The truth about investing: ‘Common sense’ can be the worst advice

There’s ​”Common Sense Investing​” by Fred McAllen and ​”Common Sense Investing​”by Rick Van Ness. James Pattersenn Jr. is the author of ​”Common Sense Investing With Index Funds​”​and of ​”Common Sense Investing With Stock Screeners. ​”

These titles all appeal to the notion that people somehow know what makes sense and what doesn’t. “It’s just common sense, after all.”

However, too many times, the appeal to “common sense” is not accompanied by evidence, only an assumption that anyone with any brains would have to agree.

Read: I’m 52 and retiring in 20 years. Should I invest in a Roth IRA or individual index funds like the Dow and Nasdaq?

Is it necessary to have a lot of money to start investing? Common sense might say yes. But for only $100 you can invest like a millionaire in four low-cost index funds, giving you a worldwide portfolio of more than 2,000 companies.

Here are three other examples.

​1​. Supposedly common sense: In order to be a successful investor, you need to know a lot about investing. Fact: Investing for retirement can be as simple as estimating what year you’ll retire, then buying a low-cost target-date retirement fund.

​​2​. Supposedly common sense: A smart, knowledgeable, hardworking fund manager or managers can beat the market and do better than a “dumb” index fund. Fact: In the long run, that has been true for only about one in 10 funds. Fact: Nobody can know ahead of time which funds will succeed and which will fail.

​3. Supposedly common sense: Index funds give investors only average returns. Fact: Actively managed funds, with higher management expenses and trading costs and higher taxes, on average produce returns that are 1 to 2 percentage points LOWER than index funds in the same asset classes.

To many young people today, the stock market is essentially a form of gambling. When the market goes up and down every business day, that seems like only common sense, right?  

If what you care about is making money this week or this month or even this year, the stock market is quite risky. But if your goal is to make money over decades, the stock market is very likely to be profitable.

Over the past​ roughly 90 years, the very worst 40-year period for the S&P 500
SPX
produced a compound annual return of 8.9%. The average 40-year return was 11%; the best was 12.5%.

Here’s the flip side of that coin: Many young people believe bonds are much safer than stocks. It’s only common sense, they sometimes tell me, to be safe instead of sorry.

Read: I have multiple IRAs and a 401(k): How do I avoid headaches over required minimum distributions next year?

The issue is: “safe” from what? If all you want is protection from losing money in a single month or a single year, bonds could be a good bet. But over the long run, bond returns struggle to keep up with inflation. If you rely on them to retire, you might never get there.

Then there’s this trap: Some market trends are so “obvious” that it can seem foolish to ignore them. It’s the end of 1999, and technology companies (and their stocks) are hitting home run after home run, transforming the world. “Common sense” tells you to ditch everything else and put all your money into tech stocks.

What could be more obvious? Oops! Ten years and two bruising bear markets later, Microsoft

MSFT

stock, to name one prominent example, still had a long way to go to simply regain its peak value from the spring of 2000.

Speaking of common sense, there’s this famous quote from Warren Buffett: “Rule​ N​o. 1: Never lose money. Rule ​N​o. 2: Never forget Rule ​No. 1.”

Sounds good, but even Buffett can’t follow it. From June 1998 through March 2000, Berkshire Hathaway

BRK.A

BRK.B

stock lost 48.9% of its value. And from September 2008 through March 2009, the stock lost 50.7%.

All this seems pretty negative, so I’ll stick my neck out and give you a few pieces of advice that I think really are common sense.

​True common sense: The earlier you start saving for retirement, the more successful you’ll be. Time is the greatest resource for the long-term investor. Once you lose a year or a decade to procrastination, you can’t ever get that time back.

​True common sense: Keep your expenses as low as possible. Every dollar you pay in expenses is a dollar you’ll never get back, a dollar that will work for somebody else, not for you.

​True common sense: Do not try to time the ups and downs of the market. Very few people have shown they can consistently and successfully do that over the long term. But virtually all investors who buy index funds and hold them for life are successful.

​True common sense: Before you buy any investment product, understand how to “follow the money.” In other words, know where your dollars are going. If there’s a significant commission involved, that’s a red flag. The largest commissions are generally paid on products that are hardest to sell; and very often those products are the riskiest ones.

In the long run, you’ll need more than just common sense. I’ve recorded a video on the investing habits and attitudes that will help you maximize your ultimate success.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways to Supercharge Your Retirement.