One of the reasons so many people have such a difficult time with their finances is because they come into the process with faulty assumptions. There are unrealistic and ill-informed expectations that set people back from the start.
Here are some of the faulty assumptions I see over and over again from both financial firms and investors:
Outperformance should be the number one goal. Many investors start out with the assumption that outperforming the market is their sole mission. Fund managers perpetuate this myth by making promises that the majority of them have no business making. Most investors have a hard enough time earning the actual performance in their own funds, let alone trying to outperform the market.
A stock with a 3-4% dividend yield is a “safe” investment. Investors have a difficult time separating income or yield from total return. A higher dividend yield is not going to shelter you from losses or offer more stable returns simply because of the existence of a stated income payment.
Hedging is the same thing as diversification. A portfolio full of hedges is not necessarily diversified. People have a habit of assuming that placing a number of hedges in their portfolio will protect them from market risk. In reality, hedges can actually introduce unintended or unnecessary risks when not used correctly.
Asset allocation needs to be perfectly optimized. Every advisor or investment firm assumes that they have the best asset allocation for their clients. A dirty little secret in the industry is that most allocations with similar stock market exposure will get you to roughly the same place (before fees). The ability to stick with a stated allocation matters much more than the allocation itself in most cases.
“Taking money off the table” is a legitimate investment strategy. Investors love to ask this question about certain asset classes, sectors, strategies or individual securities. I’ve never seen a successful investor who incorporates ‘taking money off the table’ into their process. If you have to ask this type of question it shows that you don’t have a plan or process in the first place. Even if you’re able to successfully sell at the right time, it’s highly unlikely that using a guessing game will allow you to buy back in when you need to.
Insurance is an investment. Insurance is a way to protect your wealth (or your family) from severe risks. Investing is about creating wealth. Both can be helpful, but they should not be confused. Insurance is generally not a legitimate form of investing or building wealth.
I’ll start saving later. There will always be reasons to put off saving until the future. There will rarely be a perfect or comfortable time to start saving money. It’s never going to happen if you don’t make it a habit.
Investing is the sure path to riches. Your investing skills won’t matter if you’re constantly in debt, don’t save enough money or can’t get your personal finances in order. I’ve seen plenty of finance people who have very successful careers but are terrible with their own finances. All the market knowledge in the world won’t help if you don’t understand the basics of personal finance.
Surely, everyone else is an idiot with their finances, but not me. This one has to be true, right?
Personal Finances > Portfolio Management
Here’s the stuff I’ve been reading lately:
- Your dangerously selective memory (Bason)
- 5 things smart beta can’t do for you (TRB)
- The case for and against strong future returns (EconomPic)
- To be great you must first learn to be good (TRB)
- 8 more lessons from Judd Apatow (Waiter’s Pad)
- Why momentum works (EightAteEight)
- Is happiness through wealth a zero sum game? (Monevator)
- Why do American Funds have so many share classes? (Gordian)
Subscribe to receive email updates and my monthly newsletter by clicking here.