This article first appeared in the Telegraph
Were we really so credulous? Did we really know so little about foreign food? 62 years ago today, Panorama aired one of the great April Fool’s jokes. The report showed farmers apparently picking spaghetti from trees, and laying it out to dry. It allegedly fooled even the BBC’s director general and prompted a bout of hand-wringing in the papers about whether it was right to inflict such a terrible hoax on the public.
We like to think we’re a bit more worldly-wise today, but fake news has not disappeared. Even when they are not presented as a wilful deception, there are plenty of myths peddled as truth. Nowhere more so than in the world of investment. Today is a good day to puncture a selection of them, so here are eight of my favourites.
- It’s never wrong to take a profit. This is one of the most expensive myths of all and one that is contradicted by some of the wisest words in investment: run your profits and cut your losses. The Art of Execution, a book I have mentioned a few times here, is based on the fact that successful investment is to a large degree a product of letting your winners run while acting decisively to either kill off or double down on your losers. If you do this with discipline, a success rate of less than 50% might be enough to deliver a decent return over time.
- Diversification is just di-worse-ification. The people who promote this myth tend to be investors who, thanks to skill or luck, have put together a decent run of performance. Peter Lynch, the Fidelity manager, coined the word in his 1989 book One Up on Wall Street but he didn’t invent the idea. Forty years earlier, Warren Buffett’s mentor Benjamin Graham said that 10 to 30 shares were more than enough to diversify a portfolio. Nick Train, the well-known UK investor, has made a success out of running a fund with around 25 shares in it. But for most investors the problem is not too much diversification, but too little. This, incidentally, is a problem encouraged by company share save schemes which can leave workers over-exposed to their employer when things go wrong (think RBS).
- A good story, or strong growth, equals a good investment. Sometimes these positives will result in a good investment outcome. Often they won’t. That’s because investment success is about the combination of several factors. A good growth story helps, for sure. But if you pay too much to jump aboard a glamorous band-wagon you will likely come to regret following the herd. There’s been plenty of research that shows the straight-line inverse correlation between the price you pay at the start of your investment journey and your profit at the end.
- Charges don’t matter. In the short-term a small additional charge might not seem terribly important. It is particularly easy to be convinced of this in a strongly-rising market where a 1% fee might seem immaterial against a capital gain of, say, 10%. In a lower-growth, lower-yielding world such as the one we invest in today, however, that 1% charge might be the difference between a 5% return and a 4% gain. £1,000 invested at 5% a year for 30 years will turn into more than £4,300; at 4%, it will be worth just £3,200.
- It’s already gone up a long way - I’ve missed the boat. Maybe you have, maybe you haven’t. The distance a share has gone, or how long it has been rising, is beside the point here. If earnings have been growing faster than the share price has been rising, a share could be cheaper after ten years of steady gains than it was at the outset. Bear this in mind when people say we must be close to the end of the post-financial-crisis bull market because it’s been going on for so long.
- You will be successful if you buy low and sell high. Well, yes, obviously you will. And good luck with trying it. Chances are you won’t be able to do this consistently over time. People who boast about their market-timing prowess tend to be selective with their war stories. Timing the market is the holy grail of investment but it’s a fool’s errand attempting it. Far better to focus on time in the market.
- Talking of time, here’s another damaging myth: it’s different this time. Sometimes described as the four most dangerous words in investment, this is the ultimate piece of self-delusion. The precise nature of each business and investment cycle may be slightly different but the behavioural essentials of greed and fear are unchanging.
- Cash is safer than shares. Well, that rather depends what you mean by safe. If you mean that the value of your savings will not bounce around so much, that cash is less volatile, then by all means call it safer. My understanding of risk is different. The only risk that matters to an investor is the permanent destruction of their capital. More particularly, the purchasing power of their capital. The journey an investment takes along the way is unimportant to an investor who is not obliged to sell at the wrong time. So make sure you have enough cash to hand for unforeseen disasters - and put the rest to work in the stock market, which unlike bonds and cash has outpaced inflation over the years.
There are many more myths I could take on with more space: the efficiency of markets (they’re not); the superiority of passive investing (see how that theory fares in a downturn); the past not being a guide to future performance (it’s the only one we have). Perhaps we have more in common with our spaghetti-harvest-fooled grandparents than we’d like to believe.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.