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Fund Spy
Three investing myths debunked
Lots of investing advice is wrong. The conventional wisdom is often wrong. Here's a look at where conventional wisdom fails.
By Morningstar
When it comes to investing, there is certainly no shortage of opinions. Everyone, including your friends, family, coworkers and neighbors, seems to have something to say about investing. And while their opinions can be quite different and confusing, they are usually joined together by a handful of investment axioms. Some of these are really sound, but more often than not, these pearls of wisdom only perpetuate myths -- and damaging ones at that. So, for this week's Fund Spy, I've isolated three investing myths that I simply don't agree with.
There's no risk in value stocks
At Morningstar, we tend to have a contrarian, value-based approach to investing. However, even we would agree that it's foolhardy for investors to assume that value stocks are risk-free. Sure, they came through the last bear market relatively unscathed, but that was mostly due to a unique valuation disparity that developed in the late 1990s. Now, however, it appears that investors are shoveling money into these funds with the expectation that they will always produce positive returns with minimal volatility.
This is hogwash. If you look back over the years, value funds, too, have lost money in certain markets and to this day, many experts maintain that they are by nature volatile offerings because they seek to take on a large amount of risk. That's even true of some of our favorite funds. In fact, back in 1974, seemingly harmless funds such as American Funds Washington Mutual (AWSHX) and Dodge & Cox Stock (DODGX) suffered stinging losses. The former dropped more than 17% that year while the latter lost close to a fourth of its value.
So own these funds, but do so with the right expectations. Otherwise, you're likely to be disappointed sooner or later. And by the way, if you own a real estate fund, this advice extends to you as well.
Related news and commentary on MSN Money
It costs more to run a growth fund
Do you ever wonder why you have to pay more in annual fees when you're investing in a growth fund? Large-cap growth funds on average cost as much as 10 basis points more than large-cap value funds. And small-cap growth funds are even more expensive than small-cap value funds.
So what's the reason for these inflated costs? Well, if you're listening to those in the industry, it's that growth managers and analysts have a lot more running around to do. After all, the logic goes, there are always changes in the industries that growth managers follow, so it's imperative to spend more to stay on top of these changes.
Well, if that's the case, here's my advice to growth funds: Slow down. I simply don't buy the argument that growth funds should cost so much more and shops like Janus -- and some other diversified large firms -- have demonstrated that you can run growth funds at very reasonable costs. (Moreover, all that running around seems to be driving up turnover, and hence, brokerage costs.) In fact, it's frustrating that fund boards approve expense agreements for growth funds based simply on a comparison to other growth funds. That peer group already has inflated costs, so the investors end up losing out. The truth is that it makes sense to compare funds by market cap, rather than by style alone.
International stocks are riskier than domestic stocks
For years, the conventional wisdom has been that most investors are better off keeping just 15% to 20% of their assets in overseas stocks. That's because the conventional wisdom has also relied on the flawed assumption that foreign stocks are more risky than domestic stocks. Sure, they're more unfamiliar to U.S. investors, but somewhere along the way, a lot of smart people also started saying that they were riskier.
Well, the evidence just doesn't back that up, and I certainly haven't seen any hard data to justify it. As such, we think it makes sense for investors to reconsider their level of exposure to overseas investments because most U.S. investors are systematically underexposed to foreign stocks. That doesn't mean you should put in more than what you're comfortable with, but just that you should really think about how you're arriving at your comfort zone.
Oh, and if you're thinking about investing more overseas just because foreign funds have done well in the past few years, it's the wrong reason for doing so. Do so because it makes sense for your portfolio, as you're more apt to stick with such an allocation in the long run.
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