3 Myths About Investing - Part 2

This is the next step in our series about investing myths and common mistakes that people make. Please read the prior article to catch up if necessary. Investing can be simple if you are in possession of a few key facts, and as your friendly Financial Physician, I can arm you with the tools you need to head down your path of financial understanding. I congratulate you for choosing to expand your financial knowledge base.

Myth #4) If you own a large number of US companies, then you’ve spread your money out well enough

Diversification is one of the most critical dimensions of investing. To make it simple, diversification means that you should not put all your financial eggs in one basket. Your grandmother probably gave you similar advice as a child, so you know where I’m coming from.

When you put your money into financial assets, the simple idea is that you don’t want to be overly exposed to risk and potential loss. Even if you think that an investment is a “can’t miss” opportunity, you are asking for trouble by putting too much of your wealth in one place. You may have seen the play “Raisin in the Sun”, in which one of the characters put the family’s fortune into a liquor store and saw his good friend Willy run away with the money. Whether it’s Willy or Enron, don’t let that happen to you.

Your broker may talk about diversification by stating that you should make sure your money is placed into several stocks at once. He might tell you that investing a percentage of your funds into GM, IBM, Microsoft and a few other US companies will do the trick when it comes to diversification. I hate to say it, but that message is WRONG.

First, investing should be international, not domestic. By only investing in American companies, you are missing a big piece of the global financial puzzle. If the US economy goes south, then so does your money. Also, some of the best opportunities exist in other countries.

Secondly, you should have your money placed in different types of investments. The stock market is just one place to put your money. You can also invest in real estate, a small business or even commodities and collectibles. The key idea is to spread your money around and to not get too excited about one type of financial outlet.

Myth #5) If a stock has done well in the past, it’s going to keep doing well in the future

One of the greatest myths in the financial world is the idea that a stock that has done well in the past is going to keep going up in price. Magazines fill their issues with a collection of stocks or mutual funds that did well the year before, and everyone clamors to buy these assets. The idea that a stock’s past predicts its future could not be further from the truth.

Research shows this is simply not the case. While it might seem logical that the past predicts the future, the truth is that stocks are priced based on a complex theory called “Rational Expectations”. Without going into what that theory implies, the bottom line is that any reasonable expectation that the stock is going to do better in the future has already been taken into account. For example, let’s say that you read the Wall Street Journal to find out that the Nike Corporation just signed a new deal worth an extra $1 Billion dollars. Your instinct might be to go purchase the company’s stock, in hopes that once the billion comes in the door, the price will go up. Sorry, but the truth is that the market immediately adjusts to that new information, so your ability to profit from the info is virtually non-existent. Additionally, all information about a stock’s future performance has been calculated into the current price. The truth is that its past performance can’t be predicted by ANYONE, not even a Finance Professor like me.

Would you like to know my own personal stock investment strategy? I buy a nice, diversified portfolio and then let it grow. I don’t try to pick winners from losers, and I don’t try to buy at the right time. I simply make consistent investments in the market (out of my pay every two weeks) putting those investments into a diversified portfolio. I then allow the thing to grow naturally. I don’t worry about price changes on the evening news, and I don’t sell nearly as much as I buy. What’s the result of this strategy? My money has steadily grown over the past several years.


Myth #6) The goal of money is to make more money

I study money and I have learned a lot about money. I have learned to appreciate and respect the power of money. But I have also learned the importance of keeping money in perspective. Money does not make your life wonderful: it simply enhances the beauty that your life already possesses. It can also be a protective force against some of the tougher choices we must make when our pockets are empty. Money is a tool for the improvement of your life and the lives of those around you, not the ends that one should pursue to find the holy grail of happiness.

At the end of the day, the goal is for you to be happy and fulfilled. The pursuit of wealth can play a role in this fulfillment, but you must be careful not to allow your pursuit of money to ruin the other valuable assets in your life. Money can be a means to happiness, but it is not the ends in itself. Keep that in mind as you go on your quest for riches.

Dr. Boyce Watkins is a Finance Professor at Syracuse University and author of Financial Lovemaking 101, Merging Assets with Your Partner in Ways that Feel Good. For more information, please visit www.BoyceWatkins.net