Halloween is around the corner, as evidenced by the annual return of the “Pumpkin Spice Latte” at Starbucks and 5-pound bags of sweet stuff at the grocery store! That’s also a good time to stab through the heart and kill with a silver bullet all those scary senseless finance myths, truisms, and falsehoods. Every time I hear one of the phrases below I suffer a mini heart attack. I hope people would stop saying those.
1: “Cash on the Sidelines”
If there is a lot of cash on the sidelines, the theory goes, it’s money waiting to be deployed into the market, sending stock prices skyward. That’s a common theme you hear from the talking heads on TV. But it’s nonsense. It reveals a fundamental misunderstanding of how financial markets work. For every dollar a buyer deploys into the stock market, a seller has to take money out of the market. And that money will end up, you guessed it, on the sidelines.
The total stock market valuation does not go up because money flows into it (small exception: IPOs). Instead, folks who were previously not invested revise their valuation assumptions upward and now have to entice an existing stock owner to sell. The only way to do that is to offer a higher price. Thus, money previously sitting on the sidelines flowing into the market is not the cause for the market to go up, but a symptom. But it could also be a symptom of a falling market when existing owners ask for lower prices to entice the folks with money on the sidelines to buy.
Amazingly, even in the world of sports, this sideline analogy is somewhat asinine. For every player you bring in from the sideline, one of the current field players has to leave. You can never adjust the quantity of field player, you can only replace one player with another. If a diabolical death sounds too cruel it’s time we at least “sideline” this senseless phrase.
2: “Market Timing”
If index returns are not enough and active management is too costly, what is one to do? Market timing! Simply buy low and sell high. Geez, why didn’t I think of that before? Market timing is easy in hindsight but in real time it’s very hard for professional investors and retail investors alike. If the China devaluation last year had sunk the global economy it would have been very smart had you sold in late August. But that didn’t happen. Everybody who tried to time the market and sold at the bottom regretted that decision.
Timing the stock market is poison for us in the FIRE community. Especially in the accumulation phase, I have greatly benefited from not losing my nerves during the major market drops and rather pumping new money into the stock market while everybody else was selling. I would leave market timing to the experts (who, by the way, also get it wrong about half the time!) and just roll with the punches in the stock market. Read Burton Malkiel’s book (paid link) if you don’t believe me!
3: “You need an Emergency Fund”
Most of us in the FIRE community strive to save 25 years (years!) of expenses or more. That’s 300+ months of expenses, so we don’t believe that there is a need keep 3, 6, or even 8 months in cash/money market at essentially zero interest rate. We don’t want to repeat ourselves and simply refer to our previous posts:
Our emergency fund is exactly $0.00
Why an emergency fund is a bad idea in one single chart
Top 10 reasons for having an emergency fund – debunked (Part 1)
Top 10 reasons for having an emergency fund – debunked (Part 2)
4: “Buy the biggest home you can afford”
These are quite possibly the seven most dangerous words in personal finance. And, of course, the related “I will use my house to retire.” If you had done this around 2003 and were smart enough to sell your house in 2007, good for you. That rule might have worked as planned because the house probably appreciated much faster than the carrying cost of a large house. But that kind of calculation doesn’t normally work. That fancy bathroom or kitchen? It will look only so-so after five years, slightly outdated after 10 years and embarrassingly outdated after 20 years. So, be prepared to apply a 5% depreciation rate to the major components of the structure. And don’t forget to heat, cool and clean the place. It will be hard for the average expected home price appreciation to keep up with that cost.
5: “It’s a bubble”
We had the dot-com bubble in the early 2000s, the housing bubble in 2008/9. Now we have a new real estate bubble, a new equity bubble, a bond bubble, a credit bubble, a private equity bubble, and whatever the bubble of the week might be, according to the talking heads on TV and some bloggers on the web. Every time an asset class becomes more expensive than the historical norm, journalists and analysts are quick to use the B word. The only current bubble I see is the rampant overuse of the word “bubble” itself. True, equities and bonds are expensive but a bubble looks different. What distinguishes a bubble from a simply expensive market is that in the latter there are still potential and possible paths of outcomes that justify today’s valuations, while in the former there aren’t.
The path that justifies today’s valuations? If the central banks across the world return to normalcy along a very, very gradual path without sinking the economy, a continued oil price recovery, business investment bounces back, millennials move out of their parents’ basements and form households, inflation stays calm, etc. In that case, today’s valuations are fine. You may disagree with how likely this scenario may be, but at least there is a scenario with a probability greater than zero. Hence, today we’re likely not in a bubble. Tulips in Holland in the 1600s and pets.com in 2001 were certainly bubbles because there were no fathomable circumstances justifying prevailing valuations and it was just a question of time for the imbalance to collapse. But those occasions are extremely rare.
Honorable mention: “the company missed the earnings estimate”
This was pointed out by Andrew at Par Compounded in the comments section below. Love it. That phrase is totally nonsensical. It’s the other way around: the forecasters got it wrong. As Andrew put it, it’s like saying the weather missed the weather forecast.
Good one ERN. I will add one more: “You can’t put a price on happiness”, a comment which usually precedes a big dumb purchase. When I hear it, I say Yes you can, it is often zero dollars.
Haha, that’s a good one. Together with “You deserve this”
Cheers!
Ha, just reading “A Random Walk Down Wall St” right now and learned about the tulip story. Fascinating stuff.
Peeves of Mr. PIE:
1. This is an excellent growth opportunity….
Translated as we are throwing you in the deep end and checking out your swimming abilities. Oh, and there are no lifesavers, just so you know….
2. You gotta give 110%….
Eh, not possible from my understanding of physics, maths
3. It’s not rocket science….
Like everyone says in the conversation about financial independence, yet we spend endless hours reading about it and learning how to get there. Could have learned rocket science in a smaller amount of time.
4. You are empowered…
Here is a little piece of work to spend some time on. Report back please with your findings, and when you do, know that I am still very much in charge.
Haha, thanks! All of those are very scary and cringeworthy! Happy Halloween!
Thanks for killing these myths! Someone had to do it…nicely done.
I like the E-Fund one, that’s a good way to look at it. When you are already trying save 25x expenses to retire, does an E-Fund really make sense…nah.
I’ve heard that before too on buying a big home… “oh its ok to stretch for a home, your payments will remain fixed while your salary will increase in the future so while you may be house poor today it’ll get better.” Yeah ok, and there goes saving for retirement in the meantime and I’m sure you won’t find new ways to spend future pay raises anyway.
Thanks! Yes, lots of bad advice out there on homeownership. It’s just too much of a scared cow that turns into holy cow moments for many homeowners!
Cheers!
Thanks for the shout, ERN! Muchas gracias!
I’ve got tons of cash dolares sitting on the sidelines right now like big, angry linebackers waiting for these various bubbles to pop so I can sub them in and time the market perfectly (trust me; I can do this every single time; I look at charts that are never wrong) and buy the biggest house I can find and finance it with a 15-year mortgage (or maybe a 10-year mortgage!) and put the balance into an emergency fund. It’s gonna be rad. ‘Cuz I’m worth it.
Great stuff, ERN – thanks again!
Ha, that’s priceless. I wasn’t expecting anything less thana linebacker/Luchador-sized cash hoard for the various emergencies and bubble-timing in the FL household.
Thanks, FL, appreciate it!
Ha! Good ones. I get tired of hearing those as well. Here’s mine: “Buy and hold is the best strategy”. Followed by “Buy and hold doesn’t work”.
Well, as a buy and hold kinda guy I didn’t take too much offense in your first suggestion, though, for rebalancing and tax loss harvesting I would deviate from that rule of course. Thanks for stopping by!!!
Cheers!
My biggest pet peeve is hearing within the next couple of years the US should enter a recession. Of course it will. On average the US is in a recession every 5 1/2 years so of course this sounds smart.
Haha, that’s a good one. I recently heard some talking head on TV forecasting the recession probability as 15% over the next year. Really? Without knowing anything I would have picked a 1/6 chance for the exact same reason you mentioned. Thanks for stopping by!
Cheers!
I see the “recession imminent” remarks so many times in other FI forums as if a 20% correction or recession is an actual event on next year’s calendar. “We’re due, therefore I’m pulling out.” We’re also overdue for Yellowstone to have a major eruption – give or take 100,000 years.
Haha! I’m glad we were able to visit Yellowstone last year and made it back in one piece!
I like the “buy the biggest home you can afford” myth debunked. I remember talking to my friend in middle school and he said that “I just want a big house.” His wanting a big house made me want a big house in return. Oh how times have changed. I live in a 500sq ft studio apartment and I still think I have too much space left over. It would be a different story if I had a roommate (I did go through a 500 sq ft apartment with a roommate and it wasn’t fun) but for just myself, I don’t want a big dwelling!
Smart move! Not wasting much on housing costs and saving more will get you to FIRE years earlier!
Thanks for stopping by!
Cheers!
Haha! Love this list, especially #3! So many people that we talk to about our strategy to paying off student loan debt and dream to retire early just about die when we tell them we don’t have an “emergency fund.” Sorry that I don’t hate money enough to keep it from building interest for me (or more accurately, paying off interest for me). 🙂
Haha great point. By the time people reach the EF target they might be 50 and have missed the compound interest along the way.
Cheers!
ERN,
Love this discussion!
I think my all time favorite is “earnings missed estimates”
That’s like saying the weather missed the weatherman’s forecast haha!
The more accurate statement would be something like analysts forecasted incorrectly because the models were wrong haha!
Haha, that is a priceless comment. I never thought about it that way. Probably it’s because I work in finance that I succumbed to this delusion: blame the company for the bad forecasts. Only in finance can you get away with this.
Thanks for pointing that out.
Cheers!!!
ERN
“The market is at an all time high” as a reason not to get into the market.
Yeah, it does that. A lot. What’s your strategy then? What number is your trigger to start investing? Was it last year’s all time high or the year before that?
It depends on whether you are starting out as an investor or if you already got sizable inevstments. As a young investor you should definitely not time the market. Get in and keep contributing if the market drops.
But one caveat: if you are FI and ready to RE then there is a rationale to use a glidepath: start with some bonds and shift back into mostly equities, see parts 19-20 of my SWR series.