Myths of Investing

I originally posted this on a forum under the alias Biosyn. I believe my custom usergroup was removed. Luckily, I had saved the draft on Google Docs.

1. You cannot beat the Market.

Okay, this is a big one. It’s true that over 90% of fund managers have never beaten the market in the last two decades or so. But you’re not a manager and you shouldn’t care if you beat the market or not.

Think about it this way. If the market plunges 50 percent and a fund manager loses only 40 percent. He has beaten the market. But does that seem good to you? As an investor your goal is to retire rich. The minimum annual compounded rate of return should be 15% every year.

The theory that no one can beat the market is referred to as the Efficient Market Theory (EMT). It originated in 1970. Started by Professor Burton Malkiel of Princeton University. The EMT states that all markets in general are efficient. They price things according to their value. The fluctuations in the stock market are caused by rational investors that respond minute by minute to events that may or may not affect their investments.

The market, according to the EMT, is so efficient that everything that can be known about the company, all information, minute by minute, is figured into the price of its stock. The price of the stock at all times equals the value of the company.

According to EMT theorists, fund managers are smart guys and if none of them ever beat the market for long periods, then the market is efficient. The market must be perfectly pricing everything.

But some people do beat the market for long periods of time.

  1. Warren Buffet
  2. Benjamin Graham
  3. Ed Thorp
  4. Wilkins

Origin of the myth: http://en.wikipedia.org/wiki/Efficient-market_hypothesis

2. Best way to minimize risk is to diversify and long

You hear this all the time. Diversify and hold.

Contrary to what many believe, this is not the safest way to invest in the stock market.

Remember Warren Buffet’s famous quote? “Be fearful when others are greedy, be greedy when others are fearful”

That absolutely applies when buying.

The thing to keep in mind is that more than 80 percent of the money in the stock market is invested by fund managers. These include pension funds, mutual funds, insurance funds, banking funds, etc. This is what’s called institutional money. Out of the $20 trillion dollars floating around, $17 trillion are controlled by these big guys.

You buy when the big guys are fearful and sell when they are greedy.

The fund managers are the ones that create the market.They move billions of dollars around, causing stock prices to go up and down.

You and I can get in and out of a position pretty quickly, but not the big guys.

Diversification spreads you out too thin and guarantees you a market rate of return. This means that whatever happens to the market happens to you. There’s just too many businesses you have to keep tabs on to diversify into 50 or more stocks. You’ll be stuck in front of a computer all day.

If you’re happy with a meager 6-8% return yearly and a minimum standard of living then diversification is your choice. For others, invest in a few businesses in different sectors of the market. You won’t be diversifying like fund managers do by buying dozens or hundreds of stocks at once, but you’ll have a portfolio reflecting different categories of business or industry.

 3. Just invest in a mutual fund

Okay, sure funds grew by double digits in the 1990s, but that was the 1990s. Look at the funds now. Their returns are growing by single digits. Take a look at the Money 70 list. Funds go through a vigorous screening process before making it onto the list and most are earning single digit returns.

Looking back at the charts, you will notice that from 2000 to 2009 mutual funds lost half their value.

Come on…you don’t need to hire a professional to lose 50 percent of your money.

The funds that you may be thinking about. The ones that generate billions of dollars in return are for the wealthy. These are called hedge funds. Not mutual funds.

Don’t get too hopeful if you think your fund manager can deliver double digit returns like the ones you saw in the previous decades.

 

 

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