5 Index Fund and Investing Myths

investing myths
Table of Contents
  1. Investing Myths
  2. Index Fund Myths
  3. Myth Busters
  4. Show Notes
Table of Contents  
  1. Investing Myths
  2. Index Fund Myths
  3. Myth Busters
  4. Show Notes

 Many of the reasons people are fearful of investing are myths.  Let us help you separate fact from fiction so you can feel confident investing.

Investing Myths

Don’t believe everything you hear.

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1. It’s Overly Risky

Too many people are not investing because they think it’s too risky. They’ll hand their money over to this thing they don’t understand and poof, X bad thing (they’re not really sure what a bad thing is, they’re just sure there are lots of them) happens and their money is wiped out.

So instead, they leave it where it’s nice and safe, in a checking or savings account or stuffed under the proverbial mattress. What they don’t realize is that those things are even riskier than investing.

When money is in a low yield account where it’s making less than 1% interest or under the mattress where it’s making no interest, inflation is eroding the value of that money slowly but surely. If your house burns down, the money under the mattress is ashes.

Yes there are risks to investing but an investor can choose how much risk to take and there are ways to minimize risk There are places to invest money like dividend stocks or bonds that allow money to grow with limited risk.

You can further reduce risk by having a properly diversified portfolio meaning your investments are spread out between different market sectors and different asset classes so if one area is doing poorly, you have other areas doing well to make up for it.

And while the stock market can quickly plunge, historically it has always rebounded. In the nearly 100 years since the Great Depression, there have been fewer than two dozen losing years for the stock market. That means the best way to keep your investments safe is to be in it for the long haul, set it and forget it which is what LMM has long advocated and what investing in index funds accomplishes.

You don’t put money in and pull it out based on screaming pundits or scary headlines, you don’t try to time the market. You put your money in and leave it alone. Stocks become less risky the longer you hold them.

2. Investing is Only for Rich People

In the old days you needed a stock broker if you wanted to invest in the stock market and often they wouldn’t even take your call unless you had thousands of dollars you were ready to invest.

But now that companies like Betterment are on the scene, investing has become democratized. Many investment platforms have no minimum to get started so if you have five bucks (or less) you can invest. You also need almost no knowledge of how the market works or even what it is to get started.

You don’t have to be a rich person who pays another rich person to invest for you. The fees for companies like Betterment are very low and it’s passive investing. You aren’t paying a fund manager and there is no reason to as they almost never beat the market.

If your employer offers a 401k you can get started there. It’s easy to start investing this way because almost everything is decided and done for you and the money is taken out of your check before you even see it; seamless investing.

3. You Need a Lot of Money to Make a Lot of Money

I think this is the one that holds a lot of people back even more so than fear of risk or lack of knowledge about investing. People think, “I don’t make a lot of money so there is no reason to invest. You only make money if you invest a lot of money.”

That’s not true at all. The most important ingredient if you want to make money in the stock market isn’t money, it’s time.

If at 18 years of age, you started with $1,000 and invested an additional $100 every week for 30 years at 7%, at the end of the 30 years, when you are 48, you would have more than half a million dollars, $539,643. You would have contributed just $156,000, the other $382,643 you made just from interest, from doing literally nothing.

If you don’t start until you’re 28 but start with double the amount, $2,000 and invest double the amount, $200 a week at the same 7% for 20 years, at the end of the 20 years when you are 48, you would have $461,451. You contributed $208,000 and the other $251,451 you made just from interest.

You can see what a difference time makes. We started with and contributed twice the amount but we still ended up with nearly $80,000 less because of the additional ten years our money had to grow in the first example. I’ll say it again, there is no substitute for time when it comes to investing.

Think you can’t find $100 a week? Here are 127 ways to get $100 fast.

4. Bonds are Risk Free

When you are splitting your portfolio between stocks and bonds, stocks are considered the risky investment and bonds the safe investment. It’s more accurate to say that stocks are the riskier investment when compared to bonds, that bonds are safer than stocks. That doesn’t mean that bonds are completely risk free though.

Interest rates can affect bonds. If the interest rate rises, bond prices fall. Callable bonds have a provision that allows the issuer to buy bonds back from the holders and retire the issue. This is another consequence of interest rates as it usually happens when interest rates fall substaintially since the time the bond was issued.

Just like inflation was eating into the money we had in the bank and under our mattress, bonds can be affected too. Most bond payments are fixed but the costs of goods and services are not. The longer the term of a bond, the bigger the chance that the payout will be outpaced by inflation.

Default is also possible. If the issuer of the bond has financial trouble that could mean they are unable to make the interest payments or repay the capital when it comes due. You can assess the risk level of a bond by looking at its credit rating at Moody’s or Standard and Poor’s. The lower the rating, the more risk.

Are bonds safer than stocks? Yes, generally they are but no investment, stocks included is 100% risk free.

5. Past Performances Are a Reliable Indicator of Future Returns

It’s tempting to pick stocks or a sector of the market that has historically done well but past performance cannot be counted on as an indicator of future returns. Look what happened to tech stocks in the late 1990’s. Their value soared but then 2001 happened and the bubble burst. Investors over-invested in that sector of the market took a big hit.

No one has a crystal ball and that’s what you would need in order to safely rely only on past performance as a way to decide whether or not an investment is a good one. Do your research and find out how good a company’s future prospects are and how healthy it currently is.

6. You Should Look at Your Investment Accounts Every Day

Don’t do this, you’ll drive yourself crazy. We are never to make investing decisions based on emotion and it’s easier to stick to that rule if you’re not obsessively checking those numbers every day.

Of course you want to monitor your investments so you have a sense of your overall financial picture and you know when it’s time to re-balance to get your allocation back on track but you can do that by checking in once a month, probably even less than that.

Index Fund Myths

If there are lots of myths about investing, it’s doubly true of index funds.

1. Indexing Only Works in Efficient Markets

Every market, whether it’s efficient or inefficient will have an average return.  Trying to hand pick stocks to beat this average fails more than 80% of the time. If you invested in an index fund containing several social media companies, over time you would likely make money. But if you invested solely in Facebook at it’s IPO, you would have lost money. You can’t beat the average unless you are among the near mythic 20%.

A market doesn’t have to be efficient for indexing to be the best option for the majority of investors. The point of index investing is to capture the return of a market at a low cost whether the market is efficient or not.

Even if a certain market were inefficient, the group of investors in that market would still get the market return minus their costs. Those who invest passively through an index funds will pay fewer fees than those in actively managed funds so their costs are lower.

2. Who Wants to Be Average?

When it comes to the stock market, average is pretty good. Most of us are not going to outsmart the professionals who put together index funds.  When you invest on a broad scale, you don’t have to worry about individual mistakes.

3. You Get What You Pay For

Higher fees and higher ratings do not equal higher returns. If the fee is higher it must mean that the smartest people on Wall Street are investing your money. No,it just means you should have shopped around for a better fee. Five star rated funds must garner better returns.

Nope! A Mid Cap fund with a low cost has an average annual return of 10%.  A highly rated fund has an average annual return of 7%.

One of the ways to beat the average is to lie like Bernie Madoff.

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4. Market-Cap Weighting Over-Weights

In a fund like S&P 500, how do you proportionately represent each company? The myth is when a fund over weights a company like Apple because they have a large market cap, then you’re too heavily invested in that company.  It’s better to be more heavily invested in the larger company. LMM’s is going to do a separate episode on just this topic so stay tuned.

5. Index Funds Under Perform in Bear Markets

A bear market is a down market where everyone is selling. This goes back to one of LMM’s key tenets, you can’t time the market.

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Myth Busters

There is a lot of misinformation and misconceptions around investing and index funds but none of them should stop you from investing. If you want to grow your wealth and achieve financial independence, don’t let these myths stop you from getting off the sidelines and getting into the game.

Show Notes

Betterment:  The simple way to start investing.

LMM’s Ultimate Investment Strategy Blueprint:  Get our picks of good funds with low fees.

 

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