With all of humanity’s collective knowledge available at our fingertips, you’d think investing myths would have disappeared by now.
In August, Mohnish Pabrai took part in Brown University's Value Investing Speaker Series, answering a series of questions from students. Q3 2021 hedge fund letters, conferences and more One of the topics he covered was the issue of finding cheap equities, a process the value investor has plenty of experience with. Cheap Stocks In the Read More
Yet they persist, largely because too many people consider money a “taboo” subject and avoid talking about it. Many of us also never question these assumptions, so we don’t bother running a quick web search in the first place.
These persistent investing myths cost you money though, in a very real sense. Once you move past these myths, a wider world of investing opportunities open up for you.
Myth: You Can Time the Market to Earn Higher Returns
When it comes to new investors learning how to invest their money one of the biggest myths is that you can time the market and earn better returns.
To profitably time the market, you need to get it right twice. You need to buy at or near the bottom of the market, just as it turns upward. Then you need to sell at or near the top of the market, just as it prepares to plunge.
The most experienced, best-informed professionals can’t do this predictably. If they can’t do it, you certainly can’t.
Imagine you’re standing on the sidelines, telling yourself that you’ll invest “once the market drops.” But the market continues to rise for the next year or two before its next dip. When the dip does come, its low point might still cost more than today’s price. And that’s assuming you were able to buy at the low point, which you almost certainly won’t time properly.
In the meantime, you’ve missed out on years of passive income from dividends or rents, or interest.
Rather than trying to time the market, practice dollar-cost averaging. While it sounds complicated, it simply involves investing a set amount every month into the same diversified investments, based on what your budget allows for each month. You ignore timing and just mimic the broader upward trend, to earn better returns in the long run.
Myth: You Need a Lot of Money to Start Investing
A common myth that many people assume is investing a little bit of money doesn’t make sense. They think that investing $5 a month is pointless so they never even bother to start.
That couldn’t be further from the truth. And it leads to wasted opportunities to save and invest over time. The truth is, investing a small amount of money can grow into large sums of money.
Jon Dulin, owner of MoneySmartGuides, offers this example: “Let’s say you are 25 years old and invest $20 a month for 25 years. During this time you earn an average 8% return — nothing spectacular, just average returns.
“At the end of 25 years, your $20 monthly investment has grown to nearly $19,000. If that doesn’t sound impressive, consider that your measly $20 each month could help your child or grandchild pay for college. Or it could pay for a family reunion vacation that you have on a tropical island.
“If you instead keep the money invested for another 25 years, when you reach age 75, you’ll have close to $149,000. This can cover several years’ worth of living expenses during retirement.”
Don’t make the mistake of assuming a small amount of money is a waste of time. Thanks to compounding, your money will grow into far larger sums over time.
Literally anyone can get started even with little capital. Take the first step now and start investing any excess money you have, regardless of the amount.
Myth: I’m Too Young (or Too Old) to Start Investing
The sooner you start and the longer you keep the money invested, the more it will grow.
At an 8% return, you’d have to invest $5,467 each month to reach $1 million in 10 years. But it only takes $287 invested each month to reach $1 million in 40 years. That means that even people working for minimum wage can become millionaires if they invest consistently over time.
On the other end of the spectrum, some older adults look at those numbers and despair, wondering why they should bother investing at all. But that’s the price of delaying: you need to save and invest more each month to reach the same goal.
As the proverb goes, the best time to plant a tree was 20 years ago. The second best time is now. Start investing today with what you have, and let compounding work its magic for you.
Myth: It Takes Decades to Save Enough to Retire
In personal finance, the concept of “financial independence” means being able to cover your living expenses with passive income from investments. To make your day job optional, in other words, allowing you to retire if you like.
It takes hard work and an enormous savings rate, of course. If you plod along with a 10-15% savings rate, then yes, it will take you decades to save enough to retire.
My wife and I got serious about financial independence at 37, three years ago. We’re on track to reach financial independence within the next two or three years, in our early 40s.
How? With a savings rate of 60-65% of our annual income and aggressive investing. Neither of us earns a huge salary either, but we still enjoy a comfortable lifestyle with plenty of international travel. We can save so much of our income because we house hack for free housing, avoid owning a car by living in a walkable area, and get full health insurance through my wife’s job.
Nor are we alone. Read up on the FIRE movement (financial independence, retire early) to see how thousands of other people are achieving fast early retirement.
Myth: Popular Companies Make Better Stock Picks
The idea that popular companies make for good stocks sounds appealing on its surface. After all, if a company is popular, it’s probably growing its business.
But the popularity and even the quality of a business only tell half the story. The other side is the price you pay for it.
“Imagine someone approached you with two offers,” illustrates Ben Reynolds of Sure Dividend. “The first offer is to buy a $100 bill for $150. The second offer is to buy a $1 bill for $0.50. We all know the $100 bill is worth much more than the $1 bill… But any rational person would rather buy $1 for $0.50 than $100 for $150.” Two Warren Buffett quotes sum this up nicely:
“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”
“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
The reason it is difficult to do well investing in popular stocks is because they tend to be overvalued. Everyone already “knows” the business is going to be wildly successful, and that’s baked into the price. If there’s any hiccup in results, the price is likely to decline significantly.
Also, as evidenced by the GameStop fiasco, amateur traders can make a significant impact on popular investments. Just because something is popular doesn’t make it a good investment.
Read more: Discover these 19 Blue Chip Dividend Stocks
Myth: You Need to Spend Time Researching Stocks or Frequently Trading
Many people believe that it takes a lot of time to research stock and make frequent trades to make money, resulting in people leaving their investments with a professional or relying on expensive mutual funds.
But individual investors don’t need expensive investment advisors or managed mutual funds (more on them shortly). “For most retail investors, utilizing low-cost passive index ETFs is the easiest and cheapest approach,” explains Bob Lai of Tawcan.com. “These index ETFs track a special index, like the S&P 500 or the NASDAQ Composite Index. Because of index-tracking nature, you get to own all the stocks listed in that index.”
There’s no need to spend time determining the earning trend of companies like Apple, Facebook, Amazon, or Pfizer because you own them all. By owning all these stocks in the index ETFs, you are also not making frequent trades.
Counterintuitively, frequent trades generally lead to lower returns. Think of your investment portfolio like a bar of soap: the more you touch it, the smaller it gets.
Read more: Related read: Diversify Your Portfolio With These Top 10 International ETFs
Myth: Expensive Managed Mutual Funds Outperform Passive Index Funds
Experienced, professional investors with the best data available to them still can’t pick stocks or time the market better than passive index funds.
Need proof? Over the last 15 years, nearly 90% of managed mutual funds underperformed compared to their respective benchmark index.
“The best investment strategy would be to invest in index funds of stocks or bonds that track an entire segment of the market — so you don’t have to worry about which specific security will give you the best return over short investing periods,” offers Kelan Kline, cofounder of The Savvy Couple. “My personal favorite low cost broad market index fund is Vanguard’s VTSAX.”
Myth: Only the Wealthy Can Hire Investment Advisors
A survey from JPMorgan Chase found that 42% of people who aren’t investing are staying out because they don’t think they have enough to invest.
On some level, this isn’t surprising. After all, historically people had to work with private wealth managers who require $100,000 or more. Even many popular index funds required a minimum of $10,000 to get started, just 20 years ago.
“That is changing with algorithm-driven investment tools such as robo-advisors,” says Jeremy Biberdorf of ModestMoney.com. “In many cases, robo-advisors have no minimum investment and allow you to invest for a small fee. Even investing a small amount every year can make a big difference.”
Robo-advisors also won’t run off with your money or engage in insider trading. Many investors let their guard down and trust human investment advisors without doing any due diligence on them, especially when referred to them by friends of family members. “This makes investors vulnerable to conflicting advice in even the best-case scenarios. In the worst-case scenarios, they are easy prey for scammers. That’s why I call this blind faith in financial professionals the worst investment advice I hear everywhere,” explains Chris Mamula of Can I Retire Yet?.
Read more: Can I Retire at 62 With 400k In My 401(k)?
Myth: Bonds Are Inherently Safer than Other Asset Classes
Bonds offer one type of safety — but leave you exposed to other types of risk.
When an investor buys a bond from the US Government or most municipalities, there’s little risk of the borrower defaulting. So investors can sleep at night knowing that as long as they hold that bond, they’ll probably receive their modest interest payments.
But bond values gyrate on the secondary market just like stock prices. Investors who plan to sell their bonds rather than hold them can find themselves with paper that’s gone down in value, not up.
Which says nothing of the corroding effect of inflation on bond interest payments. When inflation runs at 3% in a year, a bond paying 3% interest-only generates a 0% real return.
That in turn means that bonds may not actually protect retirees against running out of money before they die. Sure, the stock market is volatile, but in the long term, it generates an average return of 10% per year. At a 4% withdrawal rate, investors will see their stock portfolio go up in value rather than down, in most years. Even conservative income stock investing, such as in dividend kings, can yield 3-4% in dividends alone, on top of share price growth. But bonds paying paltry 3-4% interest will cause a slow decay in your nest egg.
None of that means that you should never invest in bonds. But every investor should understand all the risks — not just the risk of default.
Myth: Options Trading is Risky
For many, selling options is a risky business. And strategies such as Iron Condors add to the complexity. “However, when managed correctly, options trading can be a handy addition to an overall portfolio”, explains Gavin McMaster of IQ Financial Services, LLC.
An iron condor is a delta-neutral option strategy that consists of both call options, and put options. The strategy works if the underlying stock stays within a specific range during the course of the trade.
The key with iron condors is trading an appropriate position size (never risk your whole account on an iron condor) and knowing how to manage them.
Here are a few quick tips to reduce the risks with iron condors:
- Never risk more than 2-3% of your account size on any one trade
- Close the trade before the stock breaks through one of the short strikes
- Avoid earnings announcements
- Have one or two adjustment strategies ready in case the trade moves against you
- Focus on stocks and ETF’s with a high IV Rank
“While iron condors can be risky if you don’t know what you are doing, using appropriate position sizing and risk management rules can reduce the risks”, adds McMaster. Generating income from iron condors can be a superb way to increase the returns on your portfolio.
Myth: Pay Off Your Student Loans Before Buying a Home
Paying off student loans before buying a home is a common misconception. While there is no “one size fits all approach,” many people believe their student loan debt will prohibit them from purchasing a home, however, this isn’t always the case.
“For example, doctors and dentists often carry large amounts of student debt, and typically have relatively high debt to income ratios. Therefore, exploring a Physician Mortgage, which allows individuals to carry more debt, may be a better fit than a traditional mortgage”, explains Kaitlin Walsh-Epstein with Laurel Road.
For nonhealthcare professionals looking to purchase a home while managing high outstanding student loan balances, refinancing their student loans can be a good option. By refinancing to a longer-term mortgage, the borrower may lower their monthly payments. However, this may also increase the total interest paid over the life of the loan. “Refinancing to a shorter-term mortgage may increase the borrower’s monthly payments, but may lower the total interest paid over the life of the loan.”, adds Walsh-Epstein.
Questions to consider:
- What is your current student loan interest rate?
- (Calculate the true cost over the life of your loan)
- What are mortgage interest rates and are they projected to go up or down?
- (Currently mortgage rates are low)
- Do you pay rent each month and if so, how will your rent payment compare to a mortgage payment?
- (As well as carrying costs of owning a home)
- Is the home (or real estate) projected to appreciate in value?
The first step is to review and understand your credit score, student loan terms, and financial goals. Working towards making payments to lower your overall debt will help to raise your credit score, yet again increasing your chances of getting into your dream home faster!
Myth: The “Rule of 100”
In the 20th Century, investment advisors droned out the same advice to most clients: “Subtract your age from 100, and that’s the percent of your portfolio that should be invested in stocks.”
They pushed clients to move their money into bonds instead, as they grew older. A sound strategy — back when Treasury bonds paid 15% interest.
This century has seen perpetual low-interest rates, and bonds have offered poor returns compared to stocks. This says nothing of the fact that people are living and working longer, so they both have more risk tolerance and need their nest eggs to last longer.
Today, investment advisors tend to instead advise subtracting your age from 110 or 120 instead, if they bother issuing such generic advice at all. Everyone has their own unique risk tolerance and needs; as a real estate investor, I can earn safer, higher returns from real estate than bonds, so I avoid bonds altogether. A high earner nearing retirement might appreciate the tax benefits and security of municipal bonds and tailor their portfolio accordingly.
Be careful of anyone peddling such a broad rule of thumb as the “Rule of 100.”
Read more: Find Expert Tax Preparers Now!
Myth: You Must Pay Off All Debt Before Investing
There are plenty of great reasons to pay off consumer debt early. You earn an effective return equal to the interest rate, and it’s a guaranteed return on your money when you use it to pay off debt early.
Mark Patrick of Financial Pilgrimage explains it like this: “Our family even went so far to pay down our mortgage debt despite record low-interest rates. With that said, throughout the entire process we invested in our retirement accounts, such as our 401(k) account. The benefits are just too good to pass up.
“The company that I work for provides a 401k match of up to 6% plus an additional 1% that every employee receives regardless. Therefore, if I contributed 6% of my salary to my 401(k) I would receive an additional 7% in contributions from my employer. I was more than doubling my money right away!
“If you decide to wait to pay down all of your consumer debt instead of starting to invest for your retirement you’ll miss out on years of compound interest. Compound interest is one of the most powerful forces in personal finance. The earlier you can get started, the better. For example, if someone invests $5,000 per year from age 25 to 35 and then never invests another dollar, they would likely have more money at age 65 than someone that invests the same amount every month from age 35 to 65.
“While I am a huge proponent of paying down debt, it shouldn’t come at the expense of forgoing investing. Especially when you want that money to grow until retirement. Try to find the balance between paying down debt and investing. We certainly could have paid down our debt faster if we decided not to invest throughout the process, but after 15 years in the workforce I’m sure glad we didn’t. Those dollars invested early on have compounded into much larger amounts over the years.
Myth: You Should Pay Off Your Student Loans Before Buying a Home
It might make more sense to pay off student loans before buying a house. Or it might not.
Ultimately it depends on your goals, your housing market, your loan interest rates, and your other finances.
For example, you might live in a housing market where it’s cheaper to rent than own a home. In that case, it makes sense to pay off your student loans rather than rush into buying.
Alternatively, if you plan on buying a duplex and house hacking, and thereby eliminating your housing payment, it probably makes more sense to buy. Just think about how much faster you could pay off your student loans, with no housing payment!
Think holistically about how owning versus renting for another year or two would affect your finances. Don’t rush into buying a home — but don’t avoid it without deep analysis, either.
Myth: Buying Is Always Better than Renting
Despite having owned dozens of properties as a real estate investor, I live in a rental apartment.
In some markets, renting makes more sense than buying. Look no further than San Francisco, where the median home price is $1,504,311, but the median rent for a three-bedroom home is $4,567. After adding in property taxes and homeowners insurance, it would cost roughly double the monthly payment to buy a median home as rent, despite all the perennial complaints by San Francisco tenants.
And that says nothing of maintenance and repair costs, which average thousands of dollars each year for the typical homeowner. Renters don’t have to pay those costs or do that labor. They delegate them to the landlord.
Nor do renters need the fiscal discipline to budget money each month for those irregular, but inevitable expenses. Not everyone has that discipline, and they’re better off with the steady, predictable housing cost of monthly rent.
Finally, renting allows flexibility. Tenants can sign a month-to-month lease agreement and move out with a few weeks’ notice. Homeowners don’t have the flexibility; it takes months to sell a home, and typically tens of thousands in closing costs.
Myth: Your Home Is an Investment
Buyers love to delude themselves that they’re buying an “investment” rather than spending money on shelter. It helps them justify overspending on the biggest, fanciest house they can possibly afford.
But make no mistake: housing falls under the “Expenses” category in your budget, not the “Investments” category. It costs you money every month, rather than generating it. House hacking marks a notable exception however, since your home helps you avoid a housing payment.
Sure, real estate often goes up in value. So do baseball cards, but that doesn’t justify hobbyists spending as much as they possibly can on them, while patting themselves on the back for their wise “investments.”
By all means, invest in real estate. But do it by buying true investment properties, or REITs, or real estate crowdfunding investments. The more you spend on housing, the less you can put toward true investments.
Myth: You Should Put the Bare Minimum Down When You Buy a Home
Making the bare minimum down payment often enables buyers to overspend on housing. They end up overleveraging themselves, mortgaged to the hilt with an enormous monthly payment and little money left to actually furnish the place, or to enjoy any social life.
It also leaves homeowners vulnerable to becoming upside-down on their home, owing more than the home is worth. At that point, they become prisoners in their own homes, unable to sell without the lender’s permission. They end up stuck there until the housing market either improves or they pay their loan balance down enough to be able to afford seller closing costs without coming out of pocket.
While it sounds nice to put down next to nothing on a home, look at the bigger picture. If you spend far less on a home than you can afford, then a low down payment can serve you well. But if you’re straining against the limits of your budget, beware of putting every last penny into a tiny down payment with a huge monthly bill.
Myth: You Should Put Down as Much as Possible on a Home
The common wisdom was once to put down as much as possible when you buy a home, and 20% at the very least. However, this locks up a good portion of the money that could be growing at a faster rate with other investments.
“Putting down less than 20% does increase the monthly mortgage payment due to the higher interest rate and PMI (private mortgage insurance),” explains Andy Kolodgie of The House Guys. “However, you should compare your expected returns on that extra down payment if you were to invest it elsewhere, to the annual savings on your mortgage. For example, investing in stocks and bonds could allow you to earn more money while providing the added benefit of easy liquidity.
“A lesson learned from the 2008 mortgage crisis was you can’t eat equity in your home. During the recession, it was nearly impossible to refinance the equity out of any home, as home prices dropped below most people’s mortgage balance. Putting less than 20% down to stay more liquid and investing in alternative assets diversifies your portfolio, keeping buyers more risk-averse.”
Again, look holistically at your personal finances. As you near retirement, it makes more sense to play conservatively with a larger down payment to avoid PMI and reduce your monthly mortgage bill. For younger borrowers looking to buy a first home, it often makes more sense to put down 3-10%, and invest their other cash more aggressively in the stock market or other assets with high return potential.
Myth: You Need 6-12 Months’ Living Expenses in an Emergency Fund
To hear the pundits crying from their soapboxes, we all need at least a year’s worth of living expenses parked in a savings account in cash to protect us from a financial apocalypse.
And some people do. But not everyone.
Those with either irregular incomes, irregular expenses, or both do need a deep cash cushion. For example, as an entrepreneur, there have been months where I didn’t earn enough to take a personal distribution for myself from the company, so I earned $0 in personal income those months. Someone like me does need 6-12 months’ worth of living expenses saved in an emergency fund.
Salaried employees with safe jobs at stable employers don’t need as much cash in an emergency fund. That goes doubly if they live a predictable middle-class lifestyle with the same expenses month in and month out. They may only need 2-3 months’ expenses set aside in cash.
I go a step further with my emergency fund and think of it as tiered levels of defenses, like a medieval castle. The first level comprises cash savings — you can tap it if you need it. I also keep several unused credit cards with low-interest rates, that I can also draw on in a pinch. Then I keep several low-volatility, short-term investments that I can also turn to if needed.
All of which means I don’t actually need 6-12 months’ living expenses in cash after all.
Myth: More Education Inherently Means a Higher Income
From a statistical standpoint, education level correlates strongly with income. People with college degrees earn more than those with high school diplomas on average, and those with advanced degrees earn a higher average income still.
On a personal level, it often doesn’t work out that way. I have plenty of friends and family members with advanced degrees, and most of them earn modest, middle-income salaries. Salaries with ceilings, and little room for advancement beyond their specialized niche. I can’t tell you how many teachers I know with several master’s degrees, who earn little or nothing more than their colleagues with bachelor’s degrees.
In fact, my friends and family with the highest incomes all stopped at bachelor’s degrees and while some got high-paying jobs, others went into business in some capacity.
This doesn’t mean you shouldn’t pursue an advanced degree if it’s required for your dream job. By all means, pursue your passion. But don’t assume that an advanced degree inherently means an advanced salary.
Read more: How to Make $100k/yr As A Brand Ambassador
Myth: Gold Offers the Best Hedge Against Inflation
Many investors flock to gold when they fear inflation. But historically, gold often performs badly during times of high inflation.
From 1980-1984, for instance, gold lost around 10% in value, even as inflation raged at a 6.5% annual rate. Historically repeated itself in the late 1980s as well.
Gold actually works best as a hedge against a weakening currency — compared to other world currencies. When investors think the US dollar is about to crumble in value compared to the euro, pound, or yen, that marks a good moment to grab some gold.
But investors more generally worried about inflation should consider better hedges against it. Real estate offers an excellent hedge against inflation, for example. It has inherent value: people will pay the going rate, regardless of the value of the currency. The same goes for commodities like food staples; no one stops eating just because inflation surges.
Most professional investment advisors recommend holding no more than 5% of your portfolio in precious metals, if that. I personally own none, preferring to invest in stocks, real estate, and the occasional speculative gamble such as cryptocurrency.
Article By G. Brian Davis, The Financially Independent Millennial