THE WALL STREET LIES
For the longest time, there has been a prevailing debate on what is best investment technique. Certain financial professionals argue it is active management, but others prefer passive management. Nevertheless, the snake oil salesmen use this argument in order to take advantage of investors, especially the least knowledgeable ones and earn more money.
This article will uncover the three big lies encompassing the Wall Street, which these snake oil salesmen use on their clients or investors.
Modern Portfolio Theory Does Not Exist. This is probably one of the biggest lies an investor will always hear. The Modern Portfolio Theory (MPT) states investors are risk averse, and appropriate diversification cuts down risk to the lowest possible amount at any determined return target.
The common notion about diversification is to purchase a set of asset classes, hoping to reduce the likelihood of depleting the entire portfolio in a single, sudden event. Yes, a little diversification is better than none at all. But the best way to do it is to use assets with low correlations to one another. However, no matter how far you take the diversification, there are still market risks - and some of these risks are inevitable.
Because if we are going to eliminate market risks, we remove the possibility of optimizing the returns in the investment portfolio, which is a fuel that drives the returns above the zero-risk level. Whether you aim for highest returns or lowest returns, you still need to embrace the risk in every trade.
MPT is a tool meant to maximize results. It never claimed to remove the risk or predict future events.
There is No Such Thing as Diversification. Talking about diversification, have you heard the advice "Do not put all your eggs in one basket"? It refers to a risk management technique which combines various investment instruments in a portfolio. It aims to even unsystematic risk events in a portfolio so that the positive performance of certain investments will neutralize or counter the negative performance of other vehicles.
During the financial crisis between 2007 and 2009, diversification helped a little in improving the results in the short term. But in the long run, this technique reflected a distinct benefit. Global diversification removed the possibility of placing all the funds in the worst asset class. Each asset has its own features, and accompanying returns and risks. Therefore, it is still best to put various assets in an investment portfolio.
Remember, put your eggs in several baskets for best returns.
Buy and Hold is Not Real. Considering all other investment techniques, buy and hold is one of the worse investment strategies a trader will encounter. An active manager refrains from recognizing this technique in managing a portfolio. Active management systematically increases costs, risks, and tax exposures, and also lowers returns. But as long as investors buy, active managers will keep on using their snake oil. Like what has been said earlier, this is one of the worse investment techniques. However, buy and hold still exists, but this is not applicable in all trading situations.
At the end of the day, it is still up to the investor whether he wants to follow the snake oil salesman or do his own due diligence. No one will stop you if you take the first option. But for best investment opportunities and returns, might as well take the second option.
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