Uncommon Financial Sense

Have you ever heard the phrase “financial sense”?

While the phrase may sound awkward at first, possessing a head full of financial sense is just as important as common sense. Understanding how to save, spend, and invest is essential for financial success. Unfortunately, financial sense is not always the same thing as common sense.

Due to this inconsistency, most people travel through life with a financial toolbox full of shiny, but useless widgets—optimistic assumptions and flat out falsehoods. Here are three commonly held, but incorrect, ideas about investing.

You can beat the market.
This statement might make sense to you. In life, there are always people who consistently excel. Millions of people invest in the stock market; surely, the smartest investors will come out on top at the end of the day. And who’s to say you aren’t one of the smartest? Oddly, the evidence does not back up the theory.

The research shows that the vast majority of professional investors earn sub-par returns year after year. Even the most successful investors and fund managers do not beat the market indefinitely.

Even if someone could make the right decisions to beat the market each year, how would you find the right fund manager at the start of his career? If it’s not possible to beat the market, what is the next best option? Index funds. Index funds allow you to match the market’s return minus investing fees (which all mutual funds charge).

Investing in stocks is risky.
These is some truth to this statement. Investing in the stock market entails risk and investing in individual stocks is extremely risky. But, the deeper truth is, most people can’t afford to avoid the stock market, thanks to inflation.

Few of us make enough to simply live off of our savings. Most of us invest some or all of our retirement savings in hopes that they will grow rather than simply matching inflation. Even if you do earn enough to save tens of thousands year after year, you might find it difficult to adjust to the frugal life required to stretch your low or risk-free interest earnings.

So why is it dangerous to avoid the stock market? It is dangerous because inflation can decimate savings accounts and bond investments. Stock market investments are somewhat protected because businesses usually can charge more as the dollar drops in value.

Does this mean that investing in stocks is risk-free? Hardly. However, the stock market may not be as risky as people like to claim (i.e. purveyors of gold, real estate, etc). Fortunately, we can reduce our exposure to risk by holding our stock investments in low-cost index funds, allocating our investments wisely, ignoring the media, and the market’s short-term ups and downs.

You will earn 10% or more in your retirement account.
Investment companies and investing gurus love to quote the high returns their funds have experienced and the average return of the stock market. It is often treated as a natural law. While the stock market generally trends upward, we can only make educated guesses about how quickly the value of our holdings will go up.

Three factors have a huge impact on future returns: expenses, inflation, and current valuations. Investors can earn more by losing less to investment expenses. However, inflation is out our hands; every percentage point of inflation directly reduces investors’ real return.

Similarly, current valuations are what they are. If stocks are selling for bargain prices, there is more room for upward growth. If stocks are relatively expensive, investors may see returns in the low single digits instead of the 10%+ returns they were promised.