Myths versus Mistakes

in Investing

Riot of

Passive Muffs and Active Goofs

in Financial Markets

Revised April 2021

Steven Kim

MintKit Investing

www.mintkit.com
Keywords:

Myths, Mistakes, Stocks, Fables, Theory, Models, Random Walk, Efficiency, EMH,
Markets, Forecasting, Economics, Finance, Risk, Strategy

© 2014 and 2021 MintKit.com

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Short Summary

In an advanced economy such as the U.S., the bulk of households have a stake in
the financial markets whether directly by way of personal portfolios or indirectly via
pension funds and the like. Unfortunately, the vast majority of participants – ranging
from casual amateurs to ardent professionals – fall prey to a host of myths and
mistakes. In this tricky environment, a firm grasp of the common traps is a basic step
toward fixing up a trenchant program of investment.

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 Long Summary

The financial markets abound with beguiling myths and wanton mistakes. The two
kinds of stumblers – namely, fables and bungles – are distinct as well as entwined.
The slew of snags act singly as well as jointly to trip up all manner of investors
ranging from rank amateurs to badged professionals.

The multitude of pitfalls may be classified into a couple of broad groups. A myth
conveys a false view of the marketplace while a mistake denotes a bum move
harmful to the investor. The former is a passive flub while the latter is an active goof.

The two types of spoilers run riot in isolation or combination. For instance, a tall tale
may bedevil an investor without giving rise to a costly mistake. On the flip side, a
wrackful move could arise in the absence of a slippery myth. In other cases, the two
forms of sinkers work together to foil the hapless investor, thus fouling their agenda
to varying degrees ranging from patchy losses to complete wipeouts.

From a larger stance, the awesome complexity of the real and financial markets
hamstrings any attempt to drum up a cogent program of investment. The actors
floundering in the mire run the gamut from dewy-eyed tyros puttering in their spare
time to wizen pros plying their trade the whole day long.

Whatever the scope of experience in the field, the mass of participants succumbs to
both kinds of muck-ups. As a safeguard, the first task of the canny player is to
recognize the welter of hidden traps along with the mordant wounds they inflict. In
this treacherous environment, a solid grasp of the myths and mistakes is a basic
requirement for avoiding the sinkholes and escaping the minefield.

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 * * *

In the din and smog of the financial realm, a host of myths and mistakes besets the
mass of investors and even leads them to ruin. The two types of bogeys happen to
be distinct as well as conjoint. Together the bugbears torment players of all stripes
ranging from part-time amateurs to full-time professionals.

In this context, a mistake refers to a faulty move by an actor in the field. An example
involves a punter who jumps on a bandwagon at the height of a bubble or dumps an
asset in the depth of a panic.

On the other hand, a myth conveys a flawed view of the marketplace. A rampant
example involves the hokum of perfect rationality that holds sway over the mass of
academics as well as practitioners. According to the Efficient Market Hypothesis
(EMH), every market is an ideal system that makes full use of any trace of
information with boundless wisdom and zero delay.

In the larger scheme of things, we could regard a myth as a special type of mistake
at a high level of abstraction. In that case, a tall tale would count as a mistaken
image of the marketplace.

From a pragmatic stance, however, the two types of mix-ups entail distinct features
and impacts. For this reason, we will use the term “mistake” in the narrow sense of a
harmful move rather than the broad view of a flawed scheme in general. By this
convention, then, a mistake is an active botch in investing while a “myth” is a passive
misconception of the marketplace.

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Independence of Myths and Mistakes

A myth can stand by itself without reference to a mistake of any sort. In the example
given above, the false creed of utter efficiency asserts that the market absorbs every
speck of dope with perfect rationality at infinite speed. This fairy tale stands on its
own, without a direct link to an active goof by any player in particular.

From the converse stance, a mistake can arise in the absence of a myth. An
exemplar lies in the penchant of investors for jumping to the wrong conclusion by
adding up the returns on investment in a careless fashion.

To bring up a simple example, consider a portfolio that racks up a profit of 60% within
the span of a single year. After the windfall, however, the account loses half its value
over the course of the second year. Under these conditions, what was the overall
return on investment during the entire stretch of two years?

At this juncture, the bulk of investors would promptly tot up the two payoffs; namely,
positive 60% followed by negative 50%. In this way, the eager beavers come to
believe that the portfolio clinched a net profit of 10% from start to finish.

Upon closer inspection, though, the truth lies in the opposite direction. A plain way to
grasp the nature of the botch-up is to track the absolute value of the account from
one year to the next.

For this purpose, we will consider a small slice of the portfolio. More precisely, we
focus on a bitty share whose value at the outset amounts to a single dollar. Since the
chit appreciates by 60% over the course of the first year, it swells by 60 cents and
thus amounts to $1.60 by the end of the period.

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During the second year, though, the same token loses half its value. In that case, the
foregoing figure shrinks by one-half. After adjusting for the cutdown, the stake is now
worth only 80 cents.

In this way, each dollar of principal at the outset has shrunk to 80% of its initial value
at the end of the two-year stretch. The actual loss of 20% over the entire span
stands in stark contrast to the fancied gain of 10% reckoned by the mass of
investors.

This vignette spotlights the fact that adding up the returns on investment is a
conceptual flub as well as a pragmatic goof. Yet the bulk of investors rely on the
faulty scheme and end up with mistaken views of the performance of motley vehicles
ranging from elemental stocks to communal funds.

This and other acts of folly – whether of omission or commission – occur routinely in
the circus of finance. A showcase involves the sham claims of lush profits bagged by
operators in motley guises ranging from mutual funds and hedge funds to investment
coaches and newsletter writers.

The bobble of serial returns spotlights the type of mistake that pops out of nowhere
without resting on a fib of any kind. In this and other ways, the gamers in the morass
have a custom of tripping over their own feet without even stepping into the sea of
bunk spewed out by the canons of orthodox theory and popular folklore.

From a larger stance, the financial forum is awash with slippy myths that run wild on
their own, without any help from the flaky goofs of the investing public. Then there
are cases where the two forms of bungling reinforce each other to wreak untold
havoc.

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Mashup of Passive and Active Goofs

In certain cases, there’s a fine line between a myth and a blunder. An exemplar
involves the humbug that an index of the stock market reflects the performance of
the average equity over all timespans both long and short. A second and related
showcase concerns the mantra of mainstream finance that buying and holding a
stock forever is an unbeatable strategy for success.

As it happens, the foregoing pair of myths are tightly twined. In the olden days, back
in the middle of the 20th century, a gaggle of academics perched atop ivory towers
cast their gaze upon the turmoil in the financial landscape. In an effort to make some
sense of the commotion, the spectators watching from afar decided to rummage the
data streaming out of the markets. The aim of the pokers was to fish any patterns
slinking within the outpour of facts and figures.

Sadly, though, the tribe of scribes was far removed from the hurly-burly of the
markets they espied. Not surprisingly, the gazers saw only the superficial features
and glossed over the intrinsic aspects of the financial forum as well as the real
economy.

To cite an example, the onlookers failed to discern the subtle patterns in the stock
market over the short term. An example concerned the day trader who rode fleeting
waves in price over the span of a few minutes or hours; or the market maker who
lived off the spread between the bid and ask prices of singular stocks from one
moment to the next. In these and other ways, a small cadre of professional traders
toiling in the trenches managed to earn a living day in and day out.

Meanwhile, on the economic front, the gapers in academe overlooked the fact that
companies of all breeds bite the dust in droves. When a firm conks out, one fallout is
the rubout of the entirety of stocks, bonds and other securities they happened to
issue along the way.

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Detached from the scene of the action, the anglers in their laxness could not make
head or tail of the mounds of data they screened. For instance, the probers tried and
failed time and time again in their efforts to forecast the path of the stock market.

The litany of flops applied just as much to their attempts to pick out promising stocks
in the hope of beating the benchmarks of the bourse. Nothing seemed to work, as
their chosen candidates failed to outpace the market averages. In short, neither
market timing nor stock selection yielded the results they sought.

In pursuing their agenda, the armchair gumshoes took up a basic set of statistical
tools in sorting through the deluge of data. Yet the same repertory of techniques was
available to the entire world including the hustlers in the trenches ranging from solo
traders to communal pools. For instance, many a financial institution maintained a
stable of wonks to dredge through the sea of numbers the whole day long in a fervid
effort to divine the markets and augur their movements. The legions of analysts thus
employed spanned the rainbow from economists and statisticians to engineers and
physicists highly versed in quantitative methods.

The tourists in the halls of academe were clearly uncumbered by the weight of
common sense, not to mention a load of street smarts. If we look at the big picture, a
tool of any sort provides the wielder with a competitive edge only if it happens to be
unavailable to the other jousters. If everyone is equipped with the same gear, then
no one gains an advantage by dint of the instrument.

As an example, brandishing a knife may confer an edge over an unarmed opponent

but not against an adversary who flaunts a similar weapon. In other words, the lack
of a commonplace tool poses a disadvantage, but its presence renders no
advantage to speak of.

Given this truism, there was no reason to suppose that the casual dabblers diddling
on the sidelines could outwit the gung-ho players jostling at center stage by relying

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solely on a bunch of tools that were widely available to all comers. To presume that
such a feat lay within their reach was to call their judgment into question.

As the years of fruitless effort turned into decades, the dredgers of data were still
loath to give up and admit defeat. Instead the spin doctors declared that the endless
flops they faced were no flubs at all. According to the party line, the plethora of
letdowns merely served to show that the market can’t be predicted at all, nor the
benchmarks beaten under any circumstances. The reason, you see, was that the
stock market moved in mysterious ways in an utterly random fashion.

To lend an air of legitimacy, the posers adorned the mumbo jumbo with an epithet
hijacked from the venerable field of statistical physics. To wit, the flighty portrait of
the market was dubbed the Random Walk Model. Now that the blarney was dressed
up as a proven concept from the natural sciences and further garnished with an
Ample Dose of Capital Letters, the snow job had to be a respectable result, no?

If the market is the epitome of whimsy, then there’s no point in trying to predict the
course of the bourse in general nor the path of any stock in particular. Moreover, a
market that can’t be presaged at all lacks any basis for timing the purchase or sale of
any asset in a rational way. In that case, another dandy offshoot lies in the futility of
trying to outplay the benchmarks of the market.

No one can win the game of investment. The harder you try, the more you lose.
Abandon all hope, ye mortal, for persistence is futile.

To bring up another byproduct of the Efficient voodoo, you might as well procure an
asset then hold onto it forever. That’s got to be the supreme strategy for success. By
holding the widget till kingdom come, you’d reap the maximum gain and bear the
minimum cost in terms of time, effort and transaction fees.

In their zeal to cook up a result regardless of its verity, the tellers of tales failed to
notice a raft of real properties – both blatant and subtle – within the financial forum

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as well as the real economy. To point up a counterexample, a fundamental rebuff of
ideal markets and evergreen assets involves the fact that an index of the bourse is
not what it seems at first sight.

Chasm Between the Real and Ideal

As we noted earlier, death is the way of life for all manner of companies in the real
world. What’s more, when a corporation dies off, so does its equity. In the U.S., for
instance, the half-life of newborn ventures is merely a couple of years. That is, half of
all hatchlings conk out without ever celebrating their third birthday.

Granted, the closure of a business is in some cases a matter of choice rather than
fate. An example concerns an entrepreneur who decides to go into retirement after a
couple of years in business.

To bring up a counterpoint, though, one could question the sanity of a self-starter

who takes on the hulking workload required to launch a venture and nurture the
business only to give it all up within a few years. But the wisdom of such a move is in
itself an ancillary issue which we will not dwell upon.

More to the point, a successful venture is most unlikely to close its doors and fade
away without a whiff of fanfare. Rather, the owner of a viable firm would do much
better to sell the company to another party such as a business partner or a
competing firm. In this way, the entrepreneur could reap a handsome reward for their
labors to date.

On the whole, then, it seems fair to regard the death of a business as a sign of
failure rather than a mark of success. Millions of startups are launched by go-getters
spurred by wispy visions of building lusty ventures. All too often, though, the fond
hopes are dashed to pieces upon the craggy rocks of reality as countless firms
succumb to the rigors of competition in a harsh and unforgiving environment.

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Granted, a struggling business might perhaps be acquired by an enterprising person
or a corporate wheel. In that case, the equity of the defunct firm could get a new
lease on life in a different form. Moreover the same type of transition could occur
more than once. In such a sequence, an acquisitive firm is devoured in turn by the
next gobbler down the line.

In the fullness of time, though, even the terminal feeder at the top of the food chain
will suffer the standard fate of pooping out and dying off. As a result, the faithful
investors in the transient outfits along the way – whereby each company gives way
to the next – will end up holding an empty bag, with nothing to show for the rocky
ride they endured along the way.

Admittedly, a fortunate investor might receive an occasional payout of cash

dividends in the interim. Even so, the payments would be paltry or nonexistent during
the early stages of upgrowth and expansion for each company; and likewise
throughout the shrinkage and collapse of the late phases.

From the standpoint of evolutionary biology, a species can flourish even though each
of its members dies out. All that’s required for the culture as a whole to prevail is the
absence of a catastrophe that wipes out the entire population in one fell blow.

In a similar way, an index of the market can survive despite the ceaseless rubout of
the constituent stocks. In fact, a benchmark may even grind higher while the market
at large happens to stagnate or shrivel. For this perverse outcome to ensue, the only
requirement is that the band of rising stars covered by the index at each stage
should outclass the swarm of falling angels.

If truth be told, the endless process of renewal and upgrowth occurs by design rather
than accident. In catering to the financial community, the trustees of the index need
to weed out the senile stocks and replace them with youthful ones on a continual
basis. Otherwise the benchmark decays over time, loses its mojo, and fades into

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history. Given the tireless regimen of culling and switch-out, however, the sprightly
stocks bolster the yardstick during the zesty portions of their lives before each of the
mayflies burns out and dies off in turn.

Despite the uprise of the market benchmarks over the long range, though, the
turnout differs entirely for the woeful investor who buys and holds a clutch of shares
till doomsday. Doom is the only fate that awaits the die-hard who buys into the buy-
and-hold dogma.

In fact the poor sap is headed for the poorhouse at a giddy rate. Given the ferment of
technical progress and global commerce in the modern era, along with the upthrows
in the financial forum and the real economy, the day of reckoning will likely crop up
sooner rather than later. In this turbulent milieu, the buy-and-hold policy is not the
triumphant track extolled by the shamans of finance, but rather a sure path to ruin
amid the creative destruction of a bustling culture.

At this juncture, we return to the main thrust of this section. The traditional school of
financial economics flogs the notion that the motion of the market can’t be predicted
nor its performance surpassed. Based on the hoodoo of randomness along with
efficiency, the buy-and-hold shtick has been touted as the superlative strategy for
investment.

It’s a small step to go from the latter myth to the active goof of actually buying and
holding a stock forevermore. In this type of jam, a fuzzy line separates the inert myth
from the willful muff. In other words, the two modes of bungling are for the most part
one and the same. We could say that the pair of flubs comprise two sides of the
same coin.

To sum up, a myth is best viewed as a different kind of beast from a mistake. The
two forms of bumbling may crop up singly or jointly depending on the context.
However, there is in certain cases no difference to speak of between a fable and a
fumble.

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Wrapup of Mess-ups

A myth is a false view of the marketplace while a mistake is a bum move that hurts
the investor. The former is a passive flub while the latter is an active botch.

The two types of stumpers wreak havoc in isolation as well as combination. In the
former case, a given snag might trip up the players in the field without any tie-up to
the latter form of muck-up; and vice versa. At other times, the myths and muffs work
in concert to thwart the unwary gamer, thus fouling their agenda and even driving
them to ruin.

If we look at the big picture, the numbing complexity of the real and financial markets
hobbles the mass of investors and observers. The actors in a bind run the gamut
from clueless newbies dabbling in their spare time to jaded oldsters plying their trade
the whole day long.

Whatever the scope of experience in the field, however, the multitude of actors has a
custom of tumbling into both types of pitfalls time and time again. On the upside,
though, the nimble player can take corrective action to avoid the sinkholes from the
outset.

To this end, the first task of the prudent investor is to fathom the multiplex nature of
the deadfalls along with the grave losses they inflict. In tackling the din and chaos of
the marketplace, a firm grasp of the myths and mistakes leads the way to a sound
program of investment.

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