There are many misconceptions about investing that mainly come from poor financial literacy but also from what is often portrayed out there as “magic bullets” for investing. You ask several people what they think about investing and how to do it right you’ll most likely get all different answers, with very few being correct. So here are some of the most common ones we see in our talks with prospects/clients as well as readings on what most people do.
1) That investing is the most important thing in personal finance – it’s not
One of the big misconceptions in investing is of its importance. It is perceived that it’s the most important thing in personal finance, but the truth is that it’s not. Many people jump into investing by really skipping important parts of a personal financial plan, don’t even have goals or what exactly they’re investing for. Starting like this and with the sole, very fragile goal of “making money” is the perfect way to lose in investing. “Making money” is not a goal into itself, you have to dig deeper, why, for what goal, what’s the time horizon for such goal etc. and many people don’t do this at all. What happens then is that at the first moment of panic or losses and with nothing else to hold you on, like a long-term goal or a plan, people sell, get out, take a loss and so move on into something else. Starting with “investing first” is something that many don’t get that it’s not the first or most important thing for your personal finances.
2) Buy low, sell high – wait, what?
Many believe that’s how you actually make money, you buy low and sell high, so why am I saying it’s a misconception? Because if you follow the above first misconception, it doesn’t really matter. You invest after you set up your goals, your time horizon and your asset allocation, you don’t depend on what the market is doing at that time. If you set up your goals and you’re ready to invest, but the market is at an all-time high what do you do, wait for it to drop? What if it doesn’t drop? There are many people that delay entering into investing because the market is too high, which is not a strategy at all. You enter into the market, first when you have money to invest and second after you’ve created a goal, that’s it. The market could be doing many different things, and you won’t know how to get in low. If you enter at any time and have time on your side, over a long-period of time you’d have very high chances that the market will be higher, just by design, not by your expertise or waiting to get in low.
3) Allowing current events shaping your long-term plans
This one hits home with what’s happening in the world now, the Ukraine conflict and still COVID. No one knows what will happen, so stop trying to predict and base your investing on things that are unpredictable. One thing is for certain, that most things do pass and get solved and seem OK in hindsight, but terrifying at the moment. Just like you wouldn’t make major life decisions when you’re emotional, don’t allow what’s happening in the world to change your plan, if you have one and if it has a long-term horizon. Trying to outsmart the market is where most get burned, including professionals.
4) That you need to pick winning stocks
This one we get it often when people hear what we do, the question typically follows: “Which stock to buy now?” While I have certain favorite stocks and companies that is besides the point, which is, you don’t need to pick winning stocks to win in the investing game. What you do need is a set core of principles starting with diversification, low cost, and a tax aware strategy but most importantly with patience, discipline and your savings rate or how much you can add to investing periodically. You can win over 90-95% of all professional investors and over all of the amateur DIY investors if you do just the above right, no need for “winning stock picks”.
5) That experts know what will happen with certainty
Following the above, 90-95% of professional fund managers cannot beat their index they’re hired to beat. At short time intervals they may with sporadic success but over the long term the odds are so much against beating the market, or knowing better than the market. They may talk big, show up on TV, but most often are wrong, late to the ‘party’ and make the same mistakes as individual investors. But time after time when something works in their favor, they’re invited back on TV just to underperform for the next 5-10 years, again. They don’t know what will happen with certainty, that’s it.
6) That you can get rich fast – following ‘top secret’ formulas or people
In the path of investing now there are more sources than ever, many not professional at all discussing ways, especially quick ways to make money. There are no secret formulas or people that have figured out something foolproof. If they really did, they wouldn’t tell the world, they would just keep doing for themselves forever. But many fall for the ‘quick’ part, because we cannot wait and are very impatient by nature. That brings trouble and losses, so be careful following people that seem too sure about something that cannot be sure.
7) That performance will persist; performance chasing
This mistake comes from a misconception of how investing works. In real life once we know a certain brand for quality or price or any feature, most likely those tend to persist, example a BMW or Mercedes tend to build high quality cars as they’ve done in the past. With that example in the mind, people look for high performance funds or managers and extrapolate into the future, meaning they will continue to do so, just like BMW most likely will continue to produce high quality cars. But it doesn’t work this way in investing. Most often the performance doesn’t persist even if it was there for a period of time. Many reasons for it, like the trend breaks, or the asset class they were overweight now is underperforming or it was just pure luck that they outperformed. In investing, most asset classes or investments follow a certain path and any significant out-performance (which brings people’s attention to it) is usually followed by an under-performance to bring things to its long-term trend, so chances are actually higher to underperform going forward if they outperformed in the past.
8) What compounding does to your account balances over time
Investing well gets hard not because you cannot pick the right investments or the time to get in or out (both actually really hard), but mainly because people have no patience to invest for the long term, they move in and out of their holdings and most often make unnecessary changes. It’s also hard because compounding by its very nature of it is slow at the beginning, you don’t see significant changes to your portfolio balance in the first few years, but it’s exactly those first years that can make or break your investment strategy and specifically your account balance.
Just a quick example, investing $400/month from age 22-67 is almost double the amount of assets if you just waited 8 years and started at 30 until 67 years old. In the big picture those first 8 years (from 22 to 30) seem so insignificant since you’re still investing 83% of the time period, 37 years instead of 45 years. But those first years, in this instance 8 years, almost double the balance of the first person (22-67) compared to the second one (30-67) at over $2M in assets compared to $1M, respectively. And that is the biggest misconception in investing, as compound interest does magic with seemingly small differences in periods of time. Get time on your side by starting now… the best time to start was yesterday, second-best is today.
$400/month from 22-67 = $2.1M (assuming 8% annual return)
$400/month from 30-67 = $1.1M (assuming 8% annual return)
Every month, InvestEd posts current information about financial events happening throughout the world, or just interesting things to know about your money. Read about them here.
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