26 Apr Myths vs. Truths – The Truth About Actively Trading Stocks
– Exposing the false beliefs of the financial world
Myth: You can get the best return on your investments by getting in and out of the market at the right times.
Truth: Actively trading stocks while trying to beat the market doesn’t work!
The truth is you’ll end up buying high and selling low while trying to chase performance. Avoiding debt and sticking to a long term investment plan with proper asset allocation is the absolute best way to build wealth.
How many people waited until everyone was selling out of the market in 2008? Tons. Those that waited until everyone else sold wound up selling as stock prices were already falling. Then they waited until they were sure the market had bottomed out. How could they be sure it bottomed out before putting their money back in? Well, they had to wait until it had gone up consistently for a while. So many people waited and they missed out on getting back in while prices were low. If they had simply left their money alone and continued to invest, a large portion of their portfolios would have returned by late 2009. Plus, they would have enjoyed wonderful returns on the money they continued to invest while the market was down.
Develop a good strategy
If you want to win at investing, you have to have a long-term focus and stick to your strategy over time. Ignore the hype and the media. Buy good diversified investments and hold them. If you’re trying to get rich quick, you’re sure to get broke in a hurry. Remember that long term investing means five years or more. When you have a long term goal, picking a well diversified portfolio with aggressive mutual funds gives you the best chance for return over time. It also exposes you to more market volatility so you need to understand your risk tolerance. Diversifying protects you somewhat from market volatility but you still are along for the ride in many cases.
But here’s the kicker: 99% of 10-year periods in the stock market’s history have made money. So if you’re willing to hold on to the investments for ten years or more, you’re much more likely to earn good average returns. Even the percentage of profitable five year periods in the market’s history are above 90%. But when you drop below five years, the number of losing periods goes way up. What am I trying to say? Don’t invest in the market for the short term and expect to get rich quick. Use the crockpot approach and let your investments grow over time.
What you also need to know is that not all mutual funds are created alike either. There are several factors involved in the mutual fund world that may be sapping your returns without you knowing it. For instance, you may think you have a well-diversified portfolio with balance listed above. Chances are, though, that the different mutual funds you own are all invested in many of the same companies. This means that when one fund is doing poorly in the market, the other funds you own are probably performing poorly. So while you thought you were protecting your portfolio’s volatility, you actually increase volatility. And not even index funds protect you from the volatility because different indexes often include the same companies. Not to mention index funds reflect the emotions of the market in general, where most investors are trying to time the market. Translation: with index funds you get more volatility in your portfolio with minimal additional return. To put it another way, you get all the pain of being an aggressive investor without all the gain.
Don’t forget the Turnover
And don’t neglect the turnover ratio. This little bugger has a big impact on your fund’s return. The turnover ratio is the indicator of how actively stocks are bought and sold within a fund. There are many fund managers out there who are impatient and want to see results fast. So they gamble with your money on stocks within the fund. In doing so, they buy and sell frantically, trying to predict the stock’s performance and in effect trying to time the market. We know through extensive academic research that timing the market doesn’t work and the best investing approach is to buy and hold for the long term. So why aren’t these fund managers holding on to the stocks? There are probably lots of reasons but you need to know that a high turnover ratio hurts your return. Oh, by the way, it helps the broker house make money on small commissions for each transaction. The translation? The investment firm and broker house make lots of money while sapping your return.
The bottom line here is that you need a good long-term investing strategy to help you avoid the emotions of market volatility. Develop your strategy with the help of a good investing coach and implement the plan. Don’t stray from the plan just because you think the market is swinging. Sticking to the strategy over the long term will help you gain much more return over time and ensure you stay invested in the market to take advantage of the ups and downs for the right reasons.Matt Wegner is a personal finance, small business and leadership coach focused on teaching his clients the tools for L.I.F.E. (Living In Financial Excellence). Learn how to establish a solid investing plan by requesting a free planning session today or visit financialexcellence.net.