It’s often said we are the stories we tell ourselves. And, in a real sense, the investment industry is all about telling stories—about opportunities, risks, growth, decline, and likely future events and their significance. But are the stories—or, to use a sociological term, myths (i.e., commonly held beliefs adopted to explain the world)—that we tell actually true? Or are our stories myths in the colloquial sense—that is to say, false? The passage of time usually answers such questions, but some stories or myths seem to persist despite being discredited by experience. By way of a reality check, here are eight common but persistent market myths about investing that, respectfully, might best be consigned to the shelves of history.

1. Stock options and bonuses tied to share price performance align the interests of management and shareholders.

A fundamental flaw in stock options and bonuses tied to share price appreciation is that they give managers exposure to the upside in share prices without requiring them to put any of their capital at risk. They also give managers exposure to overall stock market gains that have nothing to do with the success of their efforts to create shareholder returns in the company’s business. Managers often derive substantial short-term benefits by talking up the value of their company’s shares to the public, rather than consistently using their communications to convey balanced assessments. Creating investment theses or “stories”—and managing expectations around them to always appear to be doing as well or better than “guidance”—can get in the way of providing full, true, and plain disclosure.

Long-term stock ownership plans that balance upside potential with downside risk are far better incentive plans from a shareholder perspective.

2. Past performance record is a good guide to future performance prospects.

It’s a strange anomaly that all advertising literature for investment funds must, by law, state that past performance is not indicative of future returns. And yet, past performance data is generally used in a manner to suggest that it is, in fact, a good guide to future returns. Investors tend to buy funds that have performed well in the recent past—the fund investor’s equivalent of buying high. Meanwhile, most investors say they’d never invest in a fund with a poor recent track record even though, for many such funds, a strong tailwind could come simply from a reversion to the mean. (A Standard & Poor’s study has revealed that 99 percent of funds in the top quartile fail to remain in the top quartile after five years.

In reality, a proper understanding of what past performance means can only be obtained by in-depth analysis of investment decisions taken by the fund managers, their rationales, and their outcomes over time—an inquiry that relatively few fund managers are willing to report on comprehensively or consistently, and which relatively few investors attempt to do for themselves.<

3. Beta is a good rough measure of market risk.

Beta is readily available from data providers, so it’s often used as a quick measure of risk for stocks and portfolios. View beta cautiously, however. Beta measures the historic volatility of a stock or portfolio compared to the market—not risk in general. A security or portfolio can be risky in nature but not correlated with market returns. Moreover, beta won’t be reliable if the stock or portfolio is illiquid and trades infrequently. A portfolio of just a few stocks can’t be expected to track the market in a stable fashion in the longer term. Beta can, and does, change over time, and it can be different in up markets and down markets.

Beta doesn’t provide a good measure of a company’s risk profile and shouldn’t be used loosely as though it does. Beta regards risk solely from the perspective of market prices, failing to take into consideration specific business fundamentals or economic developments. The price level is also ignored, as if a stock selling at $10 per share or 15 times earnings would not be a lower-risk investment than the same stock at $20 per share or 30 times earnings. Beta also assumes that the upside potential and downside risk of any investment are essentially equal, being simply a function of that investment’s volatility compared with that of the market as a whole. Beta is, by definition, a rear-view mirror metric and, as such, doesn’t necessarily predict how volatile a stock might be in the future.

Long-term investors must include many factors in addition to market risk to get a complete picture of risks. There’s no reliable substitute for a full fundamental analysis of a company’s industry, operations, outlook, and financial position.

4. Putting money into index funds is a passive form of investing.

Index funds are designed to track an index, which is a balanced collection of stocks selected according to set criteria. Stocks that do or do not meet these criteria are added or removed over time (e.g., over the past 30 years, more than 20 of the 30 stocks in the Dow Jones Industrial Average have been replaced²). Index funds are not random or one-time selections of stocks—nor do they include the entire universe of stocks. Their management fees are low because the selection criteria are pre-set and automatic, reducing the need for costly investment research and management. An investor must decide (or take advice) on what index funds to buy or sell. In itself, this is an active rather than a passive approach and can have a range of different outcomes depending on the index funds selected.

When it comes to investing money, all strategies are active in varying forms and degrees.

5. Large cap stocks are less risky than small cap stocks.

Traditionally, large cap stocks were viewed as less risky than small cap stocks because they tended to represent ownership in large stable companies in major industries that have been at the core of the economy for generations. Large cap stocks tended to have a long history of operation, a proven business model, stable profitability, a history of paying regular dividends, and good access to debt and equity capital.

Today, many high-cap issues—including many high-valuation issues such as Amazon and Facebook—have businesses in novel or highly disrupted industrial sectors in which they themselves are pioneers or lead the disruption. They tend to have high-tech business models with limited histories and visibilities of profitability; pay scant, if any, dividends; and, in some cases, expect prolonged periods of future losses (e.g., Uber and Tesla). A review of the past performance of such companies as Research In Motion/BlackBerry, Nokia, and AOL Time Warner shows just how little safety exists in size in the modern and rapidly changing high-tech world.

When share valuation risks, business model uncertainties, and financial concerns are all taken into account, many of today’s large cap stocks have few of the characteristics of yesterday’s large caps. The time for lumping all large cap issues into a single risk category has passed.

6. Bay Street and Wall Street analysts can scrutinize public companies’ operations and financial results to reach highly confident conclusions.

The amount of information available to shareholders. The extent of information disclosed and the timeliness of its disclosure by public companies increased dramatically during the last century and the pace of improvements has increased further in the current age of IT and telecommunications. However, shareholders today still don’t have complete access to the operating and financial reports that are used by managements to manage the businesses of public companies. Public disclosure is confined to selected summaries and GAAP financial statements, which are usually quite different from those used by management. MD&A reports, useful as they are, are primarily legal documents prepared by lawyers, and are often clogged with legalese and boilerplate statements. Investors in publicly traded shares almost never inspect the operations and assets thoroughly; meanwhile, analysts and institutional investors gain access only through selected property tours from time to time, and receive little detail on customers and suppliers. Information about sales and profit margins on specific products, detailed international breakdowns of financial statements, and breakdowns of corporate structures involving subsidiaries, regulatory jurisdictions, and local tax authorities are also not usually available, even though no private buyer for an entire enterprise would commit to a purchase without having examined such information.

When this writer became an investment analyst in 1971, the director of research at Dominion Securities (now part of RBC Capital Markets) recommended that I prepare an informal “anti-research report” that discussed all the important information that wasn’t publicly available on the company I was analyzing with a view to writing a report on this topic. This report would not only reveal the risks of the unknowns to investors but also document important areas for further investigation. Of course, such reports were never published by investment firms then or now, and clients would probably have become reluctant to invest in public companies if they were, but I’ve always kept my research director’s advice in mind and, over the years, have done many quick “anti-research reports” on paper or in my head. The advent of computer modelling served to remind analysts of the shortcomings in disclosure as they built their models, but also presented a trap: believing that “guesstimates” were reliable estimates and ascribing undue credence to the flow of computer-calculated figures that came from models based on such numbers.

Analysts trying to assess the performance of technology and other companies today face these same issues. Their conclusions must, of necessity, be somewhat tenuous and should be presented as such.

7. Investment advisors do a commendable job of separating investment from speculation for their retail clients.

Fifty years ago, investment dealers and stockbrokers had strict requirements for the companies whose shares they would underwrite or recommend to their clients. The mere fact that Wood Gundy, A.E. Ames, or Dominion Securities underwrote the securities of a company or had their research analysts cover its shares was an imprimatur of respectability and reliability for a company’s securities. Reciprocally, in their annual reports, companies would identify their dealer/brokers as “fiscal agents,” along with their bankers and auditors and stock exchange listings. Countless smaller firms or firms that hadn’t been in business for many years and didn’t have a sufficiently long history of profitability and dividend payments were dubbed “junior companies” or “speculative”; they were not recommended or, in some cases, not even discussed with the dealer/broker’s clients. Smaller dealers and brokers might have picked up coverage of these firms, but many would have been systematically ignored.

Over the years, these rules were greatly relaxed and went out of the window completely during the dotcom bubble of the late 1990s—never to return. All too often today, even leading dealers will underwrite and leading brokerage firms will cover virtually any company they think the public wants or can be persuaded to want to invest in. Twenty-five years ago, many companies like Tesla or Uber Technologies or the Canadian marijuana companies today would still be entirely owned by venture capitalists or private equity (merchant banking) firms, or would be listed only on speculative stock exchanges. By contrast, now there’s a plethora of high-tech start-ups that have no earnings—and even, in some cases, scant revenues—but find their way onto major stock exchanges and into the hands of savers who think of them as investments when they are, by objective criteria, high-risk speculations. Many security structures such as options and other derivatives raise the risks to investors to levels that make them essentially speculative in nature, even when they relate to stable, underlying companies.

A return to the starchy practices of the past isn’t feasible or even desirable, but a greater sense of responsibility to scrutinize risk and suitability on the part of dealers and brokers would be a good step forward in improving client care and responsibility.

8. The boom in IT and electronic communications has led to improvements in the quality of investment decisions and results.

That we have vastly more information and access to low-cost trading today than ever before is beyond question. However, that we’re less able to use it wisely to reach sound conclusions is suggested by the heightened price volatility of markets today and their extreme focus on short-term trading and internal market dynamics over judicious assessment of business fundamentals and long-term prospects. When share prices change by several percentage points in a day without any economic or financial news beyond market chatter, it’s clear that behavioural rather than fundamental forces are driving prices and that investment decisions are far from sound or high in quality.

¹ https://www.institutionalinvestor.com/article/b1c6lzr9bpw03t/Active-Funds-Fail-to-Keep-Up-Top-Performance-S-amp-P-Finds
² https://en.wikipedia.org/wiki/Historical_components_of_the_Dow_Jones_Industrial_Average