Perhaps you have seen the Discovery Channel television program “Myth Busters.” Adam Savage, Jamie Hyneman, Kari Byron, Grant Imahara, Tory Belleci go about proving whether myths are true or not. Unfortunately they have not tackled any financial myths, of which there are plenty. This post will address 5 such myths and perhaps motivate the TV show to address other financial misunderstandings.
- “Dollar Cost Averaging will increase my return.” Sorry folks, dollar cost averaging can make you feel more comfortable about investing into the markets, however there is no evidence to justify the belief that it will increase your return. A primary reason is that the stock market rises more often than it falls so the sooner you have more into the market, generally the higher return you will have. This is particularly true when you are investing over long periods of time.
- “Picking the right investment is the main factor to high returns.” Sorry…Wrong again. Several studies over time have shown that having the proper asset allocation (mix of investments, stocks, bonds, and cash) that is appropriate for your goals, time frame, risk tolerance, and risk capacity is responsible for a majority of your portfolio return. Trying to pick the next “big thing” or the “right” investment is very difficult hence the SEC states, “Past performance is a poor indicator of future performance.”
- “I don’t need to worry about long-term care costs because Medicare will pay for it.” This is perhaps one of the biggest myths ever. Medicare will pay for skilled nursing care but only for a limited time frame. The vast majority of nursing care costs are custodial in nature and Medicare specifically excludes this type of care. You are on your own for this cost. Don’t look for the government to help unless it is through the Medicaid program for the indigent.
- “It’s always best to roll your 401(k) at retirement into an IRA.” Not true but it could be in some cases. Unfortunately, many companies like Fidelity encourage employees to roll over their 401(k) to an IRA when leaving an employer. When doing so the employee loses some asset protection if sued and the ability to borrow from the 401(k). Many 401(k) plans have very good choices available at a very low cost and should be retained. In some cases, the 401(k)’s don’t give you enough diversification of investment choice or have high fees, and going to a no-load IRA would be a better choice. Understanding all the differences is important. If you are unsure, get unbiased advice from someone who will not profit from the advice, such as a fee-only planner.
- “Actively managed mutual funds have higher returns than index funds.” This myth has two sides. If you believe economists, college professors, and Nobel Prize winners, over time, index funds (passively managed) provide higher returns than the majority of actively managed mutual funds. If you tend to believe stockbrokers, Wall Street, Banks, and big for-profit companies (all of whom are trying to make money off your investments), you may believe actively managed mutual funds do better. Granted, some actively managed funds beat the index in the short run but no one knows which funds those will be until after it has occurred. Actively managed funds have higher trading and management costs and can incur more income taxes. As a result, passive index funds do better over the long term most of the time.
Do you have a financial myth that you would like confirmed or busted? Just ask!