The Biggest Lies We Believe About Investing

The stock market is not inherently sinister, but it can (and will) be manipulated—and not in your favor.

Unless you’ve been educated to understand how this happens, you can easily get hurt when you invest. As a result, despite anything you may have been told, the market is not a place for your savings.

If you know what you’re doing, as well as understand how to make good investments and how to hedge your risks, you’re the exception.

Even experienced investors who work in finance don’t have full knowledge about how everything in the stock market works.

However, if you’re like most casual investors, you probably don't know what mutual funds you own or what stocks and bonds are in those mutual funds.

If you’re setting aside money for retirement, that’s fantastic. But do you know what your end game is and what you should do in retirement?

Without a specific vision for your financial needs when you stop working, you’ll never develop a means to reach a comfortable retirement.

In this article, I’m going to share with you the same powerful, easy-to-use system that I share with my clients to help plan for retirement.

Let’s start by dispelling some common fallacies about retirement savings.

The Power of Compound Interest

A common misconception in the narrative of responsible financial planning is the efficacy of compound interest.

The typical financial planner will state that over the last 20 to 30 years, the market has grown by a certain percent every year. This number is what they use to project what a portfolio balance might look like in the future.

Most people don’t know where to begin in dissecting a statement like this, so let’s do it together.

From 1998 to 2017—a period of 20 years—the S&P 500 index earned an average rate of return of 6.78 percent according to Pinnacle Data Corp.

What exactly does a 6.78 percent average return mean?

The truth is the average American doesn’t really know. They see these numbers and erroneously conclude that if they had money in the stock market, their wealth would grow by 6.78 percent every year.

Using that logic, a $100,000 investment would turn into $371,363 over 20 years.

That is a lot of money, but that’s just not how the market works--if that $100,000 were invested in the S&P for 20 years, that’s not what it would have earned.

Markets don’t operate on a straight line and never have. They have good years and they have bad years. Yet somehow the dominant narrative concludes that they all miraculously end up balancing out to a simple equation.

This next part is where most people tune out, but it’s exactly where you should be paying close attention.

If you started with $100,000 at the beginning of 1998 and cashed out at the end of 2017, your balance wouldn’t be $371,363, as the simple 6.78 average return would suggest. In fact, it would be almost $100,000 less: $275,508.

Why?

Because markets fluctuate. When there’s a loss, a subsequent gain must be much higher in to compensate for the loss.

For example, if you lost 10 percent on a $100,000 investment, your new balance would be $90,000.

To make up the loss and get back to break-even, you would have to earn 11.1 percent, not simply 10 percent. That’s because if you lose 10 percent one year and then gain 10 percent the next, your average return over the two years is zero percent.

The following shows the actual return on that $100,000 investment. It’s really 5.20 percent—and that’s gross, before fees.

One of the primary purposes of the S&P 500 is to give individuals a benchmark for performance of their specific set of funds and to give fund managers a target for performance.

According to Investopedia and other sources, more than 80 percent of fund managers underperform the S&P 500.

Even Warren Buffett’s Berkshire Hathaway has failed to beat the index since 2008.

The Importance of Fees

When you factor in the fee structure that most brokerages utilize, which is how the fund manager is paid, the results get even worse. When the management fee is just 1 percent, the balance erodes to $225,340, or a 4.15 percent return.

According to the Investment Company Institute, over $20 trillion is invested in 20,000 different funds. There are studies that state the average equity mutual fund fee structure is 1.28 percent;  however, many are charging more than 9 percent.

Dollar Cost Averaging

Most practitioners of outdated financial advice also stress a concept called dollar cost averaging. Simply put, dollar cost averaging means you make consistent ongoing contributions to your chosen mutual fund, rather than simply investing a lump sum.

The idea here is that, over time, your consistent contributions average to a lower purchase price than a lump sum investment. In short, you make more money, assuming the fund price trends upward over time.

This technique does make a difference, but its impact on your investment is much less significant than fund managers would have you think.

For example, with a $10,000 annual contribution and a 1 percent fee structure, the ending balance would be $369,257, good for a 5.53 percent actual rate of return.

What’s worse is that this analysis doesn’t even include taxes.

The after-tax return would differ depending on whether the funds are held inside or outside a qualified plan like a 401(k).

Either way, the question remains the same: Is this rate of return worth the risk required to earn it? Of course not, but most of us are lacking the variable that enables an informed decision: financial education.

And the financial education people consume is mostly misinformation. They hear that compound interest is the most powerful force on the planet, that fees are a natural part of the process, and dollar cost averaging is the only logical way to invest.

Sadly, we’ve been lied to.

The fact is that the livelihood of financial advisors, stock brokers, and bankers is dependent upon them keeping you in the dark. If you learn for yourself, you won’t need them anymore.

If you don’t need them, they don’t get your fees. Good for you, bad for them.

The good news is that you’re taking the time to rethink your investment choices, and, as a result, you can make more informed decisions instead of trusting a fund manager who seems competent.