To move forward, we sometimes need to dispel failed beliefs that may be holding us back. In over three decades of working with individuals of all types, backgrounds and ages, I have reduced this list to 3 widely held failed beliefs:
Stocks are Risky
Bonds are Safe
Your House is an Investment
Let’s take them one at a time.
Mr. Market vs. Mr. Value
Stocks might be considered “risky” if we define risk as volatility or variability. Stock prices move up and down. The chief reason stocks provide long term premium returns above inflation is precisely because many people can’t stomach this variability. A far greater risk for many individuals is the risk of outliving their money. In essence, a willingness to take on a smaller emotional risk by owning stocks helps avoid the larger actual risk of running out of money.
Famed author/professor Benjamin Graham used the allegory “Mr. Market” and “Mr. Value” to portray the struggle we face in avoiding the day-to-day temptations that short term “news” and commentary bring to bear. “Mr. Market” quotes prices for stocks every day and the investor is free to ignore the price or accept the price and sell. Graham’s point is the whims of the short term market determine “Mr. Market’s” fate. On the other hand,“Mr Value”, described by Graham as a “dull plodder” represents the long term value of the stock absent the day to day price movements. “Mr. Value” understands that ignoring the day to day price changes will serve his interests in the long term.
Bonds are Risky Too
Bonds or fixed income investments are probably even less well understood than stocks. Fixed income investments rely on a promise to pay and therefore are dependent upon the creditworthiness of the issuer (usually a corporation or government entity). The coupon (a throwback term to the days when bonds were physical pieces of paper with detachable coupons that represented interest earnings) and the maturity (usually some period of years in the future), determine the market price. If you want to sell the bond before the maturity date, the market determines a price which could be more or less than what you originally paid.Yes, bond prices also move up and down.
Many investors view fixed income as “safe” largely because interest rates have been falling for almost 3 decades providing bond investors with interest earnings AND some price appreciation in many instances. Well, interest rates can’t decline much more so it is unlikely that bond investors will obtain this treatment going forward. Instead, the other side of appreciation, price decline, may be in store for unwitting fixed income investors. The long term expected real (inflation adjusted) return for fixed income is near zero. Therefore, the proper role for fixed income is to smooth out short term performance and to provide money for short term needs, not as a significant contributor to long term wealth.
Your Home as an Investment?
Finally, your home can be an investment but not likely one that appreciates much after inflation. Over long stretches of time, home prices have tended to provide returns equal to the inflation rate plus or minus 1% per year (or near zero , just like fixed income). Every time we bring this up with clients, they recite an exception to the general rule. Sure, there have been times where home prices were above the long term norm and of course we now understand there have been times where prices have been under that threshold.
While residential real estate may not be a big premium return generator, it does provide some meaningful value. You accrue benefits, economic and non-economic from owning the home, but you should not think of the home as a huge receptacle of above inflation investment return.
One of our primary roles is to help clients understand economic realities and to dispel biases that may be harmful to accomplishing specific goals. Are you ready for a real conversation?