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4 Investment Myths Advisors Believe

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What You Need to Know

  • Stocks have been the best hedge against inflation 75% of the time over the last 50 years, history shows.
  • Lump-sum investing outperformed dollar-cost averaging most of the time, a recent study found.
  • Apart from the Great Recession, U.S. stocks have outperformed internationals for the last three decades.

A common view of financial advisors is that they are highly analytical types who are guided by data and skeptical of unsupported market theories. 

Like many of their individual clients, however, some advisors embrace popular investing myths backed by nothing more than vague assumptions. 

Investing myths, like all misconceptions, thrive on circular reasoning: They are widely accepted because they persist, and they persist because they are widely accepted. For kids, this logical fallacy sustains belief in the Easter Bunny, Santa Claus and the Tooth Fairy. It is only after kids question their assumptions that they wise up. 

So maybe there’s value in questioning ingrained investing beliefs, some of which may be myths. Here is a look at some widely accepted myths and some compelling reasons to reject them.

1. Inflation invariably damages stock portfolios.

Market history shows that stocks have been the best hedge against inflation 75% of the time over the last 50 years. 

Since 1973, over the course of two-year periods after CPI inflation readings of more than 5%, the best-returning investment has been gold. But over the two-year periods after CPI inflation readings of 5% and under — a level that is likely for much of this year — the S&P 500 has beaten gold, returning 32.8% after inflation between 2% and 3%, 25.1% after readings of 3% to 4%, and 17.2% after inflation of 4% to 5%.

Though gold has beaten this index after readings of more than 5%, the S&P 500 has still rocked, with returns averaging 23%. The other non-gold investment that has done quite well after (and during) high inflation has been real estate investment trusts, because landlords can just raise rents. 

2. Dollar-cost averaging is better than lump-sum investing.

Dollar-cost averaging is a common practice among baby boomers, some of whom may have acquired this habit in the 1990s from reading Money magazine, which repeated the term like a mantra. DCA devotees often buy shares regularly on arbitrary dates (rather than when the price is down) through automatic purchases. 

Of course, while this method helps with investing discipline, in terms of actual returns, it rarely works better than lump-sum investing. The superiority of lump-sum investing is intuitively clear because, when you dollar-cost average in a rising stock or fund (i.e., the kind you want to buy), you acquire shares at higher and higher prices.

This intuition is confirmed by a recent study by Northwestern Mutual Wealth Management that examined returns over rolling 10-year periods from a $1 million investment starting in 1950. The study compared results from lump-sum investment and DCA, assuming that the money was invested evenly over 12 months and that investments were held for three years. 

For an all-stock portfolio, the return from lump-sum investing outperformed DCA 75% of the time. For a portfolio of 60% stocks and 40% bonds, the outperformance rate was 80%.

3. Options just add risk to a portfolio. 

Views of options are pretty much congruent with views of volatility — a word that prompts palpitations in investors who equate it with risk. Warren Buffett called this a “dead-wrong pedagogic assumption” taught in business schools.

Volatility is an asset class that can be harnessed for gain. A highly effective way to do this is to use option overlays on major indexes. These overlays reduce risk through consistent defensive positions while increasing net returns through regular cash flow. This is not a trading strategy. Rather, it is one that systematically captures option premiums. 

Various academic studies support the validity of this strategy, as does back-test study by my firm covering a 26-year period. This study showed that overlays can add some risk over the short term but significantly reduce it over the long term.

The study tested hypothetical investment in the SPDR S&P 500 ETF (SPY), with and without an overlay of options balanced by selling to protect against substantial market decline. The return was 1,183% for the index-plus overlay strategy, versus a 782% gain for the index alone. In only six of the 26 years did the overlay produce a negative return. 

For those seeking a simpler way to harness volatility, more accessible strategies are available through options ETFs that have emerged over the last few years.

Volatility flows constantly like a river, and the water should be up and brisk through 2022, as volatility has historically been especially high in midterm election years. Already this year, the market ride has been as wild as a Six Flags roller coaster as the Fed prepares for a rate increase. Advisors can buckle up for this bumpy ride by harnessing volatility’s alpha-generating potential through effective options strategies.

4. Global diversification reduces risk and increases returns.

A better term for it might be “diworsification,” because the practice of adding a global array of foreign stocks can actually increase risk and erode returns.

The argument for global diversification rests on alternating outperformance cycles for U.S. versus international stocks. If U.S. stocks are down one year, goes the rationale, international stocks may be up.

There are several problems with this. First, except for a handful of years — essentially, the Great Recession — U.S. stocks have outperformed internationals every year over the last three decades.

Proponents stress that this is an extremely long-term strategy, but lengthy U.S. outperformance periods (sustained by huge foreign investment in the U.S.) mean that U.S. investors would have to start when they are too young to have much capital. And even then, the odds would be against them because correlations between global and U.S. stocks are increasing as sovereign economies become more interconnected.

This growing correlation is whittling away at the best argument for going global. By adding 25% in international equities, the standard deviation historically has dropped only from 17.8% to 17.1% — hardly enough to outweigh the downsides of currency risk and foreign regulation risk.

Notably, in clinging to its classic recommendation to invest globally, Morningstar recently conceded that the benefits can be “surprisingly elusive.” So, the goal is to not be surprised.

These are just a few examples of investing myths. There is no end to them, nor should there be an end to intelligent questioning of their foundations. Only then can investors — and advisors — see myths for what they are.

(Image: Shutterstock)


David Sheaff Gilreath, CFP, is a founding principal and CIO of Innovative Portfolios, an institutional money management firm, and Sheaff Brock Investment Advisors. Based in Indianapolis, the firms managed assets of about $1.4 billion as of Dec. 31, 2021.