A myth, as defined by the Oxford Dictionary, is a “widely held but false belief or idea.” There are plenty of cultural, social, and natural phenomena that have their own associated myths and that goes double for the stock market. Here are three investing myths in particular that would serve investors well if debunked. 1. For higher returns, you need to take more risk There is a belief that mathematical computations can explain the financial markets, with the calculation of “beta” being central to this myth. Beta is essentially a measure of how much a share moves versus…
A myth, as defined by the Oxford Dictionary, is a “widely held but false belief or idea.” There are plenty of cultural, social, and natural phenomena that have their own associated myths and that goes double for the stock market.
Here are three investing myths in particular that would serve investors well if debunked.
1. For higher returns, you need to take more risk
There is a belief that mathematical computations can explain the financial markets, with the calculation of “beta” being central to this myth. Beta is essentially a measure of how much a share moves versus the rest of the market, and a share that moves a lot more than the market is considered highly risky, while a stock that moves as much or less than the overall market is considered less risky.
But this doesn’t make sense. Think about a large, growing company like Jardine Cycle & Carriage (SGX: C07) that has its fingers in many different pies across a large section of the fast growing Indonesian economy. The share’s more than 36% below its 52 week high of S$56 at its current price of S$35.50. But imagine now that Jardine C&C got walloped to the tune of 20%.
Is the share now more or less risky? If you ask beta, it’s much more risky. But assuming all else stays the same, an intelligent investor would say that an investment in the share is now much less risky as you’re getting the same company at a lower price. And you don’t even need a calculator to figure that out.
2. In every trade there’s a winner and a loser
This one isn’t all that farfetched and in fact, there may actually be a winner and a loser in some transactions. However, with many investors out there with many different investing goals and time horizons, it probably isn’t always as simple as one party being the smarty-pants while the other is the dunce.
Think about it this way. You decide to sell your shares of Starhub (SGX: CC3) because at 20 times the company’s earnings over the last 12 months, you think the price has just gotten too high and the expected returns from the share no longer meet what you’re shooting for.
On the other side of that transaction is a retiree who doesn’t have nearly as high of a return goal as you and is simply looking to add to a share that can give him or her a nice dividend income (Starhub has a forward dividend yield of 4.8%).
Who’s the loser here? Sure the retiree might be buying at the higher price, but if Starhub can deliver returns in the lower range that he or she is targeting, then the investment makes sense for the retiree too.
3. Index funds are for losers
If individual shares are correctly selected, those returns can straight out trounce that of any broad market index. But index funds can be a good alternative for some investors too.
So how do you know whether you should be going the index fund route? Be honest with yourself with regard to the effort that you put into your investing. Are you picking stocks based on a hot tip from a “knowledgeable source” or a quick glance at a price-to-earnings ratio?
Or are you actually taking the time to do real research like getting to the know company’s business, reviewing financial reports, and studying up on the industry? If it’s the former, you can save yourself some heartache down the road by simply investing in the entire market through index funds. As the super investor Peter Lynch once said, “There’s something to be said for the dart-board method of investing: Buy the whole dart board.”
Foolish Bottom Line
The American author Mark Twain apparently once wrote that, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” It’s the same with investing myths. If what you believe is true just isn’t so, your results would suffer – and that’s no myth.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. This article was written by Matt Koppenheffer and first published on fool.com. It has been edited for fool.sg.