Before getting into my course in economics and studying personal finance in my own time, I had a lot of misconceptions that seem to be common place when it comes to investing. Thankfully my degree and own research taught me a lot about investment and have stopped me believing these misconceptions. However, many people within society still believe many myths and misconceptions about investment options. I will outline 5 common ones below and explain why they are not true.
1. Stocks are riskier than bonds
On the surface of things this seems true. Bonds are relatively low risk and as such tend to offer relatively small returns. However, a properly diversified portfolio such as blue-chip stocks or an S&P 500 index fund can also be low risk. The important factor to note here is to not worry about short-term drops. The stock market is extremely volatile on a month-to-month or even year-to-year basis, however over a period of 5+ years you are likely to see growth in your stocks.
2. Invest based on recent performance
A costly decision is to base your investment opportunities on the idea that recent performance of the investment opportunity will continue into the future. Asset classes tend to cycle and therefore something that is showing strong growth today is likely to experience a fall at some point in the future. It is therefore a far better idea to invest in quality, long-term investments which might perform poorly in the short run but may achieve greater success over the long run. A diversified investment portfolio will have winners and losers at any point in time, but will over the course give you a better opportunity to perform well.
3. Invest in what you know
There is a difference between doing your research into a new investment opportunity, and just investing in the things you think will be successful based on your previous experience. Familiarity is a good way to lead to an investment portfolio which is not diversified. Investing in what you know may feel like the safer bet, however you need to understand the opportunity, not necessarily be familiar with it. It is often easier for new investors to avoid this as they are new to everything in the first place. Those who have invested for longer however may fall into a trap of over concentrating on certain businesses or countries.
4. I’m not the type of person who invests
Surely me, as one person who doesn’t have the best insight into the world of investment, would be massively under equipped to go against massive corporations on Wall Street? This wasn’t made for me. Wrong. With the rise of low-cost index funds and mutual funds, the average person has the opportunity to invest in easy to manage solutions whilst still seeing a return. There is lots of information out there which can guide you through the process and it is a great way to improve your finances if you do it right.
5. Rational investments
It wouldn’t be a DiscussPF blog post without a bit of discussion on psychology. It is a topic I discuss a lot and it works here also. Traditional finance theory suggests individuals act rationally and therefore choose the best investment opportunity available to them after carefully considering all of the information available. This is simply not true, and investments can often be turned down that look risky on its own but would be a good inclusion to a diversified portfolio. We make decisions without considering all of the implications – known as narrow framing. This mainly happens by us considering investment opportunities one by one. Instead, we should take care to look at our investment opportunities as part of the bigger picture.