This week, I'm going to write very little and instead just quote fund disclaimers. Here's the standard disclaimer from an Indian mutual fund that you must surely have seen: Mutual fund investments are subject to market risks. Please read the scheme information and other related documents before investing. Past performance is not indicative of future returns.
And here's the equivalent statement of an American fund from around the year 2000, which I found via the blog of Jason Zweig, who writes wonderfully about personal finance in Wall Street Journal. Without further comment, with some editing for length:
First of all, stock prices are volatile. Well, duh. If you buy shares in a stock mutual fund, any stock mutual fund, your investment value will change every day. In a recession it will go down, day after day, week after week, month after month, until you are ready to tear your hair out, unless you've already gone bald from worry. It will insist on this even if Gandhi, Jefferson, John Lennon, Jesus and the Apostles, Einstein, Merlin and Golda Maier all manage the thing. Stock markets show remarkably little respect for people or their reputations.
While the long-term bias in stock prices is upward, stocks enter a bear market with amazing regularity, about every 3 - 4 years. It goes with the territory. Expect it. Live with it. If you can't do that, go bury your money in a jar or put it in the bank and don't bother us about why your investment goes south sometimes or why water runs downhill.
Aside from the mandatory boilerplate terrorizing above, there are risks that are specific to the IPS Millennium Fund you should understand better. Since most people don't read the Prospectus (this isn't aimed at you, of course, just all those other investors), we thought we'd try a more innovative way to scare you.
We buy scary stuff. You know, Internet stocks, small companies. These things go up and down like Pogo Sticks on steroids. ... While we try to moderate the consequent volatility by buying electric utility companies, Real Estate Investment Trusts, banks and other widows-and-orphans stuff with big dividend yields, it doesn't always work. Sometimes we get killed anyway when Internet and other tech stocks take a particularly big hit. The "we" is actually a euphemism for you, got it?
Received Wisdom can turn on a dime in this business, and when that happens prices fall off a cliff. Even if we were really smart and stole these companies, if their prices run way up we are still as vulnerable as if we were really dumb and paid that high a price for them to start with. ... Just so you know. Don't come crying to us if we lose all your money, and you wind up a Dumpster Dude or a Basket Lady rooting for aluminum cans in your old age. Please e-mail us if we haven't scared you enough, and we'll try something else.
Both the above disclaimers--the dull Indian one and the funny American one--are equally correct, of course. However, only one of them is actually useful in communicating any kind of fundamental truth about investing. No prizes for guessing which one. Of course, no prizes also for guessing that the American fund which issued this disclaimer never managed to collect much money from investors. After all, telling the plain, hard, uncomfortable truth is so unusual in the financial services business that investors wouldn't really have responded to this kind of a statement.
But the truth is that if you invest in equities or equity mutual funds, then you should print out this disclaimer and pin it up on a board. There are two aspects to what it says. Both are summed up in the sentence 'While the long-term bias in stock prices is upward, stocks enter a bear market with amazing regularity, about every 3 - 4 years'. Every equity investor must take this to heart.