Investing is easily one of the most misunderstood aspects of personal finance. Thanks to the convoluted financial industry and the general misinformation on the topic, it can seem harder than ever to find a good start on your investment track.
Let’s dispel some of the most common investment myths in the hopes of clearing some of the confusion.
Myth: it’s gambling
When you play your hand at a casino or buy a lottery ticket, you’re putting your money into a system driven completely by chance. In fact, in both of these scenarios, your odds are stacked against you. However, when you invest in the market, you’re placing your money into a system driven by hard working people like you and me. The market reacts largely to the actions of our economy and the companies within it. As new businesses continue to be started and our economy starts to thrive, stock prices will generally increase in value.
While this is a romantic view of how our market works, there’s one thing that’s to be assumed – our market will, more often than not, perform well over the long term. This isn’t to say that it’s a guarantee. We can never truly know how the market will perform, but we investors generally agree that it’s far better than hoping for the one in 175 million chance of winning the lottery.
Lastly, when you don’t invest, it’s a guaranteed loss. Inflation dictates that our cash will lose about 3% value every year. Even if you invest your money and see a minimal return, it’s often far better than stuffing it into a savings account.
Myth: you (or your advisor) can beat the market
Sometimes, you might beat the market. That is, you’ll make investments that beat the market index (averages about 7% yearly). However, studies have shown that over the long term, even the most high-performing investor will eventually lose track with the market. The best investment strategy for most investors is to stick with a tried-and-true broad market index fund. Rather than attempt to beat the market, an index fund will “track” the market’s performance and attempt to match it. While that may sound a bit boring, index funds will commonly outperform their “market-beating” counterparts.
I don’t necessarily want to speak poorly of actively managed, “market-beating” mutual funds; there have been many successful actively-managed funds in the past. The problem is that this great performance is rarely passed on to you, the investor. Most of these funds include a hefty fee from the active trading. These fees range from 1% and up (I’ve seen funds as high as 2.5%). If the actively-managed fund you invested in ends the year with an 8% return and beats the market’s 7% return, that fee comes right off the top, providing you with lesser returns. Index funds, by contrast often involve fees of around 0.5% (I’ve seen a few that go as low as 0.03%).
Simply put, if your financial advisor tells you that he can guarantee market-beating results, he’s likely pulling your leg.
Myth: you know something other investors don’t
I once had a conversation with a friend in which he told me that he planned to go “all-in” on one particular stock investment. He laid out an entire breakdown of why his investment was going to win big, and he seemed convinced that it was a unique and brilliant plan.
Following our conversation, a quick Google search confirmed my suspicions — his brilliant plan had been discussed for the past several years by thousands of other investors. It wasn’t a new idea.
Unless you’re blatantly taking part in insider trading (totally illegal), then it’s unlikely you know something that other investors don’t. In fact, the market does a pretty good job at screwing you over if you go in thinking that you’re smarter than everyone else. In his excellent book, A Random Walk Down Wall Street, author Burton Malkiel tells us —
If some people know that the [market] price will go up to 40 tomorrow, it will go up to 40 today.
If we think we have a great idea about a certain stock or fund, it’s very likely that many others have the same plan. Because most people will act on this plan in anticipation of a big payoff, the resulting buying/selling will drive up or lower the price beyond the desired results. Even worse, when we buy or sell a security on the market, we’re often buying it from another investor who has a plan of his own. One man’s trash is another man’s bad investment.
Myth: investing is hard
Thanks to the overwhelming lack of education on the topic, investing is generally considered to be very difficult. To make matters worse, it’s the financial industry’s job to convince you that investing is too difficult for you and that you should buy their investment services.
In general, becoming an investor is not difficult. You’ll just need 4 things:
- Some cash to invest ($1,000 is a good start)
- A brokerage account (E-Trade, Scottrade, or Vanguard are good options)
- Four Pillars of Investing by William J. Bernstein
You generally can’t go wrong with putting that $1,000 into the Vanguard Total Stock Market Index Fund (VTI). Buy it, hold it, and learn from it. Or you could set up a free account with Betterment or Wealthfront, make a $100 deposit, and become an investor in minutes. Using these robo-investing services is one of the easiest ways to get started.
If you want to start making solid investments, avoid the analysts, stay skeptical of the “pros”, and read some great books on the topic (see above). Investing doesn’t have to be complicated, and with a little bit of cash and patience, you’ll find success as an investor.