Successful investing isn’t rocket science. But to grow your wealth, you must move past the following unproductive investment myths.
Myth 1: I’ll Just Find a Hot Fund Manager
Finding fund managers with great track records may seem like a smart thing to do. But expecting to find ones who’ll keep beating the market in the future is next to impossible.
After accounting for fees, only about 25 percent of fund managers outperform their relevant index in any year. Even worse, if you stretch the period to three straight years, just 10 percent of managers outperform.
Vanguard’s John Bogle calculated that the average stock fund returned just 9.9 percent a year over a recent 20-year period. Viewed alone, you may think this is good performance.
But contrast this with the S & P 500 Index, which returned 13 percent over that same period. That’s 3.1 percent better than the average fund!
Though it’s possible to find a fund that outperforms for a few years, you can never be sure if THIS year will be the LAST.
Here’s the truth. You don’t need to find the perfect manager. Just follow these steps:
- Study how your entire portfolio responds in different market conditions.
- Learn how your various asset classes interact.
- Determine the optimal amount of each asset to own.
- Find managers who’ll deliver that asset class consistently and at a low price.
Myth 2: Bonds are Useless
If stocks grow at about 12 percent a year and bonds average 6 percent, you shouldn’t bother with bonds, right? After all, wouldn’t you do much better in the long run by sticking to 100 percent stocks?
Sure, you can load up on stocks – IF you don’t need your money for a long time. But if you want to leave traditional full-time work sooner and semi-retire, you’ll need to make withdrawals every year. You’ll need to sell some of the stocks in your portfolio even if the market drops – which can hurt its chances of recovering.
In other words, by investing in 100 percent stocks, you’re ignoring one important thing:
The higher the expected return, the greater the risk.
If stocks are your only asset and you need to sell every year, you could lose everything. But if it’s only a portion of a balanced portfolio, you’ll be in good shape.
Myth 3: All-Bond Porfolios are The Answer
This is the opposite of Myth 2.
You may think that with all bonds, you won’t need to think about asset allocation or risk. But you’d be wrong.
Because this myth neglects inflation. In other words, this strategy will surely destroy the real value of your portfolio and its withdrawals.
So the challenge is to set aside the first three percent of yield each year for inflation. After that, you can make safe withdrawals knowing that the real value of your portfolio will stay intact.
But if you stick with all bonds, there may be little left – much less than the four percent you want to withdraw. For instance, in the past bonds have returned just three percent after inflation. TIPS and I-bonds have real returns of just two percent.
So it’s stocks that are the primary asset class that gives you adequate protection against inflation, with enough for withdrawals. Supporting a four-percent withdrawal rate requires this diversified portfolio of riskier yet better-performing assets.
Myth 4: The S & P 500 Index Is the Entire Stock Market
You may have been told that rather than trying to pick funds, you should just load up the equity portion of your portfolio in an S & P 500 index fund.
Though this approach better resembles good long-term investment principles, the S & P 500 is just a part of the world’s stock market.
Twenty-four stocks make up 33 percent of the weight of the index, and the bottom 150 stocks make up just five percent of the index weight. This means that limiting your portfolio to the S & P 500 ties you to the fortunes of just a small fraction of America’s firms.
To get real diversification, you need to go beyond the S & P 500 and into less-correlated assets. These include small stocks, international stocks, and value stocks.
Myth 5: Foreign Assets Are Unnecessary
Some people think U.S. companies are bigger and safer than all the other ones in the world. They also believe that since American firms are global nowadays, their success overseas will be reflected in the U.S. stocks.
With these beliefs, people think they don’t need to bother with foreign stocks.
But it’s important to note that U.S. stocks and bonds make up just 40 percent of the world’s financial assets.
So by investing overseas, you can now add low-correlation asset classes to your portfolio. It’s safe, cheap, convenient, and offers potential for great returns.
To learn more about investment myths and their actual truths, check out Work Less, Live More.
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