It’s easy to differentiate between good financial advice and poor financial advice. What can be tricky is weeding out seemingly good financial advice that only works in certain instances – such as the record 11-year bull run we’ve experienced, and that just came to an end.
Regardless of whether the investing advice comes from family and friends or a financial adviser, we need to be aware of the risks we are exposed to when employing the strategy. The advice may look genius because of the way the last 11 years have played out, and they may truly have our best interests at heart, but may manifest gaping holes when the economy dips into recession and markets are crashing.
Good financial advice should never just be applicable to periods of economic prosperity. If it suddenly isn’t valid when a crisis like COVID-19 strikes, it was never good investing advice to begin with.
Here are 5 investing advice that are actually bad, but may have sneaked under the radar as good investing advice in the recent past.
#1 Stock Markets Return Close to 6% P.A., So Invest All Your Money In It To Maximise Returns
Singapore’s benchmark Straits Times Index (STI) has returned 5.3% per annum (p.a.) since 2002, while the S&P500 in the US has achieved even better returns of 8.9% p.a. since 1993. These dates aren’t’ arbitrary, they are when the respective exchange traded funds (ETFs) were available.
While it may be true that stocks markets return close to 6% p.a. or more, this is on an average basis over a long time horizon – it does not happen each and every year. During strong bull runs, stocks can soar double digits. Similarly, during bear markets, stocks can plunge double digits. For example, in the past 1-year period, the STI and S&P500 have returned -19.4% and -7.0% respectively.
We need to understand that past returns should not be taken as an indicator of future returns.
Nevertheless, investing in the stock markets can still be sound advice, but we should not be investing just to chase the 6% p.a. returns. We should look at our time horizon, if we have a long time horizon, we can invest in the stock markets and potentially achieve the 6% p.a. returns or even higher. If we are nearing retirement, we may want to invest in less risky investments, such as bonds, or even contribute to our CPF Special Account (SA) or Retirement Account (RA).
We should also note that the often-quoted figure of 6% p.a. is a benchmark for market returns. This means investing in broad country indexes such as the STI ETF or S&P500 ETF. Investing in individual stocks can introduce greater risks and volatility to our returns.
#2 You Can Afford To Take Greater Investment Risks When You Are Younger
Another way to convince us to invest more aggressively is by telling us we have a sufficient time horizon to ride out market booms and bust to achieve a good return – such as 6% p.a.
This advice can come in different forms too: No pain, no gain; big risks, big returns.
While it is true we can likely achieve better outcomes by taking higher investment risks, especially while we are younger, each of us can have vastly different risk appetite, and it’s perfectly fine to avoid risks if we are not able to sleep at night.
Young people can also have diverse financial obligations to their parents or have a family already. We may not have much to plough into markets in the first place and losing a sizeable chunk will set us back significant, both financially and psychologically.
Young people definitely need to start early. The amount of risk they take should be left to the individual to decide how much risk they are able to tolerate and whether they are in a financial position to take the higher risks.
#3 You Should Use Leverage To Magnify Your Returns
During the bull run, there were many supposed “financial gurus” advocating the benefits of using leverage investing or margin financing to magnify our gains in the market. We can easily earn a much higher return in the stock markets while paying a lower interest rate to borrow the funds.
It can be easy to become blinded by greed and lose sight of the risk we are taking over a period of 11 years when the stock markets were going in one direction – up.
Even when questioned, we may think we are able to stomach the risk. Of course, this is because we may never have experienced wild swings in the market which cause it to crash more than 30% at one point. We may also never have faced the prospect of requiring to cough up large amounts of cash after getting margin called, numerous times.
Even for those with a high risk appetite, they may not have a portfolio to speak of if they are forced to sell because they lack the ability to cough up enough cash on short notice when they get margin called. Also, even if they can, they will likely be touching their emergency funds at the worst possible time – when COVID-19 is ruining businesses, displacing employees and injuring health.
#4 Buy (Invest) In The Biggest Home You Can
The notion of owning property puts a spark in every Singaporean’s eye. In the last 50 years, property prices have been on an unending surge. Even major financial crises in the past were only small blips to the price increases.
That is why some of the older generation or even property agents may suggest that we should buy the largest possible home – to benefit from the largest possible price rise. If you think about it, it’s yet another play on leverage as well.
This terrible investing advice can also come in several different forms:
- Home loans are good debt, it’s the other debts that are bad
- We should maximise our CPF for our down payment and mortgage repayment
- The bank is able to give us the necessary loan to purchase the dream property
The reality is that if we stretch our finances to its limits, any potential problem can leave us in a dire financial situation. If we lose our job or are put on unpaid leave for several months, we may not be able to afford the roof over our heads anymore. Being able to buy something is not the same as being able to afford it.
#5 Save And Invest Everything You Can, So You Can Achieve FIRE
Another trendy topic in recent years is people boasting about how they are able to achieve the Financial Independence, Retire Early (FIRE) lifestyle.
If we save everything we can today, one big problem that can arise is that we become deeply unsatisfied even with a decent job. Few of us will be able to work in a dream job, where our fulfilment is derived solely from the work we do.
Second, for those that are able to achieve FIRE, it really depends on what kind of financial position they are in. If they are relying on an investment property or dividends from their stock investments (which may even be leveraged) to pay them a few thousand dollars each month, for an extremely frugal daily living, then COVID-19 may have easily blown this plan apart. They may even have to find real jobs after several years out of the workplace or earning an allowance dabbling in hobbies.
Being able to FIRE is unlikely to be the answer to our unhappiness in life. In fact more meaningful work can be more beneficial. Even if we earn less but loosen the purse strings for a more comfortable life, we may be physically and mentally healthy to work longer.
You Need To Understand Your Own Personal Financial Situation
These seemingly good investment advice may actually be terrible for your finances. However, you should not strive to avoid these pieces of advice now. They can still be valid actions to take to improve your finances. The difference is that you need to understand the risks involved and ensure you are not going all-in thinking that the markets will continue going in one direction.
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