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08/23/2011

Ten Indestructible Stock-Market Myths

1) This is a good time to invest in the stock market.

Really? When was the last time your broker warned clients that it was a bad time to invest � October 2007 or February 2000?

2) Stocks on average make you about 10% a year.

Stop right there. This is based on some past history, stretching back over 100 years and it�s full of holes. Experts suggest 5% may be more typical. And stocks only produce average returns if you buy them at average valuations.

3) Our economists are forecasting ...

Hold on. Ask your broker if the firms� economist predicted the most recent recession, and if so, when. Warren Buffet once said forecasters made fortune tellers look good.

4) Investing in the stock market lets you participate in the growth of the economy.

Tell that to the Japanese � since 1989 their economy has grown by more that a quarter, but the stock market is down more than three-quarters. For the U.S., from 1969 to 1983 the GDP rose from $1 trillion to $3.3 trillion, yet the Dow remained steady at 1000.

5) If you want to earn higher returns, you have to take more risk.

Tell that one to Warren Buffet, who prefers boring companies and industries. The only way to earn higher returns is to buy stocks cheap in relation to their future cash flows.

6) The market�s really cheap right now. The P/E is only about 13.

The highly quoted price/earnings ratio, which compares share prices to annual after-tax earnings, can be misleading. Mostly because earnings are so volatile in that they�re elevated in a boom and depressed in a bust. No metric is perfect, but three with good track records are dividend yield, cyclically adjusted PE ratio, or Tobin�s q.

7) You can�t time the market.

This old adage is great for keeping clients fully invested. If you invest in shares when they�re cheap compared to cash flows and assets, you will usually do very well. But if you invest when shares are very expensive, you will probably do badly.

8) We recommend a diversified portfolio of mutual funds.

If this means diversifying across things like cash, bonds, stocks, alternative strategies, commodities and precious metals, then that�s good advice. However brokers usually mean different names and �styles,� as in large-cap value, mid-cap blend, and so on. These are gimmicks, for example there is no such thing as mid-cap blend.

9) This is a stock picker�s market.

Just about every market can be defined as a �stock picker�s market,� yet the lion�s share of investment returns has typically come from asset classes (see #8) rather than individual investments. Even if it is a stock picker�s market, what makes you think your broker is the stock picker in question?

10) Stocks outperform over the long term.

Define long term, please! If you can be down for ten or more years, exactly how much help is that? As economist John Maynard Keynes once said: �In the long run we are all dead.�



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