At Premier, clients sometimes ask our wealth advisors if their financial strategies should include market timing, stock picking, or other attempts to beat the market.
It's easy to understand why so many investors have questions about active management; after all, many so-called "experts," including pundits in the financial media and even many investment professionals, propagate these myths. That's why our wealth advisors believe it's essential for every investor to educate themselves as to the difference between advice based on empirical evidence and research -- and entertainment that's all dressed up as "expert" financial advice.
Here are a few of the most common investment myths.
Basing Wealth Management Strategies on Past Performance
Basing investment decisions on past stock market performance isn't an efficient wealth management strategy. Unfortunately, a fund's stellar historical performance offers no indication of future returns.
In fact, a 2014 report from Vanguard compared the results of a performance-chasing strategy to that of a buy-and-hold investment strategy from 2004 to 2013. Without exception, the passive method resulted in higher returns across the board. The takeaway? Short-term performance is not a valid reason to enter or exit a fund fund -- even if, as Vanguard puts it, an investor enjoys the "thrill of the chase."
Many Investment Professionals Attempt to Use "Skill" to Beat the Market
It's easy to confuse luck with skill; for one, it makes for more interesting headlines, which is probably why so many investment professionals market themselves as skilled at marketing timing and stock picking.
However, a 2009 study in the Journal of Finance analyzed the performances of more than 2,075 funds over 32 years. Over time, the fund managers who beat their benchmarks was statistically equal to zero. And the few that did manage to beat their benchmarks? They got lucky.
Alternative Investments and All-Cash Strategies are Smart Wealth Management Solutions
Though alternative investments such as hedge funds may get a lot of press, studies show that they simply don't measure up. Over the past 10 years, the index that measures hedge fund performance indicates that these alternative investments underperformed every major stock index, as well as some Treasury bond indexes. How is this possible? The stunningly high fees -- usually 2 percent of assets and 20 percent of profits -- may just have something to do with it.
Similarly, an all-cash strategy is often touted as a prudent, low-risk investment choice. In reality, it's risky thanks to several factors:
- Inflation can eat away at your purchasing power over time
- You'll have to time the market correctly when you jump back in -- or out
- Over time, the stock market goes up; if your portfolio is all cash, you'll miss out on the periods when the market makes the most significant gains
Your Wealth Strategies Should not Include Risk
Though some perceive risk as a negative concept, without risk, there can be no reward. Consider that so-called "risk-free investments" such as certificates of deposit and Treasury bills pay under 1% in returns. In the financial world, risk isn't inherently "good" or "bad" -- it's just necessary.
The key lies in identifying the amount of risk you feel comfortable with as an investor and structuring your portfolio accordingly. Your trusted wealth advisor can help you develop the comprehensive financial plan that considers both your risk tolerance and your financial goals and objectives.