Americans have been investing in stocks for more than 200 years, and some of the stubborn investing myths of today probably go back that far.
Given all those years to learn our lessons, one would think that the costliest investing myths have long since been put to rest. Unfortunately, human nature being what it is, many of them are still hanging around to make life difficult for the unwary.
The following six lurking investing myths could put a major dent in your portfolio.
1. It’s easier for a low-price stock to double in value.
On the surface, it makes sense. A stock that is selling for $50 would have to gain $50 in order to double in value, while a stock selling for $2 only needs to gain $2 to double in value. Perhaps this over-simplified arithmetic explains why so-called penny stocks lure many unsuspecting investors.
In truth, investors have to believe an entire company is worth twice as much as its current value in order for a stock’s price to double. A stock selling for $2 or less is trading that low because most investors sense a lot of risk and aren’t willing to pay more.
Also, stocks selling that low usually aren’t listed on stock exchanges, making it difficult to obtain reliable information about the company.
2. Past performance is a good indicator of future results.
Debunking this myth should be easy— the evidence is everywhere. You won’t have to look hard to find a mutual fund or an individual stock that performed beautifully two years ago, only to fall off miserably last year.
That’s not to say an investment that has performed well in the past won’t continue to do so; it very well may.
However, any investment is influenced by changing conditions and other factors will affect future performance. Good performance in the past may be a good place to start, but sticking with sound fundamentals and good research is still the best (though far from perfect) predictor of future results.
3. What goes down must go back up (with apologies to Newton).
Back in elementary school you learned Isaac Newton’s summary of his gravitational law: “What goes up must come down.” Perhaps that’s why some investors assume a reverse relationship of that law in the world of investing. If such a relationship existed, a stock trading at or near its 52-week low would present an unbeatable profit opportunity. Usually, though, it will not rebound.
When the market relentlessly beats a stock price down to abysmal lows, there’s something going on that may not be visible at first glance. Unless careful research tells you that the cause for that company’s troubles has been or is about to be resolved, it’s best that you look elsewhere for your next buy.
The most dependable investing goal is to buy good companies at reasonable prices. Buying companies solely because their market price has fallen is a losing philosophy.
But don’t confuse that mistake with value investing, which is buying high- quality companies that currently are undervalued by the market.
4. Paper losses don’t matter.
When a stock’s price falls below what you paid for it, it’s easy to fall prey to the myth that paper losses don’t matter. The rationalization is that because you haven’t sold the stock, you haven’t lost anything. That’s not true.
Stocks are liquid assets that can be sold quickly and are traded throughout the day at changing prices. In short, a stock is only worth its current trading value.
So, when a stock falls below what you paid for it, you have lost purchasing power. If you paid $10,000 for a stock and it falls by 20 percent, your $10,000 investment is now worth only $8,000. You now have 20 percent less to spend or invest elsewhere than you had before.
This is not to suggest that you should sell a stock whenever its price drops. Stock prices rise and fall and some of your stock prices are bound to fall. What it does mean is that you should never hold on to a stock solely for the purpose of trying to break even. Instead, use the opportunity to take another look at the company’s prospects and its fundamentals.
Ask yourself if you would buy the stock now. Your answer should help you to decide whether to hold on to the stock or sell it.
5. If everyone is buying a hot investment, you should jump on the bandwagon too.
The “follow-the-herd” mentality is one of the biggest mistakes made by amateur investors. By the time you hear about a red-hot company, its best days as an investment are probably behind it. Prices may have soared thanks to the hype, but by the time you hear about it, it’s time for reality to set in.
Don’t be like the mythological lemmings following the crowd off a cliff.
6. Beating the market is easy when you know how.
Chances are you’ve received more than one direct- mail promotion from someone who will tell you how to beat the market if only you’ll subscribe to their newsletter. Forget it. Remind yourself that if someone really did have a secret formula for beating the market they wouldn’t be earning a living selling newsletters. They would keep the secret all to themselves and retire to a sunny locale while the dollars roll in.
The language in those promotions will be skillful and persuasive, and many gullible people will succumb to the temptation. Don’t be one of them yourself.
These half-dozen myths are only a fraction of the many other financial fairy tales out there. Remember that while most of the myths sound compelling, and even logical, they aren’t.
William J. Lynott is a freelance writer whose work appears regularly in leading trade publications and newspapers as well as consumer magazines including Reader’s Digest and Family Circle. He can be reached at firstname.lastname@example.org or through blynott.com.
Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an accountant or tax advisor for advice regarding your particular situation.