In the world of personal finance and investment, it's easy to get caught up in the sea of advice and strategies that often contradict each other. Some advice is timeless, but others might not hold up as well in certain situations. Today, we'll dive into some common financial wisdom and explore why it might be worth rethinking.
Challenging Conventional Wisdom
"Buy What You Know" - A Misleading Adage?
Dean Anderson, founder of Kernel, raises an interesting point about the popular advice to invest in what you know. While familiarity with a company can provide some insights, it doesn't always translate into a good investment. Take, for instance, the case of Air New Zealand. Many people bought shares post-Covid, assuming their knowledge of the brand would pay off. However, share prices dropped, leaving investors with a lesson in the difference between brand recognition and investment potential.
Home Bias and the International Perspective
Gertjan Verdickt, Associate Professor of Finance at the University of Auckland, highlights another common pitfall - home bias. New Zealanders often invest heavily in local companies, but Verdickt argues that diversifying internationally is crucial for risk management. Academic theory suggests holding international stocks in proportion to their global market cap weight, which is currently around 59% for a global portfolio. Yet, popular advice often recommends much less, leading to missed opportunities and potential risks.
Thinking Beyond Property
New Zealanders' focus on property as an investment is a topic Verdickt addresses. He emphasizes that an owner-occupied home may not be the best investment, as it doesn't generate significant income and requires ongoing expenses. While homeownership has its merits, it's not always the financially superior choice, and it can lead to a concentration of wealth in a single, illiquid asset.
Rethinking Savings and Investment Strategies
The Constant Savings Rate Myth
Verdickt challenges the idea of saving a constant percentage of your income at every age. Economists argue for smoothing consumption over time, which means saving more when your income is higher and spending down in retirement. The constant savings rate advice ignores income patterns and the time value of money, which can be economically suboptimal.
Emergency Funds vs. Credit Card Debt
Another piece of advice that might need rethinking is the importance of emergency savings, especially when carrying credit card debt. While having an emergency fund is crucial, it might not make sense to build it up while carrying high-interest credit card debt. It's economically irrational to have money in a low-interest savings account while paying off high-interest debt.
Timing the Market: A Risky Game
Ana-Marie Lockyer, CEO of Pie Funds, warns against trying to time the market. It's a difficult game to get right consistently, and often, investors end up missing the best days of the market, which can significantly impact long-term returns. The key is to have a long-term strategy and not react to every market update.
The Patience Pays Off
Lockyer's advice aligns with Warren Buffett's famous quote about the market transferring wealth from the impatient to the patient. Investing is a marathon, not a sprint, and quick wins are often more myth than reality.
Final Thoughts
In the complex world of finance, it's essential to question conventional wisdom and seek a deeper understanding of the implications and potential risks of any investment strategy. While some advice is timeless, others might need a critical eye and a personalized approach. As always, it's crucial to do your research, seek expert advice, and make informed decisions tailored to your unique financial situation.
