Faulty Assumptions
by Ben Carlson, A Wealth of Common Sense
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.Ā 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.Ā 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 āsafeā investment.Ā 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.Ā 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.
AssetĀ allocation needs to be perfectly optimized.Ā 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.
āTaking money off the tableā is aĀ legitimate investment strategy.Ā Investors love to ask this question about certain asset classes, sectors, strategies or individual securities. Iāve never seen a successful investor who incorporates ātaking money off the tableā into their process. If you have to ask this type of question it shows that you donāt have a plan or process in the first place. Even if youāre able to successfully sell at the right time, itās highly unlikely that using a guessing game will allow you to buy back in when you need to.
Insurance is an investment.Ā 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.
Iāll start saving later.Ā 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. Itās never going to happen if you donāt make it a habit.
Investing is the sure path to riches.Ā Your investing skills wonāt matter if youāre constantly in debt, donāt save enough money or canāt get your personal finances in order. Iāve seen plenty of finance people who have very successfulĀ careers but are terrible with their own finances. All the market knowledge in the world wonāt help if you donāt understand the basics of personal finance.
Surely, everyone else is an idiot with their finances, but not me.Ā This one has to be true, right?
Copyright Ā© A Wealth of Common Sense
