Money is a bit of a taboo subject in our society, but is a key part of our well-being. Money can’t make you happy, but it’s hard to be happy if it is a source of constant stress in your life. In this three-part series, we want to empower people with basic financial knowledge so that they can live the life they want. Think of this as a crash course in financial planning for beginners.
There are no shortcuts or get-rich-quick schemes to be found here – just advice that we have found to be useful over the years. After reading our three-part series you will have a good idea on how to start investing.
Before we dive in it is important for you to accept an important fact.
The majority of people will never achieve financial freedom through working at their jobs.
We’re not saying you need to start your own company or always have a side-hustle. What we are saying is that you need to learn how to properly save and invest your money. You will need to overcome your innate desire to be a big consumer, and develop (and stick to!) a plan that will provide you with financial freedom.
In the first part of this series, we want to share five myths of the financial world with you. People often fall prey to “professionals” who perpetuate these myths, and billions of dollars have died as a result.
Myth 1: The market can be beat
When we say the “market” we mean the stock market as a whole. A good gauge for the overall market in the United States would be the S&P 500 index.
In the history of the stock market, only a few gifted people have beaten the market’s returns consistently.
Unfortunately, you and your financial advisor are not a part of this group. This is a tough pill to swallow for a lot of people, but the numbers don’t lie.
Here is a crazy statistic to prove how few people can beat the market: less than 5% of actively managed mutual funds beat the market.
An actively managed fund is where the fund manager and their team pick and choose their holdings to provide the best returns for people who buy their fund. These fund managers fly all over the world to meet with company executives to gain an edge in understanding their business. This is supposed to translate to amazing returns, but it rarely works out that way.
This means that when you buy an actively managed fund, 95% of the time you’re paying extra fees so that you can make less money than if you had just bought a fund that tracks the overall stock market. It sounds crazy, but it’s what most people do because the fund industry does such a good job at selling their products!
If you want to keep more money in your pocket, then you need to utilize passively managed index funds that track the overall stock market. With this strategy, the fund manager is not picking and choosing their holdings to try and beat the market. They simply buy the entire market (or a close approximation of it) and ride it. 95% of the time this boring and passively managed index fund will beat the glitzy and highly promoted actively managed fund.
The best part about a passively managed index fund is that the fees are way lower than actively managed funds. A passively managed index fund will usually have fees that are below 0.5% of your invested amount, whereas an actively managed fund will usually have fees in the 2-5% range.
The only people that consistently make money through actively managed funds are the ones collecting the fees.
Do you want more proof? If so, check out this bet that Warren Buffett made with managers for actively managed funds: http://fortune.com/2017/12/30/warren-buffett-million-dollar-bet/.
Action: Check your investment portfolio to see if you have any actively managed funds. If so, we would strongly suggest you consult your financial advisor on switching to passively managed index funds.
Myth 2: People are telling the truth about fees
Depending on how your financial advisor is certified, they may not have a fiduciary duty to keep your best interests in mind. Unfortunately, this means that more often than not people do not tell you the full cost of investing.
From our research, the average cost of owning a mutual fund is about 3.2% a year when you include all of the fees. This doesn’t sound like much, but for every percent increase in fees, about 20% of the final value of the average retirement portfolio is eaten away. This is because the extra fees reduce the amount of money that is able to compound year after year.
If you’re not careful, most of your savings will literally end up in someone else’s pocket.
Investing in index funds (whether they are mutual funds or ETF’s) with fees of less than 1% will make a huge difference for your portfolio.
Action: Make sure you know the total fees associated with your investments, and get rid of any investments that has a total fee of over 1.5%.
Myth 3: People are telling the truth about returns
One of the golden rules of investing is that it is way more important to avoid losses than to get gains.
Why is this you ask? Let us show you with an example.
Let’s say you have $100 in your portfolio. Due to unfortunate circumstances you lose 50% of this in your first year of investing. This means you now have $50 in your portfolio.
In the second year, your fortunes have turned and your portfolio is up 50%. You now have $75 in your portfolio.
Your average (time-weighted) return is 0%, but your actual return (dollar-weighted) is -25%. We will let you take a wild guess at which one fund companies like to report.
Also, guess what happens when a fund performs poorly a few years in a row. It usually gets closed down. This way the poor record is erased, and the fund manager can start a brand new fund.
Action: When you’re trying to decide which funds to buy, you need to make sure you understand what the actual return is, and what the track record of the fund manager is.
Myth 4: Your financial broker is on your side
Your financial broker is likely a nice person. However, he or she also likely does not fully understand the three myths above.
Furthermore, their working model has a serious conflict of interest. Your broker has a responsibility to grow your money as well as a duty to increase their company’s profits.
From what we’ve already learned in this article, the two duties are mutually exclusive. The higher the fee of the financial product you buy, the more money the broker makes.
You should always get financial advice from a registered investment advisor (RIA), who gets a predetermined annual fee from you rather than commissions from selling high cost funds.
Action: Check to see if your financial advisor is an RIA. If you need help finding an RIA, check out the National Association of Personal Financial Advisors.
Myth 5: You have to bet big to win big
Don’t forget that one of the golden rules of investing is that it is way more important to avoid losses than to get gains.
Ideally, you want to risk a small sum of money for the potential to make a large sum.
We don’t want to get into the details of how various financial instruments work, but you should ask your RIA about the following products: structured notes, market-linked CDs, and fixed indexed annuities.
All of these products have the feature of protecting your invested principle but also giving you access to upside if the market grows.
Action: Book a meeting with your RIA to learn about the products listed above.