MONEY SAVER
Tricky Truths That Can Lose You Money
Some financial advice may be right … but could still do you wrong
A GRAIN OF TRUTH can be as hazardous as a pack of lies. That’s the problem with some financial pronouncements. Yes, they can be true at times, or even all the time. But that doesn’t mean they apply to your situation. Over the years that I’ve worked as a financial planner, I have encountered a lot of these misleading statements—“tricky truths,” I call them—you might hear from a scam artist, a financial firm making a sales pitch or even a well-meaning friend. These are some common ones that can lead you astray.
1 “Don’t focus on investment costs; what really matters is investment performance.”
On the surface, this seems like the no-brainiest of truths: You get what you pay for, right? If you needed heart surgery, the last thing you would worry about is which surgeon was the cheapest. So if you want a high-performing investment, you should be ready to pony up high fees.
BUT … When you’re investing, a boatload of research indicates that the lower the expenses the better. As the investing website Morningstar put it, “The expense ratio is the most proven predictor of future fund returns—and our data agrees.” Even the high fees charged by hedge funds—investment pools open only to wealthy investors—don’t always pay off. Investor Warren Buffett famously won a bet in 2018 when, as he had predicted a decade earlier, a simple investment in the S&P 500—collectively, shares in 500 of the largest publicly traded U.S. companies—performed far better than a basket of hedge funds.
2 “If you had invested in this strategy back then, you would have doubled the return of the market.”
You’ll hear this, or a variation of it, from a wide range of sources—maybe even a small voice in your head, kicking yourself for not having bought a high-flying stock before it took off. And yes, it’s absolutely true that some investments, like Bitcoin and tech stocks such as Nvidia, have trounced the market at times.
BUT … Looking in the rearview mirror tells you little about what’s on the road ahead. Multiple academic studies have found that the continuing success of top-performing mutual funds is short-lived. Research indicates that individual stocks on a roll can persist in the short run, but take on greater risk when the momentum peters out. Witness the stock of the movie chain AMC, which took less than a month in 2021 to shoot from roughly $50 to $275. It now trades around $4.20.
3 The problem with term life insurance is that you’re likely to pay premiums for many years and get nothing in return.
Yes, the majority of term life policies will expire without a payout. Thus, I’ve often heard the argument that you should buy permanent insurance—whole life, universal life or variable life policies.
BUT … Later in life, the costs of some of these policies can skyrocket and, in retirement, you might not be able to afford the premium. Term life is very cheap compared to permanent insurance, so I’d rather buy term life and invest the money I’ve saved.
Just as I’m very happy to have no need to collect on my home or car insurance, I’m quite OK to have a term life policy expiring worthless.
4 “We have beaten the S&P 500 index over the past decade.”
It’s certainly possible that the investment someone is trying to sell you has risen in value at a faster rate than the S&P 500, the most commonly used benchmark for U.S. stocks.
BUT … Beating the index doesn’t mean you’re beating the market. That’s because the standard S&P value you see in the news measures only the price appreciation of the stocks in the index, not the dividends they pay. Since 1926, nearly one-third of the S&P’s total return has come from dividends; in the last 10 years, while the index has risen about 190 percent, the total return of the S&P, with dividends reinvested, was 250 percent. So comparing the total return of Brand X investment to an index’s price appreciation is like comparing apples to crab apples.
5 Customers who switched their car insurance to us saved an average of $432 a year.
I’m willing to believe the ads I see with statistics like this.
BUT … The ads don’t say how many potential customers checked out the new car insurance and decided not to switch. Maybe they vastly outnumbered the switchers. And maybe the people who switched ended up with a lower level of protection than they had with their previous insurer—not the same protection for a lower price. It’s a great idea to shop around periodically for auto insurance and homeowners insurance to see if you can get a better deal. But don’t limit yourself to a company that tells you how much switchers have saved; get quotes from multiple insurers.
6 Index investing is conservative and guaranteed to underperform the market.
It’s true: Broad index investing done right will get the return of the market less fees. Let’s say you put $10,000 in a total U.S. stock market index fund with an expense ratio of 0.05 percent. (That’s five-hundredths of 1 percent of your account value per year, a realistic fee for an index fund.) If the stock market goes up 7 percent in a year, you wouldn’t end up with $10,700—your original investment plus a 7 percent return—but $10,695. So yes, you’re $5 short of the market performance.
BUT … Compare that to putting the same $10,000 into an actively managed mutual fund, where a more likely expense ratio is 0.65, or almost two-thirds of one percent. Assuming the fund matches the market’s return (though odds are against it over time), you’d end up with about $10,635, or around $65 less than the market’s return. Compound that over several years and the higher cost of an actively managed fund will make a much bigger dent.
Allan Roth is a longtime financial planner based in Colorado and a regular contributor to AARP.