It is surprising how often “conventional wisdom” does not meet either criteria – it does not follow convention, nor is it wise. From predicting the winner of next year’s Super Bowl to predicting next week’s stock market, conventional wisdom can lead you astray.
Let’s explore some of the myths related to the latter subject. (You can work out Super Bowl myths separately.)
- Higher Returns Require More Risk – This statement assumes risk equals price volatility, which is only one part of risk. Understanding and managing that volatility is key to success. Rather than focusing on the volatility, focus on the reasons behind the current price and how that compares to the fundamentals of the company.Warren Buffett is not a daredevil – he is simply better at spotting bargains than anyone else. You will find many boring yet solid companies in his portfolio.
- The Stock Market is a Form of Gambling – To those who rely on random guesswork, the market can appear to be gambling. Research and in-depth understanding are important for success in both fields.However, the stock market involves overall wealth creation. Gambling is zero-sum since all gains come from others’ losses. In the stock market, losses involve the merits of an individual company and its spot within the marketplace, not someone else’s positive outcome.
Overall, wealth is created without coming solely at the expense of others. (Save the political conjectures for another time.)
- Stocks That Go Up Must Come Down, and Vice-Versa – The key to knowing when to buy an underpriced stock and dump an overpriced one is correctly assessing the company’s growth potential and fundamentals. Buying simply on name and price assuming that the stock will rise again is foolish.Prices are where they are for a reason, and that reason is not always rational. Do your research on the reason for the unusual price, and act based on your findings, not on a price trigger.
- You Cannot Time the Market – This depends on the definition of “timing the market”. For most of us, chasing hot tips or market buzz is futile. There are a few extremely skilled investors that have the knowledge and resources to do well and successfully time the market often enough to succeed. Like successful gamblers, they only bet when they are very sure they can win.Being an average investor, you probably lack the skill and resources and therefore cannot time the market. You are better off assuming this myth is true – unless you use it to justify buying into the stock market at any time, assuming that timing plays no role at all. You still need to exercise good judgment and buy when prices are reasonable and growth is expected to continue.
- Stocks Outperform Other Investments Over the Long-Term – This is often true, but the question is how long-term is defined, and where the reference points are.If you accept this statement as a reason to stick with stocks overall (not just any one particular stock) over the long course of your investing career, then this is reasonable. If you use this as a reason to stay 100% invested in stocks when you are nearing retirement age instead of shifting some assets into other investments, a longer-term recovery is of no use to you.
All of these myths have some elements of truth to them, which is why they endure. However, people make poor decisions when these myths are applied incorrectly or universally. Do not be one of those people who allow a myth to guide them to a regrettable investing decision.
More from Moneytips