If you are thinking about investing, chances are you will come across advice and suggestions, which are often unsolicited. Some are common sense, others vary on circumstances, but some are just straight-up myths not backed by credible sources. Here, we will be busting 3 such myths and explain the reality backed with research.
Reality: Actually, no. Investment fees are the primary source of lower ROIs, not market losses. Market losses are not as consistent as investment fees. Just as compound interest can grow your returns, investment fees can also compound and eat away a significant portion of your income. As your portfolio grows, so do your expenses because they are percentage-based.
Now, let us back it up with some actual studies done on it. A study done by the European Securities and Markets Authority (ESMA) found that fees (ongoing, one-off fees plus inflation) lowered ROIs average by 29%. The reduction in revenues is higher for actively managed funds than passive ones. How high, you may ask. The lower ROI was estimated up to 11% for passively managed funds but 44% for actively managed funds.
A study by Nerdwallet estimated that paying a mere 1% in investment fees would cost an investor more than $590,000 over 40 years. That very same investor could save nearly $215,000 in fees and retire with $533,000 more if he paid fees 0.93% or lower.
There are many proponents for low-cost investment, and an experienced investor would always suggest looking for brokers with the lowest costs because they have seen the difference. One way to measure whether the fees are reasonable is to look at the expense ratio.
An expense ratio calculates the fees for portfolio management divided by the value of the fund. And a reasonable expense ratio for an actively managed fund should be around 0.5% to 0.7%. For passive funds, the rate should be 0.2% or lower.
Reality: What people actually mean is that emotional investors are impulsive. They exhibit neuroticism with higher anxiety and emotions - a disadvantage when it comes to decision making. They are more aggressive, take more risks, and invest in riskier assets, contrary to "rational" investors who invest conservatively.
The reality is quite the opposite. Regarding investors with higher anxiety, the results are more balanced. Investors with high neuroticism were conservative in their investments but not too risk-averse. They spent more time researching before decision-making, leading to good investment performance.
Secondly, impulsive investors are not emotional - they are what they are: just impulsive. People should be looking at having emotional intelligence, a topic studied by financial institutions regarding investments. Emotional intelligence means having the ability to identify emotions and use them effectively, which seems more beneficial for investment performance. A study by the CFA Institute on emotional intelligence and its impact on investment behavior found that investors with high emotional intelligence take decisions that correlate with good investment returns. Such choices include using low-cost funds, not trading too often, changing portfolio too often and etc.
Investors with higher emotional intelligence are less aggressive. They take fewer risks and are less likely to engage in riskier investments. Their study concluded that "emotional" investors were more likely to pursue a balanced portfolio.
Reality: The first argument against Alternative investments is that they are riskier than traditional investments. A good rebuttal is that all investments are, and alternative investment is no exception. Therefore, to call it volatile in isolation is an easy argument but not a valid one. The reason people are wary of alternative investments is because of their availability to people through innovative measures, such as offer low-costs, a high-tech user interface, and generous returns.
A study by Blackrock found that alternative investments are just as risky and volatile as traditional investments and sometimes even lower. Sometimes, it can be more dangerous, but it depends on the asset itself. An alternative investment (AI) can lower a portfolio's volatility because it adopts several different strategies and assets that have low correlations. Hence, the overall portfolio will not be significantly affected if one asset class loses market value.
The second argument against AI is that the money invested in it is illiquid. That means one cannot access the liquid cash. Again, the reality is - it depends. Liquidity varies on investment options. Some offer daily liquidity, and some do not. Quanloop is an example of a high-liquidity investment. It is up to the investor to decide his goals on investing in AI - he could aim for high returns or aim for high-liquidity or both. That is the tradeoff the investor has to choose between. However, it is general knowledge by now that regardless of what the investment institution offers, an investor is likely to grow his wealth more over the long-term if he compounds without withdrawing too often.
Of course, people still believe in the popular notion that AI is not a good hedge against financial crashes, as it failed to protect investors from the financial crisis of 2008. However, while it is true that AI lost market value, the decrease was lesser than stocks, and it acted as a safety net for investors who could have lost more. Stocks have lost above 50% in value of total assets in 2007 and 12% after 2010. AI lost only 7% in 2007 and 15% after 2010. AI suffered losses, true, but not as much compared to the overall market indices.
Plentiful harmful myths are going around that we did not discuss. It is easier to share misinformation and not be held accountable for it. It is up to the investor to conduct due diligence before accepting them as the truth.
Last update: 22/03/2021