Seven investment myths that cost you money
Myths might be too gentle a term for financial sayings often referred to as rules of thumb or market axioms. In fact, many of them are simply not true. Others only benefit those who sell investment products. Still others lump everyone into some amorphous “average” and don’t relate at all to a given individual’s situation. Pay attention to these myths at your peril!
1. Buy, hold and prosper
This is one of the biggest myths of all, which has been inculcated by the mutual fund industry. No matter if the market goes up or down, the industry prospers richly when you purchase funds and hang on to them forever.
Management expense fees (MERs) cost investors, on average, two to 2.5 per cent annually. If you buy a poor quality fund and the return is negative or below the category average, the fee is still paid out to compensate the fund provider and advisor.
By all means hold on to a fund or any other investment if it’s a good one. But if a fund has been stinky for some time, it’s not likely to smell any sweeter in the future.
The expression should be: buy, monitor then hold or sell.
2. Risk equals profit
You won’t get a decent return on your portfolio unless you take some risks. Risk means equities and, more specifically, investments in funds, stocks or niche sectors where price volatility is high. However, conservative portfolios with equities, bonds and cash perform as well as or better than riskier portfolios over time.
While it is completely true that in the shorter term, riskier portfolios can far outperform more conservative ones, the longer you measure the smaller the difference. What doesn’t change is that risky investments have a far greater potential to lose money throughout all time periods.
So why take on risk if the end result is similar if you don’t?
3. You’re young; you can afford to take risks
The fact is young people don’t need to take on excessive risk in their investments precisely because their time frame is long. If you have a 30-year investment horizon, the compounding effect of re-invested interest and dividends (called total return) in a balanced, conservative portfolio with as much as 50 per cent fixed income will produce a return close to or better than a riskier portfolio.
4. Index investors have no chance of beating the market
This one is actually true, in a way. Index investors buy exchange-traded funds (ETFs) or index mutual funds, which are low-fee products designed to mimic indices such as the S&P 500 or the Canadian S&P/TSX 60 and so on. Obviously, if you are investing in the index you’re not going to beat it, because you’ve bought it.
However, barely 25 per cent of mutual fund managers are able to beat a given index (called the benchmark) over most time periods. DIYers who purchase stocks have an even worse track record with fewer than 13 per cent managing to best the index that most closely mirrors their portfolio makeup.
So, while this statement is true, being an index investor means fees are kept low and you will do as well, or better, than the majority of mutual fund managers.
5. Holding cash is a waste of money
Cash, i.e. GICs and high-interest savings accounts are much maligned investments, especially in these days of rock bottom rates.
However, cash plays a valuable role in a savings strategy. It is liquid, easy to access and safe. Cash never, ever posts a negative return except for investments in money market accounts where the fee is greater than the return.
There is something to be said for a positive return, no matter how slight. Best of all, cash deposits and GICs are protected by the Canada Deposit Insurance Corporation or by provincial deposit insurance.
6. Diversify widely for the best return
Diversification is essential to the safety and return of a portfolio, but too much of it actually increases risk and reduces return. Having investments scattered all over the globe and throughout a multitude of sectors and company sizes isn’t necessary. A handful of broad investments through ETFs or high-quality mutual funds are all that most people need.
7. You gotta know when to hold ’em, know when to fold ’em — in order to make a profit
Is it time to sell now that markets are hitting all-time highs? No one knows. Research consistently shows that we are lousy at predicting what the market is going to do. It’s far better to create an asset allocation or investment plan and stick with it, adjusting the allocations when they get out of proportion.