Investment Myths Abound: Flee from These Two

Investment myths abound. Some start innocently. Some start out of ignorance. Sadly, some originate with folks who should know better, but want to sell their products.

Often, I tell folks the best, most reliable, first reply to their financial questions is: It depends. Each situation is different and needs a holistic look. So, before a detailed review of their lifestyles and finances, it depends, is most proper.

Investment Myths

To some, this answer doesn’t seem thoughtful and professional as many so-called experts dispense spontaneously, standard answers to real financial issues, leading to cynicism. That’s one reason financial myths abound, particularly about budgets: they are strait jackets, they control you, you need predicable incomes before doing one, and so on. Still, I think investments’ misconceptions are the most damaging. Here are two to avoid.

You lose when the price of a stock or other investments you hold fall

It depends! In 2008 when stock markets fell, folks complained they lost their pensions and life savings, panicked, and then sold their holdings without proper evaluations, fulfilling their fears. Though my portfolio collapsed almost 60%, I didn’t lose a dime, and I didn’t lose a minute’s sleep. What happened? I did what I do regularly! I reviewed my investment goals and plans, my portfolio, chose to keep it intact, didn’t sell, and so, I didn’t lose. If I followed the logic I lost when the market tanked, how about gains over the years? Some of my investments more than quadrupled since I bought them several years earlier!

Folks, you lose when you sell investments below acquisition costs (cost bases). The converse is true on sales. The problem is many folks don’t invest, they gamble on the Stock Market with borrowed funds–leverage is the fancy financial term for this. These folks panic when the market value of their portfolios drop below their investment margin accounts, and so they sell, realizing the book loss. We can take three lessons from this: First, don’t borrow to invest. Second, markets rise, and markets fall; you can bank on it. Third, a fall in your portfolio value alone, should not cause you to sell investments.

Investing in Bonds Is safer than investing in stocks

You hear it often: “I prefer bonds to stocks; they are safer.” Really? It depends! We must consider two factors. First, the type of bonds. High yield bonds, a euphemism for Junk Bonds, as the name implies, are risky, and might not live to be repaid partially or fully. To compensate for high risks, Junk bonds’ returns are high. In contrast, Government bonds are safer, generally will be paid when due, but provide low returns. The lesson here is, high risk might lead to high returns; low risks instruments have a higher probability of producing a return, but much lower.

Irrespective of bond type, if traded on stock exchanges, bond values fluctuate daily based on interest rates, economic conditions, and corporation’s health. So, if you sell a bond before maturity, you might get less than you invested. Whereas, if you held it to maturity, you will get its face value. A $1000 bond (face value) could trade for $800 before repayment date. Equally, it could trade for $1200. At repayment, the bond holder gets $1000.

Summary

Before investing, do the sleep test–are you and your spouse likely to sleep soundly when, not if, your portfolio fluctuates? Write investment goals and plans, work with a budget to isolate household funds, understand investment preconditions, and the three P’s of investing: Principles, Players, Process. If you don’t have clear investment goals and plans, Stock Market gyrations will cause you great stress, and you will panic-sell investments you ought to hold.

Article first published as Debunking Two Investment Myths on Technorati.com.

For more on investments, read chapter six of The New Managing God’s Money-The Basics.

Copyright (c) 2010, Michel A. Bell