Ten Wall Street Investing Myths Revealed

1.  “You cannot invest directly in an index…”

This is FINRA approved disclaimer boilerplate. A Google search returns thousands of hits, many are part of the risk disclosure in mutual fund sales literature. The statement is misleading non-sense. The fact is you can invest directly in the performance of a stock index though the purchase of a stock-index futures contract. As a practical alternative, there exist large, low-cost ETFs and mutual funds that have reliably replicated the returns on the S&P 500 and other indices for many years.

2.  Bonds are safer than stocks.

This statement is a gross over-simplification. Is a corporate or municipal junk bond safer than the stock of Exxon or Johnson & Johnson? The answer is no. Corporate and Municipal bonds lack the pricing transparency of exchange-traded common stocks and are more difficult and expensive to sell. Bonds are subject to interest rate risk and purchasing power risk, more so than stocks.

3.  Options are riskier than stock.

A call option on 100 shares of stock is generally no more risky than buying 100 shares of the same stock. A covered call or cash secured put on an equivalent number of shares is generally less risky than investing in the underlying stock.

4.  Annuities are safe, tax advantaged investments.

A deferred annuity can be a ticking tax time bomb that ultimately blows up pushing an investor into a high marginal tax bracket when he cashes out. The tax-rate on annuity is usually higher than the tax rate on stock held long-term by an investor. The worst annuities have hefty, lengthy surrender charges coupled with market value adjustments that can cause big losses when you cash out.

5.  A margin account is riskier than a cash account.

A margin account can certainly be riskier than a cash account, but not always. For example, a modestly leveraged diversified portfolio of lower beta blue chip stocks is almost certainly less risky than a concentrated portfolio of volatile small cap stocks bought in a cash account.

6.  Using “Stop Loss Orders” will cut or reduce your investment losses.

In reality, there is no such thing as a “stop loss order”. In fact, statistically speaking it is probable that a stop order when executed, will cause a loss that otherwise could have been avoided had no stop order been entered. On occasion, a stop might save you money on a stock that collapses and never recovers. More typically, your stop order will sell you out at a loss and then the stock will recover.

7.  S&P, Moody’s, and Fitch Bond Ratings are useless and untrustworthy.

The bond ratings agencies were wrong to give high ratings to asset backed securities collateralized by sub-prime mortgages. They were slow to lower ratings on the sovereign debt of many European Union countries. With the benefit of hindsight, it is apparent that in recent years, many securities issued by banks received credit ratings that were too high. However, it does not follow that credit ratings are useless. Before you buy any bond, you should always check the credit rating and the rating trend. Always compare the yield on a bond to other bonds with the same rating. It also pays to read the ratings rational given by the ratings agencies. For example, the ratings agencies disclosed that they were basing their mortgage backed securities ratings on a continuation of historical mortgage default rates.

8.  Smart Money invests in Hedge Funds and Private Equity.

It is true that some managers of hedge funds and private equity funds are very smart people, and possibly even skilled investors. However, there is little evidence that overall, investors in hedge funds and private equity earn returns that exceed the returns earned by traditional stock and bond investors. This is especially true when one adjusts hedge fund and private equity returns to reflect the additional risk incurred from fund borrowings and illiquidity.

9.  American Depository Receipts (ADRs) are the best way for U.S. investors to buy the stocks of foreign companies.

Some brokerages, for example see interactivebrokers.com, make it easy, convenient and low cost to invest in a foreign stock directly in that stock’s home market. This is often a better approach than investing in an ADR.

10.  Buy and Hold is dead or Buy and Hold does not work.

Not true. To use just one prominent example and there are hundreds of others: ten years ago you could have bought Apple stock for under $10 a share, today it trades at over $500 per share. Buy and hold works really well if you buy the right stocks.