETFs at rates never seen before. As usual, the individual investor is buying high and selling low.
"The humbling fact has been and always will be that: the average investor cannot be above average." - Dalbar's 20th Annual QAIB 2014
The Dalbar report, which studies investor behavior, shows that over 20 years, (ending 12/2013), the S&P 500 returned 9.22% on average per year. Individual investors in US Equityfunds averaged only 5.02%. This is due to the faulty strategies, trading, overconfidence and emotions of the individual investor.
Individual Investors tend to buy past performance. They then sell when the performance doesn't continue. This was shown by a report by the St Loius Federal Reserve.
"The positive correlation between current flows and past returns suggests equity mutual fund investors tend to buy when past returns are high and sell otherwise." YiLi Chien, a senior economist with the Federal Reserve Bank of St. Louis, The Cost of Chasing Returns - Monday, July 28, 2014
More evidence of individual investors buying at the wrong time is Morningstar's Buy the Unloved strategy. It recommends buying certain funds that have had poor fund inflows (unpopular funds) in the prior year and selling certain funds that had high inflows (popular funds). Since 1993, the unloved have outperformed the loved 10.30% to 6.40% on an average annual basis when held for 5 years.
Finally, in a new report, Vanguard has weighed in on the subject. According to an article in Progressive Financial Advisor, "Vanguard concludes that advisors can add 3% (ann) to investor's returns by following established financial strategies." In other words, having a professional advisor can increase an investor's returns.
Individual investors get caught up in the action, the thrill of it all. They view it as a sporting event. Bottom line, without experience, education, and perspective, they let emotions rule. Emotions are not a good investment strategy.
14. "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1"
Never losing money sounds nice, but we believe it is too simplistic and many times misapplied. All too often, investors think it means they should never own an investment that goes down and their portfolio should never go down. They think it means that their portfolio needs to go up each and every month. They think it means every investment in their portfolio has to be a winner.
"If you buy all the stocks selling at or below two times earnings, you will lose money on half of them because instead of making profits they will actually lose money, but you will only lose a dollar or so a share at most. Then others will be mediocre performers. But the remaining big winners will go up and produce fabulous results and also ensure a good overall result." -Sir John Templeton
"Just because you buy a stock and it goes up does not mean you are right. Just because you buy a stock and it goes down does not mean you are wrong." - Peter Lynch
"Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market." - Warren Buffett
A good broker will get me the hot IPO’s, high fliers and stocks that jump 25% in a day.
The dumbest reason in the world to buy a stock is because it's going up." -- Warren Buffett
High fliers, hot stocks and stocks that jump up out of the blue are fun to watch, but it has been our experience that they are almost impossible to predict, and they tend to make lousy investments.
These are normally in the realm of speculation. And speculation is not investing. If you are lamenting that you that you do not have any of the day’s big winners, do you also lament that you missed the winner of the 4th race at Aqueduct? Or the 6th race at Belmont? Because you are just as likely to pick the winners at the races as you are picking a high flier in the stock market. Both are gambling, speculation; and speculation usually leaves you with a handful of losing tickets.
"Avoid hot stocks in hot industries. " – Peter Lynch
16. Big company stocks & dividends are always safe.
The list of big companies that have gone out of business or are on their last legs is lengthy. Remember Pan Am? Sears? Kodak? Readers Digest? Being big or an industry leader does not insulate you from failure. Competition is always after you. Internal mismanagement can be a problem.
Tomorrow’s list of potential failures is in the headlines you are reading today. How can Amazon keep running its business with little to no profits? How can Microsoft keep selling products people hate? How can Walmart continue to survive with such low margins and its demographics. Does it mean any of these are doomed to fail tomorrow? No. But the seeds of their own failures are already built in.
Fundamental research is an ongoing process that has to be constantly monitored and updated, without bias or favoritism. The analyst needs to get a clear picture of the companies he is researching and be able to make recommendations based on what he sees in the numbers and the company’s prospects - for better or worse.
How many times have we seen all of the analysts on Wall Street gleefully recommending "xyz big company" while only a few outliers offer a negative recommendation. How many times have those analysts been proven right? Tesla is a great example right now. Wall Street is infatuated with Tesla while only one analyst believes the stock could drop by 70%. Time will tell who is right.
"The main thing that people need to learn is that selecting assets is totally different from almost every other activity. If you go to 10 doctors and they tell you the same medicine, that’s the thing to take. . . . But if you go to ten investment advisors and they pick the same asset, you better stay away from it." - John Templeton
As for dividend safety: just ask GE. In 2009, according to corporate records, they cut their dividend by about 66%. GE is considered one of the bluest of the blue chips. Yet they had to cut their dividend. Yahoo! Finance shows that in 2000, GE hit a high of 47.80. By 2003, it was down to 15.05. That is a 68% decline. In 2007 it was back up to 32.43. In 2009, it hit 4.77, a decline of 85%. Today the stock is in the mid-twenties.
The solution is a well diversified, actively managed portfolio.
17. An investor should stay fully invested at all times.
This is good advice if you either: 1 – Don’t care about bear markets or 2 – Think bear markets have been outlawed. I have yet to meet the investor that wants to stay fully invested through a bear market. I have met people that have said they would not be bothered by a bear, but when their portfolio starts to decline, their tune changes in a hurry!
Bottom line, market cycles should determine when an investor is in the market and when they are out. There is no rational reason to stay fully invested during the down cycle.
"It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities." - Charlie Munger
"These reserves [cash] will appear almost all the time to be a suboptimal use of capital. So do fire insurance premiums. [Until there is a fire]" - Alan Greenspan, 10/17/99
18. Never sell a stock at a loss.
"The elements of good trading are cutting losses, cutting losses, and cutting losses. " – Ed Seykota
Stocks do not know at what price you bought it. Your cost is irrelevant to the timing of a sell.
If technical analysis is used, and the charts indicates it is time to sell, it is time to sell. The reason is that a technical indicator tries to give an early warning or signal that a stock is heading lower. It is better to sell a stock that you bought for $25 at $22, if it is heading to $15. That is what technical analysis tries to do for investors, give them an early warning of a stock that is about to fall much further.
If fundamental analysis is used and there is a fundamental change to the company that would prevent it from performing as expected previously, then it may require a sell.
If bad news comes out that could have a long term impact on the company, it should be sold. Conversely, short term bad news may be a buying opportunity.
Remember, we believe you do not make your profit when you sell, you make it when you buy. If you buy stocks that are undervalued, your objective should be to hold them until everyone else recognizes its value and the stock rises to that point. The profit will be realized when you sell into the hands of those willing to overpay.
"My definition of the guy who was right long-term is the one who sold Japan at 30,000 before it went to 39,000. He took a lot of grief for a while, but the Japanese market's under 15,000 and it's 10 years later. Was he wrong? Or early? No, he did the prudent thing." -Marc Perkins, Barron's, 6/29/98
"A loss never bothers me after I take it. I forget it overnight. But being wrong - not taking the loss - that is what does the damage to the pocketbook and the soul." -Jessie Livermore in Edwin Lefevre's Reminiscences of a Stock Operator
19. If it doesn’t go up right away, it’s no good.
"Nobody who plants corn digs up the kernels in a day or two to see if it has sprouted, but in stocks most people want to open an account at noon and get their profit before night." - Charles Henry Dow
Patience is a hallmark of successful investing. If an investor buys undervalued securities, it may take time for the market to recognize what he has already seen. In our experience, investors should be willing to sit on good investments for some time before the real profits are made.
"We don't get paid for activity, just for being right. As to how long we'll wait, we'll wait indefinitely." - Warren Buffett
"The biggest winners are surprises to me, and takeovers are even more surprising. It takes years, not months, to produce big results." – Peter Lynch
Jack Bogle - "If you have trouble imagining a 20% loss in the stock market, you shouldn't be in stocks."
"Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid stocks and mutual funds altogether." -Peter Lynch
20. Good Companies Equal Good Stocks.
Our research shows that Wall Street is awash in good companies with overvalued stocks. Investors need to separate stocks from companies. A stock’s price may have run well ahead of the value of the company. The company may be just fine, but the stock has become over-valued, hence it is a lousy buy. With patience, the stock price may come back to fair value relative to the underlying company, but this can happen in a couple of ways - either the company performs better than expected and catches up with the stock, or the stock declines to the point it is fairly valued. (Contrary to popular belief, stocks can actually become undervalued.)
21. Low priced stocks are better than high priced stocks.
A $10 stock is a much better buy than a $100 stock, right? Wrong. It has nothing to do with their price per share. It has everything to do with their P/E Ratio and earnings growth. Generally, if the P/E is higher than the earnings growth, the stock could be expensive. If the P/E is lower than the earnings growth rate, it could be considered cheap.
Lets suppose ABC Company is selling for $10 a share with earnings expected to grow at 10% per year. However, if it’s p/e ratio is at 20, this could indicate that the price per share is overvalued and investors are pricing in 4 years of earnings growth at 5% per year. Conversely suppose XYZ Company is trading at $100 per share and just opened up a new market overseas and is expected to grow at 15% per year. If the p/e ratio is at 10, this could mean that the stock is undervalued and considered cheap, because the p/e ratio is so much lower than the earnings growth rate. The price per share does not determine the value.
However, many small growth companies have low priced stocks, so they appear to be able to grow much more rapidly due to their price. This is due to their company’s growth and not their stock price.
Assume there are two companies, similarly capitalized and in the same industry, price per share should make no difference. A wise investor picks the one with the best prospects for earnings growth and best valuation, regardless of the price per share.
22. Market Timing Doesn’t Work
Yes, that is actually true, if by market timing you mean getting out of the market right at the top and back in right at the bottom, market timing doesn’t work. No one can do this with any consistency.
But that is not what market timing really is. It is recognizing that factors in the market have come together to signal that at some point, soon, the market is topping or bottoming. Being early on these signals does not mean market timing doesn’t work. Like horseshoes and hand grenades, close is good enough.
To prove market timing doesn’t work, Wall Street trots out a study that shows over a certain number of years, if you had missed the ten best days, your return would have been miserable. So don’t try to time the markets. Nice try. What if you missed the worst ten days over that time frame? They never tell you that part.
According to a Wall Street Journal article entitled The Market Timing Myth, dated 10/14/2010, a finance professor from the University of Navarra looked at 15 World markets, including the US. If you missed the best 10 days over the 40 year period he researched, your returns were cut in half. However, if you missed the 10 worst days, your returns were us two and a half times over the buy and hold strategy.
What does this mean? Nothing, because nobody could ever be in for just the best days and out for just the worst. It is impossible. So does that mean market timing doesn’t work? No. Remember, market timing is not about getting the exact day. It is about getting close. Within a month, a quarter, a year.
As noted in a previous quote, the guy that got out of the Japanese market at 30,000 while it went up to 39,000, but then crashed down to 15,000, had great timing. Would he have been happier to get out at 38,500? Sure, but what would the risks have been like at that point?
And that is one of the points with market timing, you are not just looking at the market, you are looking at the risk to be in it. Is it a good risk or a bad risk? At market tops, it is a bad risk, at market bottoms, a good risk. So market timing isn’t about just timing the market, it is timing the risks of the market as well.
23. I’ve missed the market!
Relax, another one will come along soon enough. That is right, many of the biggest bull markets have given it all back and then some, giving patient or late investors another shot.
According to StockCharts, the bear market that ended in March of 2009, gave back all of the gains since April of 1997. That is 12 years an investor could have been out of the market and not missed a thing. Sure, they would have missed the whole tech bubble and the housing bubble. They also would have missed the 2000 – 2002, and the 2007 – 2009, bear markets.
Shiller data shows that if someone had gotten out of the market in December 1968, they could have missed the whole 1970’s, with it serial bear markets, and gotten back in in Aug 1982, at virtually the same price as they got out, 14 years earlier.
You could have skipped the 1960’s and half the seventies if you wanted as well. If an investor got out of the market in November, 1961, they could have stayed away until December of 1974, when the market was back to their exit point.
Shillers data shows the worst situation was the bottom of the 1932 bear market. It gave back 35 years worth of gains. Someone could have gotten out of the market in August 1897 and could have stayed on the sidelines until 1932 and would have gotten in at the same price he got out.
Gains are not cumulative, so if you participate in a bull that gains 100% and then loses 50%, you are back where you started. You got no benefit from the bull.
Not realistic? Here’s the thing. Investors claim that they could just put their money into an Index fund and out-perform most money managers. Except Index funds are meant to be held through the full market cycle, so these examples above show how an index investor would have performed. From 04/1997 to 03/2009 an Index investors went nowhere. From 12/68 through 08/82 an Index investor went nowhere.
As we have already seen, the Myth that Index funds are the best choice was false and the Myth that Individual Investors can invest better than the pros is false.
Yes, short term, portfolios can under perform. And short term can be a lot longer than you think. We are looking at the full cycle, investors many times only look at the past few months or years. Even a few years of under-performance can be quickly made up for by outperformance during a bear market. It’s when you outperform during a bear market that the phrase "I’ve missed the market!" turns into a celebratory statement.
24. Big risks equal big returns.
Big risks only equal big risks. The correlation between risk and return is only theoretical. It is quickly dis-proven when one understands that risk is cyclical. At the bottom of the cycle, risks can be low, and potential returns very high. At the top of a cycle, risk can be very high, while potential returns very low.
Big risks can also equal big losses. I cannot tell you how many times investors have taken on more risk than they can handle, and then are surprised when the risk goes against them and they lose a bundle.
"You don’t get rewarded for taking risk; you get rewarded for buying cheap assets. " – Jeremy Grantham
25. When? Market Warnings have to come with a target date.
"In both economic forecasting and investment management, it’s worth noting that there’s usually someone who gets it exactly right… but it’s rarely the same person twice. The most successful investors get things ‘about right’ most of the time, and that’s much better than the rest. " – Howard Marks
This myth leads people to believe that unless a warning about the stock market has a precise date attached, it is not valid. They will blythely say, "even a stopped clock is right twice a day."
"A stopped clock is right twice a day'" is a way of dismissing warnings about the market. "Yeah, yeah; sure, sure, the market is overvalued… I get it; so when is it going to come crashing down? And what do I do while waiting for the market to come down, sit in cash? Tell me when it's going to happen and that's when I will get out." This is what believers of the myth say/think.
It is like a 300 pound guy with high blood pressure and high blood sugar ignoring his Doctor's warnings. "Yeah, yeah; sure, sure, stay off the sweets, lose weight, and exercise. I get it, but what am I supposed to do in the meantime? Eat Kale?!? You've been warning me for years and so far - I'm FINE! Let me know when exactly it is going to happen and I will worry about it then. In the meantime, I'm going to keep eating cupcakes and ice cream."
Unfortunately, heart attacks, strokes and market corrections give lots of warning signs, but never a specific date. People ignore warning signs because they don't want to leave the party. They want to stay to the bitter end, and in many cases, they stay too long. Doctors don't like visiting patients in the hospitals that didn't listen to their warnings. I don't like seeing investors put themselves in financial peril due to not heeding the warnings.
They do not ring a bell at the top. You have to understand the indicators, have a rational approach to investing and the discipline to reduce risk when the market gets expensive.
You have to be able to go against the mainstream. Bear markets arrive without notice, but with plenty of warnings. It is the wise investor that heeds the warnings without demanding to know when.
A stopped clock may be right twice a day, but the warnings of a heart attack or a market decline are not the same as a clock. They need to be heeded. To survive either requires a change of behavior.
"History teaches… that words of warning in a climate of euphoria largely fall on deaf ears. This is how it has been and how it shall be. The majority find a number of reasons to discard arguments based on the lessons of the past. History is, however, implacable with those who ignore its lessons." Friedberg's Commodity and Currency Comments, Freidberg Mercantile Group, 3/17/97
"Nevertheless, if episodic recurrences of ruptured confidence are integral to the way our economy and our financial markets work now and in the future, the implications for risk measurement and risk management are significant." - Alan Greenspan, 10/17/99
26. You should avoid all risks - especially after retirement.
This is quite simply, impossible. When thinking about risk, many people think only of principal risk. They just do not want to lose any money. But by putting your investment assets into an investment with no principal risk, such as a T-Bill or a bank CD, the investor is opening himself up to many other risks.
First would be inflation risk. As costs of things continue to rise, the income generated by your guaranteed investment will be worth less each year. As inflation continues higher, the income needs to keep pace. But guaranteed investments usually have a fixed income, so the investor may be faced with the prospect of having to dip into principal to keep up with rising expenses.
Another risk is interest rate or income risk. As inflation rises, the investor's income needs to rise with it. But due to interest rates going up and down, they could be faced with rates declining, reducing their income, just at a time when their expenses demand more income. Again, the investor could be faced with the prospects of dipping into their principal to cover their expenses.
Running out of money is a real risk for those that focus only on Principal risk. As expenses rise, more and more income is needed. If the investor has to dip into principal, the principal balance erodes, reducing the base on which the interest is earned and eroding the investor's income further - requiring them to invade the principal at ever faster rates, until it is gone.
At retirement, most people cannot just dump all of their assets into a no risk bank CD and have their retirement taken care of. They have to be concerned about rising inflation which drives up their monthly expenses. This means they need to have investments that can grow and supply an income that has the potential of rising. Generally, CD's and bonds do not have rising income streams.
Suppose a retired investor had $200,000. They need an additional $1,000/mo of income but they do not want to take any principal risk. So he puts it in the bank at a .05% rate.
To the right is a recap of what could happen under certain circumstances. If the retiree spends $1,000 and inflation is running at 4.50%, here are his results:
He runs out of money by age 78. Trying to avoid risk put him at an even greater risk.
We’ve seen that usually equities are the best choice for rising income. This means that to some extent, many retirees need to have some exposure to the stock market. That does not mean that they have to invest in risky equities. There are many lower risk choices in the markets, such as low risk utilities and other dividend paying securities. The key is understanding the risks and how to mitigate them.
Many investors do not see degrees of risk or types of risks. To many investors, an investment is either risky or zero risk. "Less risk," to many investors, means no risk. This should not be the case.
There are always risks, even with a bank CD. If an investor puts all their money into a Bank CD, they have exposed themselves to inflation risk and interest rate risk. Eventually, they could expose themselves to the risk of running out of money, if expenses rise so much they have to eat into their principal.
Investors have to accept that they will be exposed to some type of risk. They just have to choose which ones they are willing to accept and how to manage the risks. From our experience, a well-diversified portfolio, structured to give rising income, coupled with a strategy to manage the downside risk can accomplish the goals of rising income and risk management.
27 Bonds are always safe.
Bonds, just like stocks, go through cycles. Bond prices react inversely to interest rates. As rates go up, bond prices decline. The price of a bond on the secondary market can be affected by interest rates, rating changes, duration… Just like stocks, bonds carry their own risks. Bonds carry an additional risk – default. A bond can go bust. In other words, an issuer of the bond can find itself in a position where it cannot make interest payments or even principal payments. In these cases, the bond buyer can lose part or all of their investment into the bond.
This puts long term bond fund investors at risk as well. Bond mutual funds are just made up of bonds, which means they carry the same risks as regular bonds, only worse: if a bond were to default or be sold at a discount, the net asset value of the fund is now lower and cannot recover unless the other bonds somehow go up in price to off-set the loss. In an environment where bond prices are declining/defaulting it is not likely that a bond portfolio could rally and recover those losses.
28. Once I’m retired, I’m done investing.
A basic financial planning mistake many investors make is to think that once they have retired, they are done investing and planning. This could not be farther from the truth. In most cases, you will be investing for the rest of your life.
It just takes on different objectives - usually income and growth instead of just growth. Many of the investments you had before you were retired might still be appropriate for your retirement portfolio.
Not all risks are the same. A well-constructed portfolio can balance the principal risks with the income risks with the inflation risks. No, the principal will not always be stable, there will be some volatility, but risks have to be weighed and certain risks may have to be accepted in order to achieve certain goals.
29. All I need is my 401k and Social Security for a good retirement.
In my first year as a broker, I met a 65 year old man that was retiring a week later. I asked my normal questions about his financial situation and he informed me, quite proudly, that he had a 401k. He wanted to roll it over to my company and have me manage it. He was planning on living off of the profits. He showed me his 401k statement. It was worth only $5,000.
The Employee Benefit Research Institute's report entitled "Retirement Savings Shortfalls" shows the country has a $4.13 trillion aggregate national retirement deficit for all US households where the head of the household is between ages 25 and 64. This deficit can impact the retirements of millions of future retirees if they do not address it soon.
The 401k is an integral part of a retirement plan, but it needs to be funded. It needs to be funded as early as possible and to the maximum you can afford. By doing some retirement planning, an investor can determine how much they will need at retirement. Many times a 401k and Social Security will not be enough to fund a retirement. Many people will need to rely on IRAs, as well as personal investments.
30. When retired, your portfolio should be mostly bonds.
Really? Why? Does the market know your age? Why does your retirement make bonds a good investment? People retire every day, does that mean bonds are always a good investment?
Of course not. Bonds, just like stocks go through cycles. When interest rates are high, bonds can be a great buy, when they are low, they can be a devastating to a portfolio. Interest rates are cyclical and so are bonds. In the early 1980’s rates were at an all-time high, so bonds were extremely low priced. They were a good buy. Today the opposite is true. Rates are at or near all-time lows. That means bonds are very pricey and could drop in value as rates eventually rise.
The other problem with bonds is that they have a fixed income. So while inflation rises each year, your interest payment is worth less and less. And if rates rise as well, you could be stuck watching your portfolio decline, and your income not keeping up with inflation. Happy retirement!
The Bottom Line:
Myths are not a basis for investment decisions. Myths are what your friends tell you. They are what you hear on TV. They are what you want to believe. Unfortunately, Myths are just myths. They are not based on fact and only serve to confuse investors. The thing to do is remember Jesse Livermore’s words:
"…the average man doesn’t wish to be told that it is a bull or a bear market… He wants to get something for nothing. He does not wish to work. He doesn’t even wish to have to think."
You do not want to be the average investor.
Do not believe the myths.
The Prudent Man Rule
Below is the guiding principle for professional money managers, from a ruling by Judge Samuel Putnum in 1830. It is as relevant today as it was almost 200 years ago.
"Those with responsibility to invest money for others should act with prudence, discretion, intelligence, and regard for the safety of capital as well as income."
It does not say to buy the hot stocks, or speculate or be a trend follower. It does not say portfolios have to "beat the averages" or get out at the top and in at the bottom. The primary objective is "the safety of principal as well as income."