When it comes to investing, one of my favorite quotes is by John F. Kennedy, who once said “The greatest enemy of truth is very often no the lie – deliberate, contrived and deceitful, it is the myth – persistent, persuasive and unrealistic.”
In my opinion, the two greatest myths of investing are,
1) great companies make great investments (great companies can also result in horrible investments), and
2) stockpicking professionals can consitently pick enough good companies and avoid enough bad companies to outperform the stock market average, which is made up of all the good and not so good companies combined.
Speaking of investing myths, recently I put in a call to a friend of mine, financial advisor and author Jack Calhoun, who wrote a great little book on the myriad of investment myths investors have to deal with in trying to build portfolios and reach financial goals. (While you are at it, check out is great web site and learn more about investment myths by reading his recently published book, The 12 Investment Myths)
This is what he had to say . . .
A few years ago I was meeting with a prospective client of our investment firm in my office. He was a businessman, but he had been a fighter pilot several decades earlier, and he was still possessed of the same sense of confidence and bravado that had served him so well in the days when he was flying F-14s. Unfortunately, his ego was not serving him well when it came to his investments.
“You’re paying way too much in fees for your mutual funds,” I told him, which was an understatement. He had his money with a brokerage firm, and all the funds in his portfolio had management fees of between 2.5% and 3%.
”I don’t care what the fees are as long as the performance is good!” said the fighter pilot. And indeed the performance of all the funds in his portfolio had been good – just not for him. He had been sold those five-star funds by the broker after they had generated all those gaudy returns, and he was convinced it was his turn to jump on the money train.
“Fees are directly correlated to performance,” I told him. “You can’t expect good performance if you’re paying ridiculously high fees.”
“Then what about the Legg Mason Value Trust Fund?” he challenged me. “They’ve beaten the S&P 500 every year for ten years! Why would I worry about fees if I can get performance like that?”
He looked at me as if he had won the debate. And in a way, he had, but not for the reason he thought. It wasn’t that he had stumped me for an explanation – it was that I knew he was a lost cause. I could tell he hadn’t had enough painful experiences yet to believe me when I told him past performance was the easiest sell in the investment business but was, in fact, completely irrelevant to how a fund would perform going forward. (Suffice it to say, after the Legg Mason fund’s 65% drop in 2008, he knows it now.)
Sadly, I have found this man’s mindset to be more the rule than the exception when it comes to individual investors. And it’s not just the singular misconception that past performance is a good way to pick investments – it is, in fact, a variety of wrong ideas that plague investors and cause them to experience all of the downside and very little of the upside of stock investing. Complicit in this are Wall Street and the media, both of which have a vested interest in perpetuating these misconceptions.
After being confronted with these mistaken beliefs – these myths – enough times, I finally had an epiphany of sorts. I wrote down all the wrong ideas that investors had challenged me with over the years, in all their variations and forms. And I realized that, when you boiled it down, there was really a core group of a dozen of these myths that really were the main culprits in locking investors into the never ending cycle of buying high and selling low.
Thus was born “The 12 Investment Myths.”
The thing about these mistaken ideas that makes them so compelling is that they seem so right. It seems like just good ol’ commonsense that the best and brightest minds in finance should be able to beat the market on a regular basis. Or that “buying good companies” is the best way to invest. Or that “staying on the sidelines until things calm down” is not really market timing, just being sensible in a volatile market.
For the investment advisor, this is where the road diverges. The path of least resistance – the one taken by the transactional side of the investment industry – is to sell these myths to investors. It is easy to do – just run a screen in Morningstar for five-star funds over a five- or ten-year time horizon and, there you have it: Your sales story. “Advisors” who take this path will no doubt watch the money roll in as investors clamor to get in on the five-star fund action. And then those “advisors” will watch that money roll right back out again once those investors realize they’ve been sold a bill of goods that “advisor” can’t deliver.
The much harder path is the one that involves preaching against these myths – that a small minority of financial advisors in the industry endeavor to do. It isn’t easy, because you have to convince people to put aside the notion that investing is exciting, in favor of an unemotional, zen-like approach to investing that just isn’t as fun as watching Jim Cramer on CNBC’s Mad Money. You have to promote the fruit-and-vegetables to CNBC’s cotton candy, and you have to do it everyday.
What happens to the cotton candy crowd? They are the ones who likely locked in their losses in March, and then watched the market gain 50% these past five months before they even realized it, while they were earning 0.5% in cash. They are the ones who perpetually buy into all those myths that Wall Street and the media keep telling them to believe.
In short, they are the folks who experience the downside and little of the upside of investing in the stock market.