In a recent article, I argued that “common sense” is a dangerous trap for investors. Some readers disagreed.
Consider this idea for a moment and then decide for yourself.
Common sense is a popular theme for writers. I have often recommended The Little Book of Common Sense Investing by John Bogle.
There are “Common Sense Investing'' by Fred McCullen and “Common Sense Investing'' by Rick Van Ness. James Pattersen Jr. is the author of Common Sense Investing with Index Funds and Common Sense Investing with Stock Screening. ”
All of these titles appeal to the notion that people somehow know what makes sense and what doesn't. “At the end of the day, it's common sense.”
However, appeals to “common sense” are often not accompanied by evidence, only assumptions that anyone with a brain would agree with.
read: I'm 52 years old and will be retiring in 20 years. Should I invest in a Roth IRA or an individual index fund like the Dow or Nasdaq?
Do you need a lot of money to start investing? Common sense would say yes. But for just $100, he can invest like a millionaire in four low-cost index funds, giving him a global portfolio of over 2,000 companies.
Here are three other examples.
1. Probably common sense: To be a successful investor, you need to know a lot about investing. fact: Investing for retirement can be as simple as predicting when you want to retire and purchasing a low-cost retirement fund with a target date.
2. Probably common sense: Smart, knowledgeable, and hard-working fund managers can beat the market and outperform “stupid” index funds. fact: Over the long term, this is true for only about 1 in 10 funds. fact: No one can know in advance which funds will succeed and which ones will fail.
3. Probably common sense: Index funds give investors average returns. fact: Actively managed funds have higher management and transaction costs, as well as higher taxes, but on average return 1 to 2 percentage points lower than index funds in the same asset class.
For many young people today, the stock market is essentially a form of gambling. It's normal for the market to go up and down every business day.
If your focus is on making money this week, this month, or even this year, the stock market can be very risky. However, if your goal is to make money for decades, the stock market is very likely to be profitable.
Over the past 90 years or so, the S&P 500 SPX's worst 40 years had a compound annual return of 8.9%. The average return over 40 years was 11%. The highest was 12.5%.
This is the other side of the coin. Many young people believe that bonds are much safer than stocks. It's common sense, they sometimes tell me, “Don't be sorry, be safe.”
read: I have multiple IRAs and 401(k)s. How can I avoid worries about the required minimum distributions next year?
The question is, what is “safe” from? If all you need is protection against losses over a month or year, bonds may be a good option. But over the long term, bond returns have a hard time keeping up with inflation. If you rely on them to help you retire, you may never get there.
Plus, there's this trap. Some market trends are so “obvious” that it may seem foolish to ignore them. At the end of 1999, technology companies (and their stocks) are hitting home runs and changing the world. “Common sense” says you should throw all your money into tech stocks and throw everything else away.
What could be more obvious? Oops! After 10 years and two brutal bear markets, Microsoft
MSFT
To name a few, stock prices still had a long way to go to regain their spring 2000 highs.
Speaking of common sense, there is a famous quote from Warren Buffett. 1: Never lose money. Rule No. 2: Never forget rule no. 1.”
Sounds good, but even Buffett can't follow this. Berkshire Hathaway from June 1998 to March 2000
BRK.A
BRK.B
The stock lost 48.9% of its value. From September 2008 to March 2009, the stock price fell 50.7%.
This seems pretty negative, so I'm going to wrap my head around and give you some advice that I think is really common sense.
Real common sense: The sooner you start saving for retirement, the more successful you will be. Time is the greatest resource for long-term investors. If he loses a year or a decade because of procrastination, he can't get that time back.
Real common sense: Please keep your expenses as low as possible. Every dollar you pay in expenses is a dollar you'll never get back, a dollar working for someone else instead of you.
Real common sense: Don't try to time market ups and downs. Few have shown that they can do it consistently and successfully over long periods of time. But virtually every investor who buys an index fund and holds it for life is successful.
Real common sense: Understand how to “follow the money” before purchasing any investment product. In other words, you can know where your money is being spent. If there are large fees involved, that’s a red flag. Typically, the hardest-to-sell products receive the highest commissions. And very often those products are the ones with the highest risk.
In the long run, you'll need more than just common sense. I recorded a video about investing habits and attitudes that will help you maximize your ultimate success.
Richard Buck contributed to this article.
Paul Merriman and Richard Bach are the authors of We're Talking Millions!12 Easy Ways to Enjoy Your Retirement Life.
