Each year hundreds of financial studies are published debunking investment myths, but stubbornly, most still persist. We tend to default to simplified explanations, especially in the media, when an answer is not easy and involves lots of numbers.
Even if an investment truism has some credence, few investment truisms apply to everyone. All investors should be aware of the following investment myths.
Personal Investment Myths
I Need a Lot of Money to Invest – Most employers will deduct as little as 1 percent of your pay monthly and invest it in retirement savings plans. Banks will divert whatever amount you stipulate into retirement investments. There is a mutual fund budget for everyone starting at around $50. Index funds start at $100 and exchange traded funds at $1000. Automatic monthly payments can allow you to get in on some of the investments with larger minimum amounts.
My Risk Tolerance Should Match My Age – Age-based investing, which matches age with risk tolerance, is going out of style. Age is just one of many criteria to be considered in a financial plan customised to meet your financial needs.
I Am Retired and Should Invest Conservatively – This is the most persistent investment myth. Some people are retiring at 55 while others are working until 75. If you are 65 and have more money than you need, even a slight increase in your risk profile could help put a generation or two through college, or upgrade you to a higher class on cruise ships in your later years. Or perhaps there is a philanthropic cause you have always been passionate about.
Risk Equates to Volatility – If you are a short-term trader and good at timing price moves, volatility is your friend. But for most of us, according to famed value investor Warren Buffet, we need to focus on business risk. Does a company have good management? Is it a low-cost producer? Does it have too much debt?
Volatility measures price swings through a financial measurement called beta. Technically, Buffet often buys volatile stocks because he picks up undervalued stocks that have recently fallen in value. When he bought the Washington Post in 1973, for example, the stock had just declined 50 percent, but the business fundamentals were good, and thus business risk low.
I Am Better Off Actively Trading Without an Investment Advisor – This myth has been debunked many, many times but we often suffer from ego bias. That is, we believe we can do better than the market and other investors. Most of the time, according to numerous studies, passive investing outperforms active investing.
Stock Investing Myths
IPOs Are Always Winners – While financial strength has improved since slews of companies without revenue streams went public during the Internet bubble, companies that are not profitable still go public. Diversification with some dividend yielding investments reduces risk. In 2013, 9 of the 14 Singapore IPOs underperformed by the end of the year led by REITs and Trusts. Investors still benefitted from the income stream from these dividend yielding stocks. Taking a broader view, IPOs from 2000-2011 underperformed the market by 1.8 percent, and as much as 18 percent in the first year of the IPO.
Value Investments Are Always Safe – Look under the hood. Some high performing value mutual funds are spiked with high growth stocks. If the percent of growth stocks is too high, you could be assuming a risk profile closer to a high growth fund.
Company Spin-offs Are Solid High Growth Stocks – Ferrari, PayPal, and Yahoo are some of the top consumer brands being prepped for a spin off. Once separated from their parent, spin-offs sometimes underperform the market. With close to 300 corporate spin-offs over the last year, this is one of the investment myths that needs clarifying. The idea of a spin-off is to unlock value that may not be realised in a larger more diversified company. A more focused, entrepreneurial management team is appointed to lead a high growth strategy. Historically, many spin-offs fail to outperform the market long term. One reason is because companies often saddle spin-offs with debt.
Growth Stocks Outperform Value Stocks – A second well-held myth is that value stocks only outperform growth stocks during bear markets. Let’s look at the bigger picture. The data shows that large cap value stocks outperformed growth stocks 11.66% versus 9.91% from 1980 to 2010, according to Fidelity Investments.
Fallen Angels Will Go Back Up – Do not invest in a stock just because it is underperforming relative to its peers. Value investors look for undervalued stocks that are mispriced relative to their strong fundamentals.
As always, do your due diligence and research each investment. In the case of the Ferrari spin-off, the controlling ownership is going to be in the hands of the family of the founder Giovanni Agnelli, which should make it a closely managed and lower risk investment. Each investment opportunity should be evaluated on its own merit, not folklore.
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