The Dirty Dozen: 12 Fallacies that Investors Believe in Good Times

As the longest bull market in modern U.S. history just keeps on rolling, have you noticed that many people have become less comfortable talking about their investments?  It’s almost as though the topic of personal investing has joined the ranks of politics and religion at holiday tables.  Remember the bull market of the 1990s?  Back then, it seemed that everyone wanted to talk about investing.

But things feel different now.  I imagine that there are several reasons for this shift.  Some people may have acquired artificially strong convictions about their investments and just don’t want to be challenged.  Others may be in denial that the bull market eventually will end.  Still others may remain caught up in the fear instilled by the last financial crisis.

Whatever the reason, now is precisely when we should be talking about our investments.  While markets are achieving new highs, we should be practicing humility and honesty, reminding ourselves of the most common fallacies that investors tend to believe in good times.  Here’s my dirty dozen, in reverse order:

12. All risks are eventually realized. Investors must be prepared for myriad risks, but just because they prepare for a risk that never comes to fruition does not mean that they made a mistake.

11. We should invest in what excites us. Certain investments can be exhilarating, but it often pays to be boring when it comes to investing.  Emotion generally is not an investor’s friend.

10. Risk should be measured primarily with statistics. Statistical measures are important, but what is most important is potential variability in current and future cash flows.

9.  A winning portfolio should be left alone. Even when a portfolio is well constructed, rebalancing to strategic asset allocations should occur regularly.

8.  Three or five years is a long time. Investment strategy – and assumptions regarding risk and return – must be considered over far longer periods of time.

7.  There is a best investment discipline. Sure, sometimes passive investing outperforms active investing; or growth investing outperforms value investing.  The list goes on, but it is critical to remain objective and have a longer-term perspective.

6.  The crowd knows best. Running with the herd is the perfect strategy for wildebeest avoiding lions.  It’s not the best strategy for people trying to optimize portfolio performance.

5.  A specific investment, or the markets generally, owe you something. If you suffer a loss, never assume that if you just hang on, it will be restored.

4.  Your portfolio returns can be compared to those of your neighbor. Well, they can, but the odds of your neighbor having the same goals, needs, and other circumstances as you are pretty low.  If you’re investing to beat your neighbor and not to achieve your personalized goals, you’re probably taking too much risk.

3.  It’s ok to ignore or obsess over taxes. Taxes are always an important consideration when constructing a portfolio.  People often fail to understand that after-tax returns can be enhanced dramatically through security selection, asset location, and sound management techniques such as tax-loss harvesting.  Yet, people also are prone to over-emphasizing taxes when making investment decisions.  Holding on too long to concentrated positions that should be diversified into better performing investments or making investments with the primary goal of minimizing taxes are classic mistakes.

2.  Markets can be predicted because they act as they did in the past. Markets often rhyme but rarely repeat.  Never assume that the next rise will look like the last one or that the next crisis will look like the last one.

1. Diversification is overrated. Don’t get lulled into a false sense of security.  Long bull markets are notorious for doing just that.  Diversification and proper asset allocation are critical to ensuring long-term success in and through a variety of conditions.

Want to be successful not just during bull markets but over the course of your life?  Respect the markets, stay humble, and remember that all of the above are fallacies.