In the world of investing, it pays to have your facts straight. Unfortunately, there are some common misconceptions about investment strategies that can cost folks money.
The good news is you don’t need to be a financial expert to make prudent investment decisions. Perhaps the best way to guide your investment strategy is to learn from the mistakes of others – it certainly beats you making mistakes that impact your bottom line. Learning vicariously can help you avoid losses, and generate more profits for your pocket.
Here’s a list of four common investment misconceptions to consider as you manage your portfolio.
1. Passive Investing is Best for the Long Haul
For the past few decades, investment advisors and individual investors alike have touted the strength of a “passive” approach to investing. What proponents mean here is an investment strategy where you, say, put all of your money into the S&P 500 index fund, and let it ride until you hit retirement. These folks, however, are missing a key element when they talk about pure passive investing: it only exists in theory.
In day-to-day life, no matter how your investments are allocated, you are engaging in some form of active investing. Even if you’re bought in fully on the S&P 500, you’ve still made the active decision to invest in only 10% of the world’s investable marketplace. So, if we agree then that there’ no such thing as a purely passive, hands-off approach to investing, the question becomes just how active we want to be.
A recent PIMCO/Morningstar study shows the majority of active bond funds and active ETFs best their index counterparts. The takeaway? Active investing can lead to significant rewards. But, you have to have the tolerance, inclination, hand-on-ed-ness, and emotional balance to weather the intrinsic storms of highly active investing. The key, in the end, is to find what level of active you are comfortable with and go with that.
2. Bonds Are Safe
Bonds are typically considered a safe investment. They’re categorized this way because, generally, bonds are far less volatile than stocks. But remember “safe” is a relative term, and most people’s concept of “safe” is shaped by their individual risk tolerance. Okay, sure, bond investments typically bring less risk than their stock counterparts, but a healthy return on your bond investment can never be guaranteed.
Perhaps the biggest misconception about bonds is summed up in the following assertion: All bonds are created equal. This one-size-fits-all approach to bonds just isn’t helpful, nor is it factually accurate. Today, there are many different types of bonds, and the bond market is $40 trillion. For perspective, that’s double the size of the stock market. So, even when discussing these stalwarts of investing, don’t generalize about bonds’ safety or performance.
3. Seniors Shouldn’t Hold Stocks
As we age, oftentimes we are advised to move our assets from “volatile” stocks to “safer” bond investments, to safeguard against the market’s temperament. Sure, switching out some of your stocks as you age may be a good idea, but scrapping stocks completely once you reach a certain age is always a bad one.
Enter the 15/50 Stock Rule. It’s a simple rule, and one you should consider following. The 15/50 Stock Rule stands for the premise that if you believe you have more than 15 years left on this planet, your portfolio should consist of at least 50% stocks, with the remaining balance in various bonds and cash. It’s a surefire way to strike a balance between risk and reward.
Your stock allocation can be made up of either dividend-paying stocks (my preference) or growth stocks. Just remember to keep an eye on your portfolio and reallocate as necessary to prevent your stock allocation from creeping beyond the 50% mark.
Let’s ask the obvious question: Why the balance? Though stocks do carry more risk than bonds, they also carry the potential for more reward. The well-known 4% rule is based on the assumption that a senior’s portfolio contains a healthy mix of stocks and bonds. This rule states that if you start withdrawing 4% your savings during your first year of retirement, and then adjust subsequent withdrawals for inflation, your savings should last you 30 years. If your portfolio is too bond-heavy, it may not generate enough income to support the 4% withdrawal rate.
4. Don’t Worry About Investment Fees
Maybe you’ve accepted fees as an unavoidable part of investing. That’s not a bad way to keep yourself from losing sleep at night. While fees may be inevitable, you can still work to keep your costs to a minimum. Try something different here. Studies have shown that many investors don’t address the issue of fees in their investment portfolios, and end up losing out as a result. According to research, a typical worker who starts earning a median salary at age 25 will lose an estimated $138,336 over their lifetime in 401(k) fees alone. Don’t be one of these folks.
Whether your investment vehicles is a 401(k), IRA, or traditional brokerage account, keep an eye on fees and choose options that have the lowest cost attached. In a nutshell, this will mean shying away from high expense ratio investments, like actively managed mutual funds, and opting for more passively managed index funds instead.
Investing smartly is often a matter of getting your facts straight and benefiting from the wisdom (and mistakes) of others who have gone before you. By familiarizing yourself with this list of the most common investment misconceptions, you’re already off to a great start.