Myths are widely held beliefs that are mistaken as truths. For example, for long periods of time people believed (and acted) as if the world was flat. Below are similarly misguided assumptions that exist in the financial markets that I have come across during my investment career. I have found the reality that lies behind these to be invaluable in guiding my investment decisions…

Myth 1: There is no free lunch

While I subscribe to the aphorism, "If something is too good to be true, it probably is", I believe there is one free lunch in the financial markets, the impact of which is often understated. This has often been referred to as the eighth wonder of the world and, you’ve guessed it, it’s compounding (Click here to read 'The power to become rich'and learn more about what Einstein called 'the most powerful force in the universe).

Everyone can benefit from compounding. It is not a zero sum game and it does not require any special insight.

The benefit of compounding can best be illustrated by the following example:

If you can achieve a return of, say, 12 percent a year from your equity portfolio, it will effectively double in value every six years.

For every R100 you put away at age 25, you will have R5279 when you retire at 60. If you delay your savings until you turn 30, your R100 will only be worth a comparable R2674.

So you see it’s the last double that has a material impact on your pension savings, which means you should start saving as early as possible to benefit from the impressive power of compounding.

Myth 2: Earnings drive share prices

While this may be true in the short term, valuation ultimately trumps short-term earnings expectations.

On their own, earnings do not create value for shareholders, dividends do. I have seen several companies that have consistently grown earnings, but at the expense of shareholder value creation, which comes from generating cash and reinvesting the cash back into the business at returns that are above the cost of capital.

Sometimes it takes years for the market to recognize that the emperor is in fact wearing no clothes (i.e. earnings are growing, but not shareholder value). Some examples that come to mind in the past 10 years are CS Holdings and Imperial (prior to its recent unbundling).

Myth 3: Active managers outperform the market

This is a highly contentious issue and while some managers do outperform their benchmark, they are certainly in the minority.

If you look at the data over the last year, active managers have done quite well. Just over 50 percent of all unit trust managers in the combined general equity, value and growth category outperformed the JSE All Share Index.

But unfortunately as one increases the time horizon, so the statistics get worse. Over 10 years, just one third of all managers beat the JSE All Share Index (and this is ignoring the effects of survivorship bias).

Investing in the market is a zero sum game, half will outperform the Index and the other half will not. After taking fees into account, roughly only half of the remaining group (i.e. roughly one quarter) actually beat the JSE All Share Index.

While there is no magic formula for beating these odds, a detailed, disciplined and value-oriented approach to investing should swing these odds in your favour.

(Click here to learn more about Satrix, an inexpensive tracker fund that passively follows the market and regularly outperforms actively managed funds.)

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