Investment Myths and Realities

3 10 2009

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By Jon Castle, CFP®, ChFC®

Myth:  A story made up to explain a phenomenon beyond the science of the day. 
 
As human beings, we all have a tendency to want to believe in myths, legends, or heroes of some sort.  Something about the idea that another person can accomplish superhuman feats strikes an adventurous chord in our breasts.  Imagine what it must have been like to hear stories of the great Babe Ruth, Audy Murphy, Wyatt Earp, and others – back when all we knew of someone or something was what we heard from other people or what we read in books – before television and the internet and a swarm of expose’- hungry media exposed the frailties and failings of even great men and women as soon as they came into the public eye!  Even today, we look for myths and legends and heroes – there is just something romantic and exciting about believing in heroes… and the Loch Ness Monster and Sasquatch and Santa Claus…
 
I think the fact that we want to believe in myths has a tendency to work against us as investors – causing us to act on beliefs and rules of thumb that often are not true.  Sadly, these actions may be more damaging to our financial futures than we realize.  In this article, I am going to briefly examine 3 of the most common investment myths, discuss the investment truths that academic research has discovered, and discuss our role as financial coaches for our clients as we pursue these financial truths together.
 
MYTH # 1:  Investment advisors (including mutual fund managers) can add value by exercising “superior skill” in stock selection.  Unfortunately, this is generally FALSE.  According to Morningstar, most money managers do NOT beat their index.  This is not because they aren’t smart or because they don’t work hard, but rather because today’s markets are so efficient that all known information – plus the probabilities of all known outcomes for a company or a stock – are continuously factored in to the price of the stock at any given time.  Rare is the man who can out-think the collective intelligence of millions of investors and consistently identify underpriced securities so as to beat the market.  As a result – depending upon the asset class – anywhere from 60-90% of money managers underperform their benchmarks.
 
MYTH # 2:  Finding money managers with a great track record  is a reliable method of figuring out which funds will do well in the future.  This too is FALSE.  Unfortunately, according to Morningstar and Baird Research, getting a 4th or 5th “star” rating is often the kiss of death for a mutual fund or money manager.  88% of all mutual funds that were rated a “top” fund (ie awarded their 4th or 5th star) went on to perform below average in the next 10 years.  66% of “top” funds actually performed in the bottom quarter of their peers during the next 10 years!  So picking the managers with the best past performance or the highest “star” rating actually gives us nearly a 90% chance of owning the poorest performers, not the best performers.
 
MYTH # 3:  Money managers – including investment advisors – are able to utilize market timing to effectively predict up and down markets.  Oh, how I wish this were true.  Unfortunately, it just isn’t.  If the loss of trillions of dollars in the markets during 2008 isn’t convincing enough that market conditions are often unpredictible and even the wisest of money managers do not effectively time the market – consider this:  If you had invested directly in the S&P500 (which you can’t – but suppose you could) from January 1, 1989 to December 31, 2008 – you would have achieved a long-term rate of return of 8.43%. In this scenario, $10,000 would have grown to over $50,000.  However – out of those 5040 trading days – if you missed only the best 5 market days – your return dropped to 6.27%, and your pot shrinks to $33,700.  If you missed only 20 of the best days, your return is now a paltry 2.58% and your $10,000 grows to only $16,600.  Consider the math on this – you could be right 99.6% of the time – and have done better in a savings account!1  The fact that the best days usually followed on the heels of the worst days – makes timing the market even more difficult.  To date – no one has ever been able to successfully and consistently time the market – ever.  Yet every day, financial talk show hosts ask their ‘expert’ guests, “So… what will the market do next?”
 
This discussion begs the question, “OK, if all these myths are false – then how ARE we supposed to make investment decisions?” 
 
Beginning soon, PARAGON will begin an exciting series of investor education events – fun, engaging events for our clients and their guests where we examine the most common investor pitfalls, discover the determinants of investor success, and offer the opportunity for all who would like to be a part of this journey to come along for the ride. We will examine each of these myths – and many more – and spell out exactly the steps an investor needs to take in order to shift their personal experience of money and investing from a scarcity mode – characterized by worry and frustration – to an abundance mode – characterized by clarity, focus, and hope for a bright financial future! 
1  Source:  Chartsource, Standard & Poors Financial Communications.  The S&P 500 is an unmanaged index that is generally considered representative of the U.S. stock market.  Past performance is not a guarantee of future events.

This blog is for informational purposes only.  This is neither an offer to purchase nor sell any securities.  All investing involves the potential of loss – including invested principal.  Indices quoted are general barometers of security price movement.  You cannot invest directly in an index.  All information is obtained from sources deemed reliable but not guaranteed.  Past performance is not a guarantee of future performance.  No tax or legal advice is given nor intended.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by PARAGON Wealth Strategies, LLC, a registered investment advisor. 

10245 Centurion Pkwy. N. Ste 105, Jacksonville FL 32256   (904) 861-0093

www.WealthGuards.com

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