It's Only Money By Stephen J. Butler Archives
Bunker Hunt of Texas lost several billion dollars when, with his brother, he tried to corner the Silver market back in the 70's. At the time, he told reporters, "a billion dollars isn't what it used to be." Some of us have seen a lot of money evaporate from our retirement plans over the past two years, but we need to remember that these losses haven't exactly been our hard-earned dollars. Collectively, we have lost over four trillion dollars, but thanks to the roaring nineties, a trillion dollars isn't what it used to be. We have trumped the Bunker.
Some of us are upset, if not mad, and this is a big mistake. In the movie "Godfather III" after the helicopter gun ships shoot up the restaurant, Al Pacino reminds Andy Garcia, "Never hate your enemies. It can affect your judgment." We have reasons to be annoyed, starting with institutionalized corporate greed and corruption, but on the whole, things are not so bad. Most of us, unless we did something really stupid, have far more money today than the after-tax cost of all contributions we have made over the years.
To improve our general outlook and feel really good, we need to first disabuse ourselves of several destructive thought patterns. First, we need to get a grip. We should have expected to have this happen sooner or later. We should also forget about the one person in 50 who just happened to cash out of the market at the end of 1999. We all know at least one of these people, as this proportionately small group tends to be good about sharing. I happen to know some people who also bailed out of the market after the 37% rise in 1995. They saw that year as the blowout year and walked away from the 22%, 33%, 28%, and 21% successive gains over the following four years.
The numbers never lie, so it pays to look at a typical case for someone who has the most to be concerned about. This would be someone with perhaps $100,000 in retirement plans as of the beginning of 1992 who has also deposited $10,000 per year every year starting in 1991. Everything in the following analysis is linear, so if your numbers amount to half or double these amounts, you can adjust accordingly.
Based on the returns of an S&P 500 index fund, the $100,000 at the beginning of 1992 has now accumulated to approximately $270,000. Its high point was about $420,000 at the end of 1999. The $10,000 per year contribution has accumulated to about $175,000. Its 1999 high point was $235,000. Today's combined total is almost $450,000, and this is after the greatest market collapse since 1929. Assuming that some of the initial $100,000 consisted of compound earnings, the cost in after-tax take-home pay for all the contributions required over the years was about $140,000 (about 2/3rds of the actual contribution amounts thanks to effective "subsidies" in tax savings from state and federal governments.) This is how much we sacrificed in consumer spending to achieve our $450,000 nest egg.
Unfortunately, many view the glass as half empty instead of half full. Some of these are younger people who have all the time in the world to wait around for the next roaring decade. In the meantime, they can be loading up on mutual fund shares at the lowest prices we have seen in years. It is reassuring to note that some of the greatest single-year market gains occurred during the middle of the great depression. Later, after the '73 decline, the market had recovered by 1976. Markets could go lower than they are today, but with prices this low, a lot of good things can happen over the next five or ten years. When they do, they will take us by surprise. Last Tuesday's 5% gain in market values is a very good example.
While we're at it, we're taking this opportunity to conduct a thorough housecleaning of corporate America. We've fired a broadside into the ranks of some of the largest corporations and investment banking houses. I love these "perp walks" with people like Andrew Fastow in handcuffs having to carefully duck his head as he gets into the back into the back of a squad car. This sends a shot across the bow of corporate America and offers a reminder of who the true owners are. The power of a democracy is truly awesome and wonderful to watch. A policeman once reminded me that most crimes are solved because criminals are basically, as he put it, "stuck on stupid." When the curtain closes on this chapter of business history, a lot of frozen assets will have been returned to us stockholders.
Meanwhile, with regard to the war in Iraq, the lesser of evils would be what I see as Colin Powell's inclination toward coercive inspections. In my mind, this means that if a single plate of food is spilled deliberatue="http://www.buyandhold.com/bh/en/retirement/qa/index.html">Help Topics Retirement Planner Retirement Perspectives Manage Your Retirement Money and Bad Behavior By Stephen J. Butler Archives John Nash, the character in the movie "A Brilliant Mind," was a Nobel prizewinner in 1994 for his experiments in game theory?the process of making mathematically rational decisions based on calculations of probability. A few weeks ago, by comparison, the Nobel Prize for economics was awarded to two academics who studied the extent to which irrational behavior ruled much economic decision-making. Meanwhile, here we sit staring at our retirement plan statements showing how much money we have lost. We feel like we ought to do something, anything, but can we be sure that our next move will be rational and profitable? The odds are great that we will do the wrong thing. Morningstar, the mutual fund ranking service, did a study at the height of the stock market frenzy showing that the average mutual fund investor had only earned an average of 3% per year while the average fund had been gaining at 16% per year. Understanding what caused this abysmal result is what propelled professors Daniel Kahneman and Vernon Smith into the Nobel winners' circle. We basically don't like to lose, so we become paralyzed. We would rather sit on a bad investment than take the risk of switching to a new one and losing more money as a result of our decisive action. It bothers us more to lose as a result of pro-action than as a result of inaction. So, we avoid the possibility of taking a step that runs the risk of making us feel stupid. Sitting tight offers the peaceful fog of denial and leads to something called "the status quo bias." How we ask ourselves the question can impact what we decide to do. The stories about Kahneman's and Smith's work all cite the following simple experiment: Students were told that they could save 200 out of 600 people from a disease. Or, they could select a second option where there was a one-third chance that everyone would live and a two-thirds chance that everyone would die. Seventy-two percent of the students took option one. Then the same question was presented differently by describing option one where 400 people would die versus option two where there would be a one third chance that no one would die and two-thirds that everyone would die. Presented this way, seventy-eight percent of the students elected option two. How the question was asked determined the outcome of the poll even though the arithmetic was the same in both cases. Of course, these were just Princeton students, but they reflect the basic truism of society in general. People will shun risks when gains, like lives saved, are at the forefront of the brain. They will take risk, on the other hand, when they are focused on avoiding a certain loss, even if the loss could be magnified further by taking the riskier course of action. Risk, remember, is a measure of future uncertainty, so option two offers more uncertainty as to the future outcome. The relatively new field of behavioral economics represents the attempt to understand why we make so many financial decisions that are based on factors other than cold, hard, economic probability. When it comes to investment decisions, we need to decide how to ask the question. Is the glass half empty or half full? If we view our retirement account as being half full, we will want to lock in what we have today by moving out of stocks and into a money market fund. This is the equivalent of saving at least some lives (above) with 100% certainty. If we view the glass as half empty, then we will be more inclined to accept the risks that will fill it up again. Unlike the students' experiment, our investments do not have a finite test with a beginning and an end. We have the luxury of knowing with some certainty that, given enough time, the glass will be full once again. The current bear market, when compared against historical standard deviation measurements, represents an event that has had less than a 5% chance of happening. The probability of its dropping substantially lower is perhaps one or two out of a hundred. At this point, long-term investors with portfolios whose contributions were largely made before the big run-up of the nineties are now about even with long term stock market returns of about 10% per year. Those whose accounts are newer have a greater percentage of assets that were contributed throughout the nineties when market values were much higher. If this is the case with you, your losses are greater because you bought most of your mutual fund shares at higher prices. In the first case, the glass is half full right now, and you can consider locking in gains by moving toward fixed income investments. In this way, you will be responding to the human delighted to pay estate taxes someday. They are largely voluntary and they prompt all kinds of commendable behavior like family gift giving, charitable giving, and succession planning in general. Meanwhile, we are doing away with a source of 1% of our tax revenue. Where will we make this up? If we're not careful, it will be a repeat of the "stealth taxation" of the 1980's, when we had the largest percentage increase in taxes since World War II. At that time, we dramatically increased the social security tax?a regressive tax increase that today hits every earned-wage dollar up to $84,900. On the whole, I am optimistic about the future of American business and the direction of corporate governance. We eat an elephant one bite at a time, and last week we gobbled up Harvey Pitt, our flawed SEC chairman. Rudy Giulianni transformed New York City by enforcing simple laws like jaywalking and turnstile jumping. He applied the famous broken window theory that says when we allow one window to be broken, all that remain will be shattered within days. It's never too late to improve our legal climate and apply common sense to taxation issues. Our general well-being, after all, depends far more on the strength of our society than on the quality of our burglar-alarm systems. John Adams and our founding fathers placed a premium on the need to develop a large, strong middle class. They specifically cited the need for a strong educational system. They gave us a great start over two hundred years ago, but to build further we should start by asking, "What do we have to lose?" Copyright © 1999 – 2012 Freedom Investments. All Rights Reserved. Freedom Investments, Inc. Member FINRA/SIPC Privacy & Security
Money and Bad Behavior By Stephen J. Butler Archives
John Nash, the character in the movie "A Brilliant Mind," was a Nobel prizewinner in 1994 for his experiments in game theory?the process of making mathematically rational decisions based on calculations of probability. A few weeks ago, by comparison, the Nobel Prize for economics was awarded to two academics who studied the extent to which irrational behavior ruled much economic decision-making. Meanwhile, here we sit staring at our retirement plan statements showing how much money we have lost. We feel like we ought to do something, anything, but can we be sure that our next move will be rational and profitable?
The odds are great that we will do the wrong thing. Morningstar, the mutual fund ranking service, did a study at the height of the stock market frenzy showing that the average mutual fund investor had only earned an average of 3% per year while the average fund had been gaining at 16% per year. Understanding what caused this abysmal result is what propelled professors Daniel Kahneman and Vernon Smith into the Nobel winners' circle.
We basically don't like to lose, so we become paralyzed. We would rather sit on a bad investment than take the risk of switching to a new one and losing more money as a result of our decisive action. It bothers us more to lose as a result of pro-action than as a result of inaction. So, we avoid the possibility of taking a step that runs the risk of making us feel stupid. Sitting tight offers the peaceful fog of denial and leads to something called "the status quo bias."
How we ask ourselves the question can impact what we decide to do. The stories about Kahneman's and Smith's work all cite the following simple experiment: Students were told that they could save 200 out of 600 people from a disease. Or, they could select a second option where there was a one-third chance that everyone would live and a two-thirds chance that everyone would die. Seventy-two percent of the students took option one. Then the same question was presented differently by describing option one where 400 people would die versus option two where there would be a one third chance that no one would die and two-thirds that everyone would die. Presented this way, seventy-eight percent of the students elected option two. How the question was asked determined the outcome of the poll even though the arithmetic was the same in both cases.
Of course, these were just Princeton students, but they reflect the basic truism of society in general. People will shun risks when gains, like lives saved, are at the forefront of the brain. They will take risk, on the other hand, when they are focused on avoiding a certain loss, even if the loss could be magnified further by taking the riskier course of action. Risk, remember, is a measure of future uncertainty, so option two offers more uncertainty as to the future outcome.
The relatively new field of behavioral economics represents the attempt to understand why we make so many financial decisions that are based on factors other than cold, hard, economic probability. When it comes to investment decisions, we need to decide how to ask the question. Is the glass half empty or half full? If we view our retirement account as being half full, we will want to lock in what we have today by moving out of stocks and into a money market fund. This is the equivalent of saving at least some lives (above) with 100% certainty.
If we view the glass as half empty, then we will be more inclined to accept the risks that will fill it up again. Unlike the students' experiment, our investments do not have a finite test with a beginning and an end. We have the luxury of knowing with some certainty that, given enough time, the glass will be full once again. The current bear market, when compared against historical standard deviation measurements, represents an event that has had less than a 5% chance of happening. The probability of its dropping substantially lower is perhaps one or two out of a hundred.
At this point, long-term investors with portfolios whose contributions were largely made before the big run-up of the nineties are now about even with long term stock market returns of about 10% per year. Those whose accounts are newer have a greater percentage of assets that were contributed throughout the nineties when market values were much higher. If this is the case with you, your losses are greater because you bought most of your mutual fund shares at higher prices.
In the first case, the glass is half full right now, and you can consider locking in gains by moving toward fixed income investments. In this way, you will be responding to the human delighted to pay estate taxes someday. They are largely voluntary and they prompt all kinds of commendable behavior like family gift giving, charitable giving, and succession planning in general. Meanwhile, we are doing away with a source of 1% of our tax revenue. Where will we make this up? If we're not careful, it will be a repeat of the "stealth taxation" of the 1980's, when we had the largest percentage increase in taxes since World War II. At that time, we dramatically increased the social security tax?a regressive tax increase that today hits every earned-wage dollar up to $84,900.
On the whole, I am optimistic about the future of American business and the direction of corporate governance. We eat an elephant one bite at a time, and last week we gobbled up Harvey Pitt, our flawed SEC chairman. Rudy Giulianni transformed New York City by enforcing simple laws like jaywalking and turnstile jumping. He applied the famous broken window theory that says when we allow one window to be broken, all that remain will be shattered within days. It's never too late to improve our legal climate and apply common sense to taxation issues. Our general well-being, after all, depends far more on the strength of our society than on the quality of our burglar-alarm systems.
John Adams and our founding fathers placed a premium on the need to develop a large, strong middle class. They specifically cited the need for a strong educational system. They gave us a great start over two hundred years ago, but to build further we should start by asking, "What do we have to lose?"
Copyright © 1999 – 2012 Freedom Investments. All Rights Reserved. Freedom Investments, Inc. Member FINRA/SIPC Privacy & Security