There's a good chance that a significant portion of what you think you know about investing is wrong.
At least that's my conclusion after reading a new survey of 1,013 Americans. While the results may not apply perfectly to the Canadian landscape, they do point to the knowledge gap that exists among many financial consumers – a gap that is likely to be just as large on this side of the border.
The most striking example in the survey was the apparently widespread belief among respondents that actively managed funds will reliably produce better results than index funds. Fifty-one per cent of those who owned an actively managed fund said they were motivated by the belief that it would produce higher average returns than a passive fund.
Of course, this faith in active management is contradicted by the historical evidence. The SPIVA scorecards from S&P Dow Jones Indices show that index investing beats more than 70 per cent of actively managed funds over periods of five years and more. The results hold true across Canada, the United States and European markets and have been a well-established fact of financial life for more than a generation.
A faith in active management wasn’t the only questionable belief highlighted in the study, titled What Matters To Individual Investors? Evidence From The Horse's Mouth, conducted by James Choi of Yale University and Adriana Robertson of the University of Toronto.
The researchers found that more than a quarter of people believed value stocks will produce lower returns than the rest of the market. The vast majority of respondents also believed that a mutual fund's size should have no effect on its ability to beat the market.
In both cases, the opposite is true. The strong long-term performance of value stocks is one of the better-established propositions in finance. Most studies also show that a fund's performance tends to fade as it faces the challenge of putting more money to work.
Perhaps it's unrealistic to expect everyone to be up on such issues. However, the survey numbers also underline the fear with which many people approach the topic of investing.
The vast majority of respondents declared that they were “the person in your family most knowledgeable about your assets, debts, and retirement planning,” but 41 per cent owned no stocks at all. In some cases, that was because they lacked money, but almost four in 10 of those who avoided stocks said they simply did not like to think about their finances.
Among both stock owners and non-owners, 45 per cent said the fear of a rare economic disaster was an important factor shaping their decisions about how much to invest in the market. Meanwhile, 37.5 per cent said they worried that "companies, managers, brokers, or other market participants might cheat me out of my investments."
Those figures suggest schools could do a much better job of preparing people to manage their own money. Even a modest commitment to financial literacy might help reduce the high level of anxiety around personal finance and show people simple ways to assess their investments. Until then, it seems likely that many small investors will continue to be ruled by fear and mistaken notions.
Ian McGugan