When it comes to investing and retirement, there is so much misinformation and contradictory advice out there that it’s difficult to know what’s true and what isn’t.
Here are 12 myths busted:
Myth #1: Stocks are riskier than bonds; bonds are safe.
One thing that’s true for retirement is that the older you get, the less risk you should take. But, are bonds safe? Are stocks riskier? The answer is, it’s complicated.
Stocks
Individual company stocks can be very risky. Some are designed for growth, some pay dividends, some are rated higher than others, etc. Most mutual funds are comprised of many different shares of stocks with different characteristics depending on the focus of the fund itself (international, mid-cap, etc.) Owning a mutual fund is usually less risky than owning shares of only one stock, because the risk is spread among multiple companies’ financial performance. (See myth #3.)
Bonds
Individual bonds are much different than bond funds. Individual bond notes are issued by international governments, the United States, municipalities and corporations, to name a few. They offer protection of your principal* which is returned at maturity, along with a fixed interest rate paid or credited along the way, depending on how the individual bond note is structured. The interest rates paid by bonds are correlated to the interest rates set by the central banks, and interest rates have been kept low since the 2008 recession.
*It’s important that you pay attention to the principal value you have in your bonds. In general, your principal is usually safe, especially if you buy high-grade bonds and hold them to maturity. However, some individual bonds are riskier than others, known as credit risk. What you need to watch for is if/when your bonds ever break par, like Puerto Rico bonds did; investors lost thousands on those. Many municipal bonds are at risk now, too, as they struggle to pay pensions.
Bond Funds
On the other hand, bond funds are mutual funds comprised of various types of bonds with different maturity dates paying various rates of interest. These funds are traded on the stock market.
Most brokers use the term “bonds” when they actually mean “bond funds.”
When you move beyond bonds into bond funds, you start introducing new sources of risk that you don’t have when you’re buying individual bond notes. And, that’s because of the way these mutual funds are structured. They’re pulling together hundreds of millions of dollars, and they’re constantly buying and selling large numbers of bonds over time.
And, time, when it comes to bond funds, is absolutely vital. There’s a metric when you’re buying bonds that you should understand: it’s called duration. What a lot of these bond funds are trying to manage is the duration of the underlying portfolio. They’re also trying to manage interest rate risk, because when interest rates go up, the value of bonds goes down.
Let’s say the fund owns a lot of Triple-A corporate bonds that yield 3.3%. Newly-issued bonds with the very same rating may be paying a higher interest rate. As an example, maybe the interest rate just went up and the new ones are paying 4.3% now. In order to sell the older bonds, the fund manager has to sell them below par. And that’s what these large bond funds are doing daily. Bond fund managers are offloading their lower-interest-rate yielding or lower coupon bonds and selling them below par in order to chase higher yield for the fund as interest rates are going up.
Bond funds are also subject to market risk; they are affected by the market’s overall performance.
This additional risk puts your principal at risk; it puts pressure on your principal over time. So, are stocks riskier than bond funds? It’s tough to compare, but your principal is certainly not safe with bond funds. Bond funds should not be considered safe for retirement, which busts our next myth wide open.
Myth 2: You should shift into more bonds as you get older.
First of all, with interest rates at rock bottom lows, it makes no sense to hold the majority of your retirement portfolio in a lot of bonds yielding next to nothing right now. Second of all, if you have a broker using the “Rule of 100” for your retirement, you need to find another advisor, pronto. (Skip to myth #12.)
The Rule of 100 says that as you get older, you should move more of your assets into “safe” investments: if you’re 60-years-old, 60% of your assets should be in “safe” investments, if you’re 70-years-old, 70% should be moved, etc.—the percentage should match your age as you get older.
Sounds good, right? But the trouble is, most brokers define safe as bond funds. Period.
We just talked about the risks with bonds and bond funds earlier in myth #1. When you are young and can afford to just hold onto them, you are usually fine. But remember, in retirement, you’re going to stop receiving a paycheck, and start withdrawing money from your portfolio to create retirement income.
If interest rates move up from their current rock bottom, your bond funds—the majority of your portfolio—will lose value. This is a recipe for disaster. Just say no.
Myth 3: Diversification will protect your portfolio.
Portfolio diversification is what Nobel prizes have been won on; the concept is not putting all your eggs in one basket. It’s pretty well understood with modern portfolio theory that you should not have everything in a single stock because you start exposing yourself to unnecessary risk. Think about it, if you have a portfolio containing 100% Apple stock, if Tim Cook gets hit by a bus tomorrow then you can bet that that stock will be down a substantial amount. Whereas if you owned a whole basket of tech stocks, while Apple would be down, the other stocks would be unaffected.
A properly diversified portfolio should spread risk out among various asset classes or types beyond stocks. However, asset-class diversification is not a way to immunize or vaccinate yourself against risk in general. Diversification still means you are going to go down with the market when it crashes; your portfolio will still fluctuate, it’ll get bigger and it’ll get smaller through the years.
This is fine when you’re young, because you are simply “buying and holding” your investments. A stock market downturn, which happens historically every seven to eight years, won’t affect you because of dollar cost averaging—you may even pick up some bargains in a bear market.
In retirement, however, you’re adding a new variable, which can cause a lot of damage to your portfolio over time. When you start withdrawing money from a fluctuating account, you’re increasing your losses and limiting your gains. Depending on what’s happening to the market at the beginning of your retirement, you could be wiped out, as many retirees were in 2008 due to sequence of returns risk, which multiplies losses exponentially.
Myth 4: Insurance is an investment.
Insurance is not an investment; it’s a tool used for specific purposes. Primarily, it’s a hedge against unexpected death or disability. But, many policies come with high fees and an underlying structure that’s complex and not in your favor. Some universal life or whole life policies might fall into this category.
Relatively inexpensive term life insurance, however, might be exactly what you need to protect your young family from the financial fallout of the unexpected death of the breadwinner. And the death benefit aspect of some permanent insurance policies available to healthy older people might appeal as a kind of tax-advantaged estate or wealth transfer plan. Insurance can sometimes provide income replacement for a surviving spouse in retirement, too.
It’s really on a case-by-case basis how insurance might be used. But three kinds of insurance in particular should come with red flags and warnings, because they’ve often proven to be terrible investments for retirees.
1. One is traditional long-term care insurance. The risk of needing long-term care at some point in retirement is real, and it can bankrupt the healthy spouse, but traditional long-term care policies do not deliver. You can pay thousands into the policy through the years, and suddenly you get a letter from the insurance company saying, “Premiums are going up, and you have three options. You can pay our new exorbitantly higher premium—often double—and keep your same benefit. Or, you can pay the same premium but cut your benefit in half, or you can cancel the policy.”
All of these options are a win situation for the insurance company, and all of them are lose options for you. You’ve invested a lot of money through many years which may now be completely wasted, because the price just went up to the point of being unaffordable. And even if you can afford to keep the policy in place, what if you never end up needing it? That’s a lot of money you could have invested in something else in order to self-fund long-term care if you do end up needing it.
2. Second is variable annuity policies, which are life insurance policies, but are actually sold as investments because part of the policy is tied to the stock market. Variable annuities are just full of fees, if people actually knew what they were buying, they would not purchase them.
There’s the fee to the broker, insurance agent or whoever sold it to you which gets paid to them at the time of sale, as well as every year that you own it. There’s a fee that gets paid to the custodian or the institution that holds or houses the variable annuity. And there are yearly fees to the insurance company as well as the mutual fund.
Because of the high fees, variable annuities lag the market in the up years and they accentuate the losses in the down years; they can’t keep up with the S&P or whatever index that they’re trying to keep up with.
And on top of all that, the guarantee is just a high watermark when you die. What’s the point of a guarantee if you never get it—if it only goes to your beneficiaries when you die?
3. Income annuities with income riders. In short, you are paying an insurance company to get your own money back, which almost never pays off when you examine the cost of this privilege.
Myth 5: Index funds are better than actively-traded funds. Index funds will protect you against market volatility.
Markets go up and down. Index funds, or funds tied to stock exchanges like NASDAQ or the S&P 500, don’t protect you from market downturns, they move up and down with the market. Your principal is not protected, whether you own an actively-managed mutual fund or an indexed ETF with extremely low fees. The only thing you’re getting with indexed funds is inexpensive diversification. And as we’ve already covered in myth #3, diversification doesn’t protect you from market volatility.
As Roger Ibbotson, a Yale emeritus professor considered one of the most brilliant people on Wall Street often points out, there are more indexes out there than actual investments to pick from. Everyone just has a different calculation for their index, and it just gets kind of silly. Indexes are almost more of a sales tool than anything else today.
Unlike index funds, the variables you get with managed, actively-traded funds are the human variable of a portfolio manager making decisions and executing trades based off of rules that they’ve dictated in their prospectus and/or the particular algorithm they use to make their decisions. This can be a benefit or a detriment depending on current results. The biggest downside with actively-managed funds is their higher fees. Watch out for 12B-1 fees in particular, which brokers are not required to disclose, and which can affect overall performance.
When you’re young and in the position to hold your investments rather than draw money out for retirement income, ETFs can cost less. But ultimately your investment decisions should be based on net-of-fee performance as well as your need for principal protection in retirement.
Myth 6: You should sell stocks on a seasonal basis.
There’s a phrase that says, “sell in May, and go away.” But, in reality, stocks are active in the summer months, so this is just a personal choice. In fact, during summers the markets average a 5.6% gain historically. So, if you decide to go on vacation and want to ignore the stock market, that’s your choice, but the argument that you should get out doesn’t have merit mathematically.
Myth 7: Gold is the best investment of all time.
There isn’t any single investment out there that can be considered the “best.” It’s all relative to your time horizon in terms of needing the money as well as your goals. Gold, as a long-term repository of value, has proven to be effective. But, gold prices fluctuate drastically, and gold is not reliable as a hedge against stock market volatility. The moral (and pun) is: “Don’t chase shiny objects.”
Myth 8: Five-star mutual funds are the best.
You’ve probably read the investment disclaimer that says something like, “past performance is not a reliable indicator of future success.” The five-star list is very likely to change. Once again, your decisions about retirement should be based on safety, principal protection and retirement income. Does it make sense to be in any mutual fund which is at risk in the stock market if you’re going to need to withdraw the money in the next seven to ten years for retirement income?
Myth 9: You must buy low and sell high.
If it was easy and if it actually worked, everyone would be buying low and selling high. That’s everyone’s investing goal. But slow and steady strategy, removing the emotion and focusing on math, actually wins in the end.
In fact, slavish addiction to buying low and selling high can be the quickest way to lose money. Day trading and chasing returns with the latest hot stock is where retail investors—retail investors are the people that are not institutions or hedge funds or sophisticated investors—fall down.
Retail investors often fall into the “buy low, sell high” trap and they don’t even realize that they’re doing it. They’re buying in thinking, “Oh, it’s been a huge run-up, and I’ve missed out, I should’ve bought it 10% percent ago. And my friends, I should’ve listened to them, man I’ve got to buy this now.” And then bam, it goes down and they lose money.
You do not know what is going to happen in the future, especially if you’re talking about a single asset class. No one does. It is much smarter to have a long-term investment horizon, anticipate that you will have losses and plan on having some gains to offset those losses. It absolutely is not smart to attempt to dictate whether an asset price is low and then try to call whether it’s at a high.
Most people are going to have a friend that says, “Well I do it and I’m successful.” And they probably won’t admit to it, but it’s just a matter of time before they are wrong again.
Myth 10: Wall Street is rigged.
Some people claim that Wall Street is rigged against the individual investor. There is some evidence to back that up, like after-hours trading. But the investors proclaiming “rigged” the loudest are just spreading a conspiracy theory, a sort of victim mentality.
The question really should be, “How informed is the individual investor about investing?” Because if they are just going off their emotions and gut feelings, then, yes. The emotional investor could feel like trading is exactly like playing the slots in Las Vegas.
But if you are professional and you have the information coming in with the experience, the tools, and can assess the market as it really stands, then no, it’s not rigged against you. Not at all.
It would be a disaster if you tried to play football and didn’t know the rules. It’s a disaster to try and earn money in the market without understanding the fundamentals about how the market actually works.
Myth 11: You can get 12% returns in the market.
Twelve percent? Really? Are you aware that the market since 2000 averaged anywhere from 6-7% or so? Expecting a 12% return is unreasonable, it would be enormous and nearly impossible given today’s economic and market conditions.
It’s important for any investor to understand that the markets crash every seven to eight years, and cycle every 18. If you were somehow able to magically have predicted exactly when to be in the market and when to get out over the last two decades, you might be able to sustain a 12% return. If you would have missed every downturn or crash, yes.
But that’s impossible. No one has a crystal ball. A 12% return every year is too aggressive.
Myth 12: All investment advisors are the same.
You could broadly define an investment advisor as an individual that’s providing you with advice on investments. But the truth is, the types of investments that various advisors recommend, or are even able to offer, differ completely based on whether they are an insurance agent, a stockbroker, a banker or an actual independent fiduciary required to provide only recommendations in your best interests, not theirs.
When you dive into technical definitions, details and licensing requirements, all investment advisors are absolutely NOT the same. For instance, fiduciaries have different legal compliance standards; they have different tests that they have to take. They have different regulators that come in to their offices and review their books to evaluate whether they’re actually doing what is legally in the best interests of their clients. They are fee-based, and they are required to disclose all fees. Fiduciaries are not allowed to make commissions on securities trades.
Working with a fiduciary is critical. And yes, they are hard to find—Tony Robbins did the research and found that less than 5% of the investment advisors out there are actually fiduciaries. You also need to understand that some fiduciary investment advisors specialize in retirement, but many do not.
No, all investment advisors are not the same. Not even close.
