Warren Buffet says “Investing is simple but it is not easy.” There are a lot of misconceptions about investing, but let’s look at four big ones.
Misconception #1 – Studying the financial statements of individual stocks and learning the techniques of how traders execute will improve my investment returns.
This is a surprisingly common idea, that if we just learn enough that we can do better. I know this concept does work for many things in life. If I want to change my oil, I need to read the owners manual, so I know what type of oil, where to find the drain plug, etc. The problem is the concept does not apply to equity markets. Let me give you a better analogy. You are just leaving a sporting event, and you are trying to get out of the parking lot along with the 20,000 other fans. There are five exits. How do you choose which one will get you out faster? Well, if one exit starts to move faster, everyone will extend the line to that exit, so you are still going to get out at about the same time. This is how markets price stocks, efficiently and based on the behavior of the group. Some stocks are riskier (e.g., more debt, or less profit certainty) than others, but because many buyers and sellers (like institutional investors, for example) are taking those risks into account, prices for riskier stocks are discounted in price until a ‘more fitting’ expected return applies for the added risk taken. The ‘power of the group’ has decided what you thought you could figure out on your own: what is this stock worth? If it is in a financial statement, or it was on the news two minutes ago, the stock price has already adjusted to reflect that new information. Markets are efficient.
Misconception #2 – Markets are not efficient. Just look at the 2000 tech bubble, or the 2008 housing crash. I just need to pick the next bubble and cash in.
Markets are efficient, but they are not perfect. Markets can certainly become irrational. If you have read The Big Short by Michael Lewis or seen the movie (it was pretty good), you know that sometimes even financial institutions can lose all reason and prices for financial instruments can get out of whack. One lesson the book teaches, albeit in an indirect way, is that even when you are right, markets can stay irrational longer than you can stay solvent. For the protagonists in The Big Short, they held on just long enough to cash in, but were nearly wiped out in the process. Again, the point here comes from John Maynard Keynes, the English economist: Markets can stay irrational longer than you can stay solvent.
Misconception #3 – If I can just find the right money manager or mutual fund, I can beat the market return.
I am not even going to get into this misconception in detail because it has been so thoroughly documented that active management does not beat passive index investing over the long term. You do not have to believe me, just google Rick Ferri or Larry Swedroe. These guys have covered this topic in much greater detail and more clearly than I ever could. In short, even when those rare few managers who do beat the market are discovered, they cannot be identified sufficiently in advance for an individual investor to profit. Then, others figure out their secret sauce and then the strategy no longer works. Active investing is a zero sum game. There will be winners, but there will be losers also. That is how the average (index) is determined. Because markets are relatively efficient, why play a zero-sum game? You can passively invest and receive all of the returns the market is generous enough to provide over the long term.
Misconception #4 – Markets and investing are complex. I want help to make the right investments by getting professional help.
As written in a previous article…
Index investing is actually quite simple, and for most people, knowledge of the basics is enough to make your own investment decisions. Having 10 or more Robo-sliced investments instead of 3 or 4 broad-based index funds is not really going to improve your results much, if at all. And then, there is the troubling aspect of handing over your financial life to an advisor for a financial future you alone will face.
The most common argument I hear for getting an advisor is to have someone to talk to when the markets get rough, or to help with tax issues. Well, if you need to talk to someone, why not just call a friend, or better yet, go on over to the forums at Bogleheads.org? How many Robos have a human to help you? While some have limited support, don’t count on a lot of hand-holding. If you need tax help, why not go to an accountant or a tax specialist? Why would either situation require you to seek professional money management, Robo or human? The mechanical process of buying mutual fund shares is already free when you select broad index funds, and that includes technical help with processing the trades. It is hard for me to understand how an index fund investor, especially a 3 or 4 fund indexer, can justify needing professional money management.
I agree some people may need professional financial help. You might have a trust, rental properties, a business, or you may have complex tax issues. I am not talking about you. For the rest, if you need help at all, you don’t need to hand over your financial assets to a Robo or other advisor for permanent babysitting. Yes, you need to have a plan. You might even decide to pay someone to help you build it. But, if it is actually a good one, then you should not need ongoing asset management services to implement it or to manage it. Otherwise, it is just not a good plan.