5 Current Misconceptions About Investing

By Ryan C. Fuhrmann | April 23, 2012 AAA
5 Current Misconceptions About Investing

A figurative sacred cow usually refers to an individual, organization, institution or any other entity that is exempt from being criticized or questioned. A belief also qualifies in this category. In investing, a number of sacred cow conceptions exist, but they should be questioned as they qualify as misconceptions that could end up costing investors' money. Below are five misconceptions in the industry today.

SEE: 4 Misconceptions About Free Markets

Buy and Hold Is Dead
Since the bursting of the dotcom bubble in March 2000, stock market returns have been less than stellar. Overall, market returns have been flat for roughly a decade now, and since the height of the credit crisis in late 2008 and into early 2009, returns have been particularly volatile. Because of these flat and more volatile recent returns, a number of investors and market commentators have declared that simply buying and holding a stock for the long term no longer makes sense.

For the market as a whole, this argument may make sense. However, there have been plenty of companies that have performed well and even spectacularly over this period. Those in the latter camp include Apple and Amazon, while firms such as Starbucks and International Business Machines have reported solid gains. Professional stock pickers, including the Yacktman and Fairholme funds, have also done quite well by locating companies whose underlying operations are growing. In this respect, buying and holding a great company has continued to pay off, even though overall the market has struggled.

United States Government Bonds Are Risk Free
A risk free investment is the theoretical rate of return on an investment that has zero risk. Typically, U.S. government securities, such as the U.S. Treasury Bill, have been used as proxies for a risk free investment. The market volatility of the past few years has pushed many investors into these and other similar U.S. government bonds with longer maturities. Currently, the 30-year Treasury bond rate is around 3.40%, which is close to its all-time low.

Because of the popularity of these bonds, an argument can be made that they are now far from being risk free. The risk-free concept is only theoretical in nature as all securities contain some form of risk. In the case of these government bonds, and many bonds in general, there is considerable risk that they will lose money if interest rates rise. Bond returns move in the opposite direction as interest rates, and with the rates being at historical lows, there is a good chance that they could go up soon. Higher inflation could also eat into the return of bonds going forward.

Professional Investors Are Smarter
Professional investors, and in particular institutions, manage the majority of the world's financial assets; but as a group, they fail to beat their index. John Bogle, who founded Vanguard Investments, has estimated that actively managed funds have a less than 1% chance of beating the market index over the course of an investor's life. This outlook is a key reason why Vanguard has become one of the largest asset managers in the world and advocates a passive approach.

Individual investors can improve their returns by focusing on low-cost investment managers and mutual funds and by hiring outside help that has a solid track record at beating the market over time. The two managers above have great track records over the past decade. In this respect, individual investors can outsmart the professional ones and better protect their wealth over time.

Passive Beats Active
As we've already detailed above, passive investing makes sense in many cases, but there are certain managers capable of outperforming the market. We listed two stock managers above. In the fixed-income world, Bill Gross and his firm PIMCO have risen to prominence by successfully picking bonds. Dan Fuss of Loomis Sayles also has a stellar long-term track record in the fixed-income space. Bill Miller has famously stated that passive investing guarantees underperformance, which occurs because passive options still charge some kind of fee, which effectively locks in not performing as well as the index. But as with carefully picking a select handful of stocks that have solid potential to outperform, a small handful of active managers have established track records for beating the market and passive investment alternatives.

Diversification Is Key
Another important industry recommendation is to spread out your investment bets. Asset allocation is said to offer the safest approach to investing, allowing one asset class to zig upward while another class may zag into the negative performance territory. Theory states that the risk of the overall portfolio is less risky by holding more assets.

This may hold true when an individual is already wealthy. In this respect, it is quite important to protect wealth and spread out bets into many different assets. However, if an investor aims to grow wealth, he or she should consider concentrating bets into specific investments that have a solid likelihood of outperforming their indexes, and therefore accruing wealth at a higher rate. Continuing the discussion above, picking good stocks, and a manager with a solid investment track record, can help investors accelerate their wealth creation.

The Bottom Line
At best, the misconceptions above could cause investors to miss out on future gains in their portfolios. But at worst, such as in the case of collectively being too heavily invested in government securities, these misconceptions could end up causing losses in their portfolios.

At the time of writing Ryan C. Fuhrmann owned shares of Starbucks and IBM but did not own shares in any other companies mentioned in this article.

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