Investing Myths

Six Investment Myths Busted

Wednesday, July 13, 2022

Gordon Gekko hasn’t done the investment industry’s reputation any favours. Michael Douglas’ unscrupulous movie character quickly became shorthand for all that is wrong with Wall Street and financial markets with his infamous ‘greed is good’ speech. But you don’t have to look too far away from the big screen to see real-life examples of people whose actions have perpetuated the link between the wealth industry, untrustworthy characters and get-rich-quick trades.

Many of you will have heard of Nick Leeson, the man who brought down Baring’s Bank after attempting to cover up a colleague’s mistake. The former derivatives broker made fraudulent and unauthorized moves which, by the end, had resulted in losses of $1.4 billion and a prison sentence. Poignantly, he now deeply rues his ego-fuelled actions and believes risk-management and discipline are a must for any investor1. Of course, no one remembers that, only that he was the rogue trader who gambled away other people’s money.

Gekko and Leeson both contributed, in their own very different ways, to the myth that good money management is akin to high-stakes poker with the client an irrelevant bystander. But in the same way that Elvis is still alive, the earth is flat, and the Loch Ness monster is real, this is far from the truth. In that myth-bust spirit, here are six of the most common misconceptions about investing.

1. It’s all about returns

Sure, returns are important; no one wants negative numbers on their statement. But is chasing 12% worth the investment risk when 6% is what you need to live the retirement you want? The key question when you start your retirement journey, therefore, is not how much but why?

The industry is increasingly commodified, meaning every product provider out there will tell you ‘how’ they can get you returns. But what a skilled advisor can do is help you determine your ‘why’, which is deeply personal. What do you want to leave the kids? Do you want to travel in your twilight years? How much do you need to fulfil your dreams? Find your ‘why’ and it’s likely you won’t need to chase double digit returns in bear market years.

2. Buying and selling is crucial

The archetypal image of Wall Street is of stressed traders wheeling and dealing their way to handsome profits and a house in the Hamptons. But when it comes to retirement planning and long-term investing, this might be the worst thing you can do. There is, of course, room for strategic trades and portfolio rebalancing but investing is like soap, the more you touch the smaller it gets.

Let your portfolio compound over time because getting out and trying to get back in again can be dangerous. In addition, not enough people understand that percentage gains and losses are not equivalent. For example, if you were down 10% yesterday and up 10% today, you are not back to where you started. If you started with $100 two days ago, lose 20% (or $20) yesterday, and then gain 20% today, you have only $96. The mind can deceive you, so stay invested and play the long game.

3. You have to time the market

Success stories stand out but tend to be the exception not the rule. We all have a buddy who timed the Bitcoin rally and made a ‘fortune’, right? But the truth is, not even the most experienced advisor can time the market every time. To do that, you need to be able to predict events and the market’s reaction, which is nigh-on impossible. To make timing the market even more unlikely, bad days are often followed by good days and vice versa. Take the election of Donald Trump as President of the United States; markets rallied on the prospect of a Hilary Clinton win but when Trump won, they initially declined, only to quickly rally much higher. Try timing that?

Look on your investments through a long-term lens, just like you would with your house, with the price just one factor. If the value dropped, would you sell up? Unlikely because you like the location and the basement movie theatre where you watch The Wolf of Wall Street. The stock market goes through ups and downs, so stay the course and, most importantly, be comfortable with your portfolio mix.

4. You have to pick winners

Investing is not a game and no one should be gambling with their hard-earned cash, unless you want to take some play money to the horse racing or blackjack table. Frankly, treating investing in this manner can mess with your head. Behavioural finance 101 tells us that we remember the wins but forget the losses, so one success with Amazon or Apple, for example, doesn’t suddenly make you Warren Buffett.

Instead, lean on the time-tested principle of investing’s ‘only free lunch’ – diversification. Rather than focus on one stock, a well diversified portfolio actively managed by a trusted advisor contains a mix of distinct asset types and investment vehicles, limiting exposure to any single asset or risk. The same principle is applied to mutual funds or ETFs, some of which can contain hundreds even thousands of different stocks. This helps you balance risk because economic conditions that cause one stock to perform poorly – like rising interest rates - may cause another stock to perform well. Spreading your money can protect your portfolio in down markets but allows you to enjoy gains when the market soars.

5. Volatility is bad

Instinctively, when stocks are whipsawing and uncertainty is in the air, it feels disastrous. Your investments are down, headlines are doom and gloom, and analysts are quick to weigh up the possibility of economic Armageddon. But if you take a big-picture view, short-term pain translates into long-term gain, if you stay invested. Volatility is, first and foremost, a healthy reminder that markets don’t go up in a straight line, something that’s been easy to forget in the decade since the Great Financial Crisis during which the S&P 500 roughly tripled. Volatility, therefore, is a warning to stick to your asset allocation and not take on more risk than you can handle.

Market volatility is also a necessary form of quality control. If everything increases in value, it makes every entrepreneur look like a genius and every corporation appear a well-oiled operation. Volatility can put pressure on companies to sharpen up and, in extreme cases, even sink failing enterprises. Survival of the fittest is a vital capitalist requirement. For investors, with the help of their advisor, it’s about knowing your money is tied up in sound, quality companies and funds. Over the long term, the cream will rise to the top, and that applies to portfolios too.

6. Advisors are too expensive

Fees are an emotive topic, especially now financial advisors are up against a raft of discount brokers. Why pay for someone to do something you can do yourself? That’s a hard to argue against when markets are soaring and young investors have not experienced a bear market. The truth is that, left to their own devices, the majority of people succumb to myths 1-5 at some point – human biases are natural – and they need a steady hand to guide them towards their long-term goals.

The numbers back this up. According to Russell Investments Canada’s 2022 Value of an Advisor study2, advisors added value of 3.85%, with the behavioural coaching side of this accounting for 1.93%. This means that, on the whole, finance professionals are helping clients stay focused on the long term rather than falling prey to temptations like chasing individual winners, overreacting to volatility, or chasing outsized returns with excessive trading. Crucially, this suggests clients are getting value beyond the typical 1% charged on assets under management.

References to Gekko or Leeson may seem frivolous in this context but that is often how the investment profession is highlighted in mainstream culture; thrilling trades or life-destroying fraud. The reality is that good investment strategy, which prepares clients for the retirement of their dreams, is relatively dull. As legendary investor George Soros said: “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”

A trusted Portfolio Manager can help you guard against falling into any of these common myth traps, keep you invested with the right amount of risk, and steer you towards the type of retirement you want. If you feel the need for excitement, watch movies, not the stock market.

1 https://www.wealthprofessional.ca/news/features/the-original-rogue-trader-bares-all/247901

2 https://russellinvestments.com/ca/resources/financial-professionals/value-of-advisor

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