“Just 20 years ago, 29 per cent of the world population lived in extreme poverty. Now that number is nine per cent.”
This is one of many interesting facts in a Hans Rosling book, Factfulness — Ten Reasons We’re Wrong About the World and Why Things Are Better Than You Think, in which he endeavours to correct misconceptions about the state of our planet.
Unfortunately, the investment industry also has its share of deeply ingrained misconceptions. Here are five of them.
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Ability to predict markets
Too many investors believe the stock market is predictable. They see the ups and downs as being foreseeable and, as a result, base their strategies on a market call.
The reality is we have zero ability to predict the market for anything shorter than five years. Even if it were possible to reliably forecast thousands of political, economic, structural and behavioural factors, it would also be necessary to determine how they interact.
The myth of market timing persists because there’s always someone who has called the latest zig or zag. But if you flip a coin, you’ll be right 50 per cent of the time, too.
The economy-market link
On the same theme, investment strategies are often based on an economic view. For example: The market will continue going up because the economy is strong.
Stock prices are driven by profits, which are fuelled by economic activity, but the linkage between economic statistics and the stock market is tenuous at best. Mr. Market is not looking at the latest numbers, but is rather trying to anticipate what they’ll be in 12 to 18 months.
The Trump effect
There is a perception at times that one dominant issue or factor is driving stock prices, whether up or down. Recent examples include Greece, China, gridlock in Washington, the next U.S. Federal Reserve move and, of course, Donald Trump.
But the stock market is a complex animal. Investors consistently overestimate the impact of an action (or inaction) by a central banker or government official. These and other players may have an impact for an hour or day, but rarely does it last.
Fees don’t matter
I hear too often that fees aren’t important; it’s results that matter.
It’s true that investor outcomes are what it’s all about, but future returns are not guaranteed, so you always want to tilt the field in your favour.
To use an extreme example, I like my chances of beating a hedge fund manager who charges three-to-five per cent (including performance fees) if I have a fee of one per cent. I don’t have to be as smart or aggressive, because I start each year with a lead of two-to-four percentage points.
Costs have a huge impact. On a $500,000 portfolio, saving even one percentage point on fees is the equivalent of a new car every 10 years.
ETFs always beat mutual funds
You’ve no doubt read that low-cost exchange-traded funds always beat actively managed mutual funds. It intuitively makes sense, given that costs matter.
But the proof for this belief comes from a flawed source: Standard & Poor’s Indices Versus Active Funds (SPIVA) scorecard, which is regularly referenced even though it’s an apples-to-oranges comparison. Indeed, ETFs aren’t even included in the study.
SPIVA uses market indexes as a proxy for indexing. That means no fees or trading commissions, and no allowance for tracking error (in aggregate, pre-fee ETF returns lag comparable indexes). Mutual fund returns, on the other hand, are shown after subtracting management fees, fund expenses and, in most cases, advice or trailer fees.
It would be a much tighter race between ETFs and mutual funds and make the headlines far less compelling if a like-for-like analysis was done.
Investors need to cut through the industry lore to see that stock markets aren’t predictable, no matter how much economic analysis is done; that fees matter, particularly in a two-per-cent interest rate world; that product comparisons must be based on comparable products; and, as Rosling notes in his book, that they “stay open to new data and be prepared to keep freshening up your knowledge.”
Tom Bradley is president of Steadyhand Investment Funds, a company that offers individual investors low-fee investment funds and clear-cut advice. He can be reached at [email protected]