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13 common investing myths

Shane Oliver  |  01 Apr 2014Text size  Decrease  Increase  |  

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Shane Oliver is head of investment strategy at AMP Capital.

 

The increasingly complex nature of investment markets leads many to adopt simple rules of thumb often based on common sense when making investment decisions.

Unfortunately, though, the forward-looking nature of investment markets means such approaches often cause investors to miss out on opportunities at best or lose money at worst.

This article reviews some of the common myths and mistakes of investing.

Myth 1: Rising unemployment means growth can't recover.

Whenever there is a downturn this argument pops up. But if it were true then economies would never recover from recessions or slowdowns. But they do.

Rather, the boost to household spending power from lower mortgage rates and any tax cuts or stimulus payments during recessions eventually offsets the fear of unemployment for those still employed. As a result they start to spend more, which gets the economy going again.

In fact, it is normal for unemployment to keep rising during the initial phases of an economic recovery as businesses are slow to start employing again, fearing the recovery won't last.

Since share markets lead economic recoveries, the peak in unemployment usually comes after shares bottom. In Australia, the average lag from a bottom in shares following a bear market associated with a recession to a peak in unemployment has been twelve-and-a-half months.

Hence, the current cycle where the share market has gone up despite rising unemployment and headline news of job layoffs is not unusual.

Myth 2: Business won't invest when capacity utilisation is low.

This one is a bit like the unemployment myth. The problem is that it ignores the fact that capacity utilisation is low in a recession simply because spending is weak. So when demand turns up, profits rise and this drives higher business investment, which then drives up capacity utilisation.

Myth 3: Corporate CEOs, being close to the ground, should provide a good guide to where the economy is going.

Again this myth sounds like good common sense. However, senior business people are often overwhelmingly influenced by their own current sales but have no particular lead on the future.

Until recently it seemed Australian building material CEOs saw no sign of a pick-up in housing construction even though it was getting underway. Now it's widely accepted.

This is not to say that CEO comments are of no value - but they should be seen as telling us where we are rather than where we are going.

Myth 4: The economic cycle is suspended.

A common mistake investors make at business cycle extremes is to assume the business cycle won't turn back the other way.

After several years of good times it is common to hear talk of "a new paradigm of prosperity". Similarly, during bad times it is common to hear talk of a "new normal of continued tough times".

But history tells us the business cycle will remain alive and well. There are no such things as new eras, new paradigms or new normals.