Five Little Lies Many Investors Tell Themselves

Sometimes advisors face an uphill battle.  Investors have “truths we hold to be self-evident” that either aren’t true or aren’t as simple as they think.

1. Free trades and no load funds are really free.

Everyone is talking about zero commissions.  Is this much different from $4.95 trades or fist five trades are free?  Appearing to get something for nothing has been around for a long time.  The bar offering “free lunch” might have required a two drink minimum.  “Free shipping” doesn’t mean you can bring a package from home and ship it without cost.  It means the cost of shipping is built into the price.  More accurately, the firm is making mioney in other ways.  Years ago, “no load” funds came on the scene.  Some investors might have been under the impression these funds were run by monastic charitable orders that apply their expertise for free.  Using no load funds as an example, there’s only one less person being paid, the financial advisor.  Everyone else along the way still gets their piece. Strategy:  Read the fine print.  Stay current.  Many articles will likely appear soon explaining how firms make money on trades.  Use the technology on your desktop to look at total costs on various mutual funds.

2. Money managers add no value because the indexes always beat them.

Investors see reports showing indexes outperform the average equity mutual fund.  This likely means all equity mutual funds blended together, regardless of size and style.  In this example, no investor owns the “average fund” because there is none.  Years ago, consumer products advertisers compared their performance vs. “Brand X.”  There are rating services showing how funds within a certain category have performed relative to their peers. Although you can’t predict the future, you can choose from the historical overachievers. Strategy:  You have certain funds that are favorites, earning multiple stars.  How have they done relative to the indexes over time?

3. You can’t lose because the stock market always goes up.

You’ve seen the mountain chart showing how equities outperforms several other asset classes.  This implies as long as you sit tight and don’t sell, you should be alright.  The problem is the market rarely goes in a straight line, it usually has it’s ups and downs each week.  You stand a better chance of success if your holding period is forever, but nobody lives forever. If a person wants to pull, out their money at the wrong time, they can lose money. Strategy:  Some funds show best and worst performing quarters.  What did that look like?  The NY lottery had a saying “You have to be in it to win it.”  This means you need to be continuously invested in the market long term to try and get those long term returns.

4. I haven’t lost money yet because it’s only a paper loss.

Funny how we don’t think that way about profits.  The value of a security is what you can sell it for at that moment.  In most cases, when you buy a car, it depreciates when you drive it off the lot.  You wouldn’t realistically think you could resell your used car for what you paid in the first place.  Paper losses on stock are just more volatile. Strategy:  If your child comes home with bad midterm grades, do you brush it off because it’s only the final grade that counts?  Probably not.  You recognize a midterm grade as being real.

5. The way to make money is by risking other people’s money.

We’ve heard in the movies about OPM or Other People’s Money.  When you invest, this is margin or some other form of borrowed money.  Yes, when you make money, it’s all on your side of the ledger (less interest).  However, when you lose money, the losses come from your side of the equation.  OPM is good, but when things go bad, those other people want all their money back.  They are not into sharing. Strategy:  If you suspect your client is borrowing money to invest, go through lots of “what if” scenarios so they know what might happen. Part of the advisor’s job is tactfully explaining life is more complicated than they assume. Related: Private Bankers: The SEALs of the Investing World