Investors are battered daily with an avalanche of financial information. Much of it is wrong. The securities industry spends hundreds of millions of dollars annually sponsoring all forms of financial media, a great portion of which is little more than an infomercial for its services.
The consequence of so much sponsored media content masking as financial journalism is quite predictable. Investors accept many myths propagated by the securities industry, and have harmed themselves significantly as a result.
The full truth is even more insidious. The securities industry has figured out how to subconsciously trigger knee-jerk responses that encourage bad investor behavior. It does so largely by instilling fear and anxiety, and playing on the appeal of greed.
Here are the most common investing myths that, if believed and acted upon, may prevent you from saving enough to retire.
1. You are in control. Technically, you are the one who makes the ultimate decision about how to invest. But you may not be aware that the securities industry, through powerful advertising methods, may be sending you a message that causes you to subconsciously act in a way that is not in your best interest.
Brain images taken of investors as they watch a stock that is rapidly increasing in value are remarkably similar to scans showing the brain activity of people addicted to drugs or alcohol. According to CNN Money writer Jason Zweig, it’s this dopamine rush that causes us to “play lotto, invest in IPOs, keep too much money in too few stocks and invest with active portfolio managers instead of index funds.”
The next time you read about a hedge fund with a huge return, try to picture what that information is doing to your brain.
2. Positive personal traits are indicative of investing skill. The name “Bernie Madoff” is all you need to hear to understand the subtle “halo effect” that plagues investors. We have a tendency to form an overall opinion about a person or circumstance based on our perception in one area. Madoff had an appealing personality and an aura of respectability. Investors assumed that investing with him was a safe and prudent decision, notwithstanding numerous red flags.
Don’t be deceived. Just because your broker or advisor is good-looking and glib doesn’t mean the advice you’re receiving is in your best interest.
3. “Investment pros” are skilled in “beating the market.” Of all the myths, this one is the most pervasive and widespread. One peer-reviewed study, “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas,” looked at the 32-year record of 2,076 stock mutual funds. The authors used sophisticated statistical testing to differentiate results attributable to luck from those based on skill.
The number of fund managers who beat their benchmark over time was “statistically indistinguishable from zero.” The few that did were simply lucky. Wall Street is extremely proficient in one area: confusing luck with skill.
4. Investment clubs are a source of sound investment advice. Investment clubs serve a useful function, like providing a place for networking and socializing. However, the very nature of the group’s activities (stock picking, market timing, trying to select the next “hot” fund manager) will likely result in lower returns.
An exhaustive study, “Too Many Cooks Spoil The Profits: Investment Club Performance,” by Brad Barber and Terrance Odean, showed that 60 percent of investment clubs underperform the market. The average club underperformed a broad market index by 3 percent per year.
5. Alternative investments are good choices. Many investors believe hedge funds and private equity funds are good investments, and bemoan the fact they don’t meet the minimum qualifications necessary to invest in them. The hype surrounding these investments is not supported by the data.
For the past decade, the index used to measure the performance of the hedge fund industry underperformed indexes in each major stock asset class and even three Treasury bond indexes. It accomplished this remarkable feat by charging obscene fees, typically 2 percent of assets under management plus 20 percent of profits.
Larry Swedroe analyzed the performance of private equity funds. He concluded that investors would be better off in a passively managed small-cap fund that is far more diversified.
All of these disseminated myths share a common goal. They are calculated to get you to take action based on short-term information. In addition to creating fear and anxiety, the securities industry has another way to get you to trade. They tempt you with new products that promise increased return without additional risk.