5 Common Investment Misconceptions we Hear From our Clients
January 11, 2022 | By Michael Kimmel, CFP®
If you follow the stock market closely, you have probably noticed that what we read in the news oftentimes doesn’t reflect actual market trends. Commonly accepted stock market myths have become so pervasive that they can affect how we choose to invest and how we characterize ourselves as investors.
At Wealthstream Advisors, we hear about these misconceptions from our clients all the time, so we’ve decided to do a little myth-busting of our own. Below are 5 of the most common investment misconceptions we hear while advising clients.
Investment Misconception #1: It’s a bad idea to invest in stocks after reaching a new market high
The media in particular loves to highlight new market highs. Often these mentions are followed by headlines about ‘the coming correction’. But hitting new market highs is less significant than most think, and most of the time doesn’t actually signal danger.
For one, if stocks are supposed to rise over time (and that’s the only reason investors put their hard earned money into the stock market), then there should be new highs all the time! In fact, looking at the S&P dating back to 1926 (through the end of 2020), the average annualized return after a new market high is 13.9% in the 1 Year Look Ahead Period, 10.5% in the 3 year Look Ahead Period, and 9.9% in the 5 Year Look Ahead Period. That’s why TIME IN the markets is more important and tends to lead to better outcomes than TIMING the markets.
That’s not to say you shouldn’t have a comfortable reserve in cash, but there are consequences to keeping money on the sidelines after each new market high.
Investment Misconception #2: I should avoid bonds now with interest rates so low
The question is: What’s the alternative to bonds? Some might argue you should leave your money in cash. The problem with that approach is that it’s a good way to go broke slowly. Cash tends to lag inflation, which means that unless you earn enough on your investments to keep up with inflation, your dollars will be worth less in the future. In other words, it will cost you more in the future to purchase the same goods and services that you purchase today. Generally speaking, you will earn more investing in bonds than you will by leaving your money in cash over long periods of time.
Some might argue you should invest in securities that offer higher interest and dividends, like High Yield Bonds, Preferred Stock, REITs, Crypto Lending, Annuities, etc. The problem with ‘searching for yield’ is that in order to achieve higher interest, dividends or returns, you have to take on more risk. And for an asset class like bonds, which are in the portfolio to minimize risk, investments like these should be looked at with extra caution. You know how the saying goes: ‘if it sounds too good to be true, it usually is.’
Investment Misconception #3: I shouldn’t let go of my concentrated position
‘I’ve owned the position for so long,’ you tell yourself. ‘It’s at a huge gain, so it will continue to perform well. (Or it’s at a loss, but it’ll come back.) It would be silly to sell now.’
Does any of that sound familiar? While it’s difficult to put emotions aside when it comes to investing, whenever you are dealing with a concentrated position that you are attached to because of an embedded gain or loss, ask yourself this: If I was investing cash today, would I purchase this position? If the answer is ‘no,’ then you should sell whatever you are holding (especially if at a loss, and realize that loss to offset taxes) or trim the holding over time to spread out the tax impact.
While there are certainly some concentrated positions that will make a few lucky folks wealthy, they also present a lot of risk.
Investment Misconception #4: I’ve had success picking stocks
The number of times we’ve heard this line! The reality is that most individuals don’t compare their returns to the appropriate benchmark, and more importantly, don’t compare those returns to these benchmarks after accounting for taxes (and in the event they hire an active broker or stock picker, after fees as well).
Computing one’s actual return properly can be difficult, since it involves making computations based on tax rates and information from one’s tax return. With all that said, there are studies that show that everyday investors overestimate how well they’ve actually done.
More so, evidence has clearly shown that even the professionals have trouble beating their own benchmarks over long periods of time after both taxes and fees. So if the majority of people who dedicate their careers to this are struggling to beat the benchmark, chances are, the majority of everyday folks are too. Yet somehow, these same people continue to believe that they can be more successful than the majority.
Investment Misconception #5:I’m in retirement, and should focus on investments that provide dividend income
This is an example of something that the media and a number of investment companies tend to push. But by focusing on investments that generate cash, you actually reduce your diversification.
When you focus on investments that provide dividend income, you have less control over taxes. Dividends force you to pay taxes and are often taxed at the same rate (if not higher) than long term capital gains that are realized when you sell a position.
Just because a company offers a dividend doesn’t mean that it will actually give you the best return. Some companies offer dividends when they do not have more attractive growth opportunities. In fact, appreciation is often a bigger driver of returns than dividends are. That’s what drives a retirement investment strategy that focuses on prioritizing and maximizing ‘total return.’
When you take a total return approach to generating retirement income, you allow yourself to think more broadly, beyond the risky approach of solely chasing stock returns. It requires consistent portfolio maintenance that takes into account the lifestyle you hope to achieve in retirement, and enables flexibility through further portfolio diversification beyond the rigidity of stretching for yields.
At Wealthstream Advisors, we help our clients create and adjust portfolios that help them maximize their lifestyles. We go beyond the myths and help you dig in to ask real questions. Do you need an experienced advisor to help you work through your own investment habits and misconceptions? Don’t hesitate to reach out to us today.