Your Black Money Myths: 3 Myths About Investing

When it comes to money, there is a lot of hoopla. As I witness the financial frenzy that comes with each fad, I am reminded of the days of snake oil salesmen, taking advantage of the hopes and dreams of many to fill the coffers of the immoral. When I watch the late night “Get rich quick” schemes, I wonder if anyone is getting rich other than the professional, perpetrator or pastor selling the book being featured. Some of the advice shown on television isn’t bad, but as a Finance Professor, some of the advice makes me shudder. Not to say that all of the self-proclaimed “financial experts” are immoral or incorrect, but it is not hard to find flaws in their perspective.

Being mislead causes the most pain to those who do not understand money. Many people do not understand the basics, which can make them vulnerable to those who use long words to confuse them. When I teach Finance courses to my students, I enjoy finding simply ways to communicate complicated concepts. The ultimate goal is for the student to be able to discern the good advice from the bad.

I have compiled a list of quick and dirty myths about money and finance that can help you to get started on your path toward financial understanding. While this is just the tip of the iceberg, perhaps the ice will whet your appetite to learn more about the world of financial management.

Myth #1) An investment is only good if it helps you to earn more money

According to quite a few financial advisors, every penny you invest should be put into assets and ventures that are going to give you a financial return. The “gurus” tell stories about how investing your money to make more money implies that you are smarter than the person next to you. By virtue of your being smarter, you are therefore entitled to a happier life. Money is also made into the most important thing on earth, and you end up feeling bad if you are not, as you are sometimes told, hoarding every penny and allowing those pennies to dominate your personal life.

There are quite a few scenarios in which money should be used to make more money, and there is nothing wrong with that. But more money doesn’t always imply you will have a wealthier life. There are times when buying a car or taking a vacation can be much better uses of your money than buying another stock, bond or piece of real estate.

In fact, if the sole objective of money is to make more money, then that means you should just send your children to Dr. Kervorkian (the man who kills people for a living), since kids are expensive and don’t give you any of your money back. Don’t be so hard on yourself when it comes to investing. Investment is like working at the office or having sex: it’s ok, as long as it’s done in moderation.


Myth #2) Only some investors have a portfolio

What is a portfolio? A portfolio is a set of valuable investments that give you something back. When I ask my students “How many of you have a portfolio?”, only a few of them raise their hands. I then explain that making an investment is equivalent to putting a scarce and valuable resource toward the creation of something more valuable over time. Most of the students fail to realize that money is NOT the only scarce resource you can invest. You can also invest your time, your energy, your health and even your love. All of these amount to allocations of scarce resources, and most of us make these investments every single day. The decision to get out of bed is an investment, since you could easily spend your time lying around watching TV. The clothes on your back are part of your portfolio, since you have invested to obtain them, and they do provide you a return (your reward for investing in clothes is that you get the peace of mind of looking good and not having to walk around naked!).

The point here is that you should have a more complete way of thinking about investing. Money is only one type of investment, and it is sometimes the least valuable asset in our life portfolio. You have probably heard people say “time is money”. Well, that’s not exactly true. The truth is that time is MORE VALUABLE than money! If you are 22 years old, and you waste your time, you will never get to be 22 years old again. No amount of money can make up for being, say, falsely incarcerated for 15 or 20 years. However, if you lose money, you can usually get it back later. So, whether we have money or not, we are always investing.

Myth #3) The stock market is one of the best places to make money

The stock market is not a great place to make money, at least not in the short-run. It is a great place to keep the money you’ve already made. Don’t get me wrong. There are many people who’ve made their fortunes trading stocks, but that is not the norm. Additionally, even though there are many who’ve made a fortune trading stocks, more fortunes have been made using other investments. The stock market is what they call an “efficient market”, which means that it is tough to find a good bargain. This is a lot different from some other markets, where you can find a pretty good deal if you look hard enough.

When looking for a place to invest your money first, you should start with the investments that offer the highest return for the lowest risk. In other words, if you find something you are familiar with, you are likely to have a better outcome. One place to start might be with an investment in YOUR SELF. Do you have enough education to have the kind of career you would like? How about going back to school for that college degree or MBA? In my own research, I have determined that the returns to this kind of investing far exceed the returns generated from the stock market or other places.

You might also consider investing in Real Estate or even in the business of a relative. If you have a friend that is going into business, and you have reason to believe that this person is fulfilling an unmet need, has a guaranteed customer base, and is reliably going to give you your money back, then this kind of investment might be better than going right to the stock market. Just make sure that you sign a legal contract so there are no misunderstandings.

You can also make a lot of money by cutting your spending. Consider the following two options. Let’s say you have a credit card that charges 15% interest with a balance of $10,000. You have $10,000 available for investment, and you can either use the money to pay off the credit card or invest in stocks. Let’s also assume that you expect to earn 10% on the stock market (roughly what the US stock market earned during the 1997 – 2001 time period). There are two things you must remember about this investment:

1) The amount you are paying on your credit cards is greater than what you would earn from the stock market.
2) The amount you would earn from the stock market is risky, so it could be higher or lower than the average. The amount you are paying on your credit card is going to be the same, no matter what.

So, you have two choices: You can either a) invest the $10,000 in the stock market, earning an average of 10%, or you can b) Use the money to pay off your credit cards, ridding yourself of the 15% interest expense. If you go with option a) (investing in the stock market) and assume that you are guaranteed 10% on your money, you will earn $1,000 and have to pay $1500 in credit card interest (15% x $10,000). This leads to a net loss of $500.

If you go with option b) (paying off the credit cards and not investing in the stock market), you can save $1500. So, there is a $2,000 ($1500 – (-$500)) difference between these two choices.

The point is simple: “A penny saved is a penny earned”. You can rephrase this statement as “A penny not paid in interest is a penny earned in interest.” By using excess funds to pay off high interest debt, you have found one of the best investments around.

The point of this article is the following: Investing in the stock market is nice and glamorous, but it’s not the way to make money. If you really want to make money, you should start with investments around you: Buying a home, paying off credit cards, or going back to school. These investments give higher returns than the stock market and lead to a wealthier life.


Myth #4) Putting all your eggs in one basket might be OK

“Diversification” is an important investment concept that most investors do not think about. It is the idea that you should not put all your eggs in one basket when investing. Many investors do not follow this rule, instead putting all of their money in one place. This is a BAD idea! Consider the employees at Enron (the company that went bankrupt a few years ago). Some of the Enron employees had their entire retirement plan with one company. Many of these people lost their life savings when the company went bankrupt.

Every good thing eventually comes to an end, and if you are properly diversified, you are protected when things really do fall apart with your investments. Diversification means that you not only buy a large selection of stocks, but you keep your money in different types of investments. For example, if a person has a portfolio to invest, they should keep a few thousand in different kinds of stock, some of the money in their savings account for a rainy day, some of the money in real estate, and some of it in the family business. Spreading your money around protects you well when things go bad in the market.

Another thing about investing is that it should be GLOBAL. If you buy a portfolio of stocks, you do not want to have your money focused on the United States. There are mutual funds which allow you to invest all over the world, where many of the best opportunities are. Make sure that you are diversified across boarders, so if one country’s market fails, you will have investments all over the world to protect you.


Myth #5) If a stock has done well in the past, it will continue to do well in the future

Most people think that if a stock has a good past performance, it is going to continue to be a good stock in the future. All of my own academic research, as well as the academic research of many others, shows that this assumption is almost always WRONG. There are some rare exceptions in special cases, but for the most part, the past performance of a stock or mutual fund manager is no indicator of what is going to happen in the future.

You see it all the time: magazines will rank the best performing stocks, top industries, and best performing mutual fund managers. This publicity is great for the fund manager, because he/she knows that most investors do not know the truth. The truth is that when ranking investment managers and stocks on the prior year’s performance, there is almost no positive relationship between the performance of the past and that of the future. Notice that I say “almost no positive relationship”. That is because my research shows there are some rare cases in which there is some relationship, but this is not something worth betting the house on.

The best way to invest in stocks is not to chase winners. The best approach is to simply invest in solid companies for the long haul and keep your portfolio diversified. If your portfolio is properly diversified and you leave money in your investments for several years, you will most likely find a natural growth which allows you to sleep at night. Those who chase every hot stock down the street end up driving themselves nuts.

Dr. Boyce D. Watkins
www.myfinanceprofessor.com