The Seven Myths of Investing
Wednesday, December 01, 2010 » posts.tags:
In our economic system it is essential to take responsibility for your own financial well being. Where under certain protective economic systems the state will care for the individual to a large extend, these systems tend to come with loads of disadvantages. We’re all happy to live in a free world … but this freedom also includes the freedom to die poor.
The answer is to use investments. After 2008 we all know that this is not so easy, many people are still recovering form serious losses and feel uncomfortable to any risk. Only the safest thing such as the savings account or term deposit can be considered. But by doing so unintentionally one risks to earn less interest than the inflation … and therefore erode one’s capital.
While this might be a good prospect compared to incurring huge losses on the stock exchange this strategy is bound to be suboptimal if your time horizon is longer than a few years. The only answer for a happy and sorrow-free retirement is investing.
Investing is for the novice and experienced person full of myths and mysteries. We’ll look at some of those myths now:
I need to be fast, the slow are lunch for the fast. That’s what online broker platforms would like you to believe, but nothing is less true. Research (e.g. Terrance Odean and others) persistently finds the opposite: trading more erodes your investments (even without taking the trading costs into account). There is something with high frequency trading, but then we’re talking about sub-millisecond trading. Lesson: think about the investment goal and select an investment profile that suits the investment horizon and only look at your portfolio every year or so.
My banker knows! How many times did you raise the questions “What should I invest in now?” That’s not an investor’s question it’s a gambler’s question. And what are the odds that your advisor would keep his old job if he would really be able to tell? Lesson: Ask the right questions! An investor starts from a goal and investment horizon, then selects a strategic portfolio composition.
Investing is only for the smart. Financial press would love you to believe that, but see point 1: generally people that believe themselves to be smart are overconfident and trade too much and hence have poor performance. You need a basic knowledge about investments and their risks, but don’t need to read every day the financial newspaper. Lesson: don’t get lost in short term news overload, but focus on the long term goals and fundamental risks.
I’m too unique, I need a special (expensive) structured thing. We’re indeed quite unique in many aspects. But investing should be the answer for a real need, and those needs tend to be less unique as you would believe. Harry Maslow groups all human needs in a handful of layers. Investments are a tool to cater for those needs. Lesson: you need a few portfolios with each a clear goal (retirement, schooling children, and special projects).
I need a lot of money to start investing. While it is true that the best way to collect a small capital on the stock exchange is to start with a large one, there do exist efficient structures that allow one to invest for very small amounts. Investment funds, Exchange Trades Funds, and some index notes will provide a well diversified portfolio for amounts starting as small as a 100 Zl. Lesson: use simple structures and make sure you get the diversification that you need. Consider a systematic savings program.
I’m too young to think about my retirement, I still have time left. Consider this: when you save every month from your 20th till your 60th year of life 100 Zl a month and assuming an interest rate of 5% per year this will yield 148'956Zl at retirement. If you only start at your 40th, you will not have to invest 100, but 392 Zl per month in order to get the same result. Lesson: the early bird gets the worm.
I need specialized press. Not any more! I plan to bring more concrete advice, look for the the next Blogs in this section!