Why Conventional Wisdom Is Wrong When It Comes To Investing

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For many situations in life, old adages and clichés can be extremely helpful in making decisions.  Sayings like “Rome wasn’t built in a day” or “even God took a day off” are easy ways to justify a choice or a course of action that you may already made. But in terms of investing, it is important to be wary of how you apply conventional wisdom. If not carefully thought about, implementing seemingly sensible sayings can lead to poor investment outcomes. Below are several common phrases that can be useful in certain contexts, but are ones that you should steer clear from when you are making investment decisions:




1)
“You get what you pay for”

We all have had experiences where this often cited cliché unfortunately ends up being far too accurate. Its relevance to investing though is limited. In fact, when it comes to selecting mutual funds for your retirement portfolio, you actually want to do adhere to the exact opposite.


There are two broad categories of mutual funds that are available to most retail investors: actively managed funds that seek to outperform the market and consequently charge higher fees, and lower-cost index funds that seek to passively mirror the market, not outperform it. At Nerdwallet, we conducted a study that found that only 24% of actively managed mutual funds outperform market indices. What does this mean? Investors should really be committing their money to low-fee index funds, given that the vast majority of actively managed funds don’t outperform the market. Most investors are looking to build wealth for long-term financial goals like retirement or buying home. Unfortunately, the higher fees paid to active fund managers becomes very substantial and can end up costing hundreds of thousands of dollars over time.

Key Takeaway: Chose low-cost index funds


2)
“If you encounter failure, change your plan”

Technically, this is not really a saying, but it is an idea that is deeply ingrained in the minds of most people. The though is that if your initial plan goes awry, something must have been done incorrectly and the best solution is to significantly alter your approach. While you should certainly not ignore failure, it is important to separate between process and results. Far too many people abandon sound investment strategies because the market is in a deep slump or in a huge bubble. Even a well-constructed portfolio is susceptible to the vagaries of the market, but that does not mean your commitment to your investment strategy should be as well. Having a diversified, equity-oriented asset allocation with low cost index funds is a strategy that has historically proven to return over the long-term. 

Ultimately, investing rewards people who invest with a longer time horizon and remain committed to their strategies even in bear markets. Of course, you should review your portfolio from time to time to ensure your portfolio corresponds to your financial objectives and risk profile, but by and large your strategy should remain stable. The entirely wrong thing to do would be to become increasingly risk-averse when the market is struggling, and conversely more aggressive when the market is doing well.

Key Takeaway:  Construct a sound strategy and stick with it

 

3) “Trust Your Gut”

Gut instinct is a very powerful signal for many social interactions and decisions, but when it comes to investing, it is better to leave your intuition out of it. If you even reach a point where you are contemplating whether to trust your gut over your rationale, it likely means you have become too involved in managing your investments. Unless you are a part of the small minority of people who are sophisticated investors, investment management should not be a daily activity. By following your gut, you will probably deviate from your investment strategy that is not consistent with your risk profile. Investing is ultimately a long-term activity, and should be approached with a rational, long-term outlook. The very nature of reacting to short-term market news contradicts the core of what sound investing is all about.

Key Takeaway: Trust proven portfolio management principles, not intuition

More than any adage, maintaining a diversified, equity-oriented asset allocation, investing in low cost index funds and trusting your rationale, not your gut are the most relevant principles that will help you achieve your investment objectives.

 

Joseph Egoian is an analyst at Nerdwallet, a website focused on helping consumers make better financial decisions, whether it’s to help them find the best credit card for their needs, or to find the right online brokerage account.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Business , Retirement

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