Why are there so many myths about investing?
Because it serves the economic interest of powerful interests to keep investors confused and misinformed.
I find it particularly interesting that there is little distinction between wealthy investors and not-so-wealthy ones. Most people have no idea how to invest. And the results are stunningly bad.
Just how bad?
Studies by Dalbar, Inc., a leading research firm, demonstrated that, for a 16 year period ending in 2000, the average equity-fund investor realized an annualized return of only 5.32%, compared to 16.29% for the S&P 500 Index.
How can this be?
Investors hold steadfastly to a series of "sacred beliefs" that practically guarantee that they will underperform the markets.
So let's take a look at six of the most deadly investment myths.
Investment Myth #1: My Broker or Advisor Can Help Me Pick The Best Mutual Funds
Wrong! The reverse is true. Your broker can help you pick mutual funds that will underperform the markets.
A recent study by three well credentialed and highly respected authors showed that funds selected by brokers and financial advisors significantly underperformed those selected by investors on their own. The costs of these funds was higher and the risk-adjusted returns were lower.
Investment Myth #2: My Broker or Advisor Can Help Me Pick The Best Stocks
Sorry. There is not a shred of data to support the ability of anyone to pick outperforming stocks.
Take a look at some notable bankruptcies: Enron, Worldcom, Delta Airlines, K-Mart, Conseco Inc., Polaroid, and the list goes on.
Did your broker see those coming?
Investment Myth #3: There Are Actively Managed Mutual Funds That Will Outperform the Markets Over the Long Term.
Most investors believe that there are some great actively managed funds out there, if only they could find them! Certainly, there are many brokers who claim to have this skill.
There are many studies that show that over a ten year period, only a tiny percentage of all actively managed funds will beat their benchmark index.
The problem for investors is that there is little possibility of identifying the few funds that fall into this category and there is no evidence that this past performance will be repeated in the future.
Investment Myth #4: Technology to the Rescue. Trading Programs Can Save The Day.
What about those infomercials for trading programs? It looks so easy. You just buy when the green light flashes and sell when the light turns red.
Here is what Burton Malkiel says about charting programs (which he likens to "alchemy") in his seminal book, A Random Walk Down Wall Street:
"There has been a remarkable uniformity in the conclusions of studies done on all forms of technical analysis. Not one has consistently outperformed the placebo of a buy-and-hold strategy. Technical methods cannot be used to make useful investment strategies."
By the way, in February, 2005, Citigroup fired its entire technical analysis group. Yet millions of dollars is spent by gullible investors on these useless programs.
Investment Myth # 5: Study More and Get Better Returns
This is a tough one. In most areas of life, more study pays rich dividends. So, the theory goes, if you study the fundamentals of companies, relying on books, articles and the financial media, your returns should reflect this effort.
Actually, when it comes to investing, you would be better off studying less.
The predictions of talking heads on television and the financial media are often wrong and misguided. Let me give you one of many examples:
At the end of each year, many financial publications assemble "experts" to make predictions about the coming year. Business Week did this at the end of 2004. The "experts" consisted of representatives from some of the best known brokers and mutual funds. Each of these "experts" picked five stocks they recommended for 2005.
Here is the bottom line:
Some were right and some were wrong. However, as a group, the selected stocks significantly underperformed a number of broadly diversified market indexes.
Now I am sure that these "experts" took the exposure they were getting in a well-respected business magazine seriously. No doubt significant resources were expended to get it right.
If they can't do it, it is unlikely that you or your broker can do better. If you try and succeed, it is more luck than skill.
No amount of studying, analyzing, listening and evaluating can overcome this irrefutable fact:
The markets are random and efficient. They are not susceptible to any analysis that is likely to result in superior returns over the long term.
Investment Myth # 6: If Only I Could Get Into A Hedge Fund.
Those great returns! It is no wonder that the rich get richer. Right?
A recent survey of the performance of hedge funds from 1994-2005 concluded that the returns were about the same as the S&P 500 index.
Hedge funds are beset with problems that include illiquidity, lack of regulation and high fees. It does not appear that their returns offer any incentive to assume these risks.
So what's an investor to do?
I will deal with this issue in my next column. However, be prepared. It is not exactly scintillating reading.
Unless you find superior returns exciting!