I've decided that times like these call not for the long essays I like, but for short nuggets of financial guidance. Here's the first.
Have an investment that has lost value? Waiting for it to just get back to what you paid for it? Deciding you'll sell an investment after it gets back to what you paid for it is like saying, "I'm going to keep dating this jerk until he starts treating me right, and then I'm dumping him!"
—Ken Robinson
Friday, November 11, 2011
Sunday, November 2, 2008
The best of times—for long-term thinking.
Times like these are when sound financial plans really shine. As unsettling as it can be to watch the stock market careening about like a loud drunk who can't decide whether he's elated or depressed, those who've been following well-thought-out financial plans know they won't be waking up with a hangover.
I just got an email from a client who's moved out of state—maybe the most professionally gratifying email I've ever received. He said he was almost happy seeing their assets down by about 10%, and that he had me to thank for the fact they weren't down even more, as many of their neighbors' were.
Still, even the best of us can have our faith shaken. A colleague emailed me recently, asking how I felt about the investing model that I and over 100 other Alliance of Cambridge Advisors (ACA) members follow.
Here are excerpts from my reply to my colleague, explaining why I remain very confident.
If your assets were allocated reasonably well before the market turmoil, there's no reason to abandon your long-range plans now. For those who have been following thoughtful plans, whether times are about to get worse or are about to get better, the strategy should still be about staying the course.
I just got an email from a client who's moved out of state—maybe the most professionally gratifying email I've ever received. He said he was almost happy seeing their assets down by about 10%, and that he had me to thank for the fact they weren't down even more, as many of their neighbors' were.
Still, even the best of us can have our faith shaken. A colleague emailed me recently, asking how I felt about the investing model that I and over 100 other Alliance of Cambridge Advisors (ACA) members follow.
Here are excerpts from my reply to my colleague, explaining why I remain very confident.
These are the very times that separate us from all the rest—
—because so many of our competitors are capitulating. We don't do that, because we realize that success in the markets means staying in the market through the long term.
The panic is being fueled by the news business, which is by nature a day-to-day (lately a moment-to-moment) business. But investing in equities is a year-over-year-over-year process. So the news is the wrong yardstick to use to measure the success of our plans. It's like measuring the distance to the moon with a microscope.
I tell my clients that most advisors talk about 5 years as the time horizon for stocks—I say 10. Are they going to need assets 10 years or more from now? If so, they ought to think about how cheap stocks are now, and consider rebalancing to their target allocations while stocks are cheap.
Pretend for a moment that times are good. What would you tell a client about why it's important to leave "so much money" in bonds and cash? Times like these are why we have the bonds and cash. But it's usually easier to get them when times are good.
If they think stocks will stay low forever, let's show them the spreadsheet about long-term returns on different asset classes.
Hang in there. We plan precisely for times like these. Even if our plans were merely mediocre (they're not), such a plan carried out decisively is better than the "best" plan that you abandon during times of trouble.
These are exactly times for which our model works the best.
The only reason to change your plans is likely to be if something substantial has changed in your life. What's changed in the markets is likely of little relevance.
If your assets were allocated reasonably well before the market turmoil, there's no reason to abandon your long-range plans now. For those who have been following thoughtful plans, whether times are about to get worse or are about to get better, the strategy should still be about staying the course.
Friday, October 3, 2008
An antidote to overheated rhetoric.
I recently posted the text of an email I sent to my clients about the current financial crisis. Here are excerpts from another I sent just over a week later.
Good morning, clients and friends.
I've spoken and exchanged emails with many of you about the current state of the economy and the financial markets. When the Dow falls by 777 points in one day (isn't that a memorable number?), it gets our attention. But I want to assure you that it's still no reason to change our long-run outlook.
And there's more encouraging news from some quite reliable sources this week.
Well, actually, it depends on your definition of "encouraging." How's this: the outlook is NOT for another Great Depression, only for a recession. Put differently, we might need to be prepared for a broken nose, but not a life-threatening concussion.
Tuesday's The Plain Dealer (Cleveland, Ohio) ran a piece on page C2 entitled "No threat, no risk of a Depression, economists argue." Rather than any comparisons to the G.D., "A better reference point ... is the recession of the early 1980s."
Admittedly, this was not a happy time, with unemployment at close to 11%. But during the G.D., unemployment was more than twice that rate. And in the 1930s, if the breadwinner in your house was out of work, it usually meant no one in the house was bringing in any substantial income. The rise of two-income households mitigates the effects of rising unemployment. Being out of work is still bad, but the situation is often far less scary than during the G.D.
And who are these economists assuring us that comparisons with the G.D. are well out of bounds? The article cites:You can see the article at http://www.cleveland.com/plaindealer/stories/index.ssf?/base/business-8/1222763614174910.xml&coll=2. (The PD website moves these articles around from time to time, so if you're interested, look soon.)
- Erik Hurst, economics professor at University of Chicago's Graduate School of Business.
- Kenneth Rogoff, economics professor at Harvard University.
- James Galbraith, a University of Texas economist (son of the famed economist John Kenneth Galbraith).
Would a recession be fun? No. But the financial system looks nothing like the system that was in place in 1929. That's why comparing the current situation to the G.D. is, in my view, unrealistic, and even irresponsible. But I suppose such an inflammatory comparison is a good way to get on television.
(You've probably noticed, I'm calling it the G.D., not spelling it out. I guess you could say it's a modest attempt to de-legitimize comparing of our current situation with those very different times.)
You may have heard me say it enough times that you can repeat it verbatim: what's happening in the economy in the short term shouldn't alter your plan. Change your plan only if something in your life has changed to alter your goals.
In the meantime, feel free to call me with any questions, concerns, or curiosity you may have about the economic situation and how it will affect you.
Have a good weekend,
Ken.
Wednesday, September 24, 2008
No Need to Panic: an update.
Back in March, I posted a column entitled No Need to Panic. In the aftermath of the Fannie/Freddie takeover, the fall of Lehman Brothers, and the federal buy-up of AIG, I sent an email to my clients. Here it is.
Dear Clients:
Most of you have known me for quite a while. So what's in this email will come as a no surprise at all to you.
This is the email where I tell you that everything’s going to be OK for investors with properly allocated portfolios.
The financial world has undergone tremendous upheaval in the past two weeks or so. Government intervention has salvaged several financial giants, and as I write this, a further government bailout for the economy is in the works.
Should you be worried about these events?
No.
Am I worried about these events, either professionally or personally?
No.
It’s true, as the analysts are saying, there will be ripple effects from the rescue or collapse of finance giants and—if it comes to pass—the takeover of bad debts held by financial firms. But ask yourself this question:
When these giant financial firms were prospering, how much did that affect your well being?
Chances are, not much. At least, not nearly as much as your own good habits of saving some of what comes in and living within your means. The effects of following your plan likely did more to benefit you than any ripple effects of the growth of giant financial firms.
In the same way, the effects of the failure of giant financial firms will, in the long run, be more than canceled out by following your plan, which will provide you better results and more calmness of mind than trying to outguess what’s about to happen next. In challenging times, following your plan is usually the best strategy. It’s still the best strategy, even with—especially with—headlines like those we’ve been reading.
The news tends to focus on the wild swings of the stock market. But remember, you’re invested in more than stocks. My investment recommendations assume that it’s important to have other assets prepared to stay afloat during a market downturn.
We do this because we can’t possibly know what’s coming next. Many analysts try to outguess the near future, but the machine they’re trying to deconstruct has too many moving parts.
So, what is coming next? Is it going to get worse before it gets better, or better before it gets worse? The answer is yes. It will either be one, or the other. Or something else entirely. That’s why we don’t try to rush to “where the action is,” because by the time we see what’s happening, it’s too late to fully participate in it.
We’re much better off to identify what we need in our lives, and then structure our savings and investments to serve those goals. So typically, we should strive to have enough cash for the near term, bonds or bond funds for deflation protection, real estate for inflation protection, domestic stock mutual funds for long-term growth and foreign investments to hedge the dollar. Your specific situation may vary: Since our allocations are based on your life, your investment recommendations are unique to your situation.
Who will be hurt in the current market? The investors who suffer the most will likely be those who panic and cash out. They’re locking in their losses, and if they wait until the market “gets better” before they reinvest, they’re planning to skip the recovery. This is not a strategy to profit from the investment markets. The last time I looked, the procedure went “buy low, sell high,” and sadly, fear will make many people do exactly the opposite.
If we want to buy low and sell high, then as we look at your investments, we’ll sell some of what’s been doing well and buy some of what’s been doing lousy. This is how we keep the financial risk at an appropriate level, and as markets fluctuate, it means you automatically buy low and sell high.
So I am not being overly sanguine in saying that if the balance of your portfolio was reasonably sound before these market shocks, it will likely require only a little attention in the wake of them. I am simply confident that like any market boom or bust, this, too, will pass. And those who profit most will be those who stick to their long-term strategy.
Of course, if you have any questions, especially if you’re feeling nervous, please call me. I’ll be glad to schedule as much time as we need to be sure you’re traveling through the market turmoil as comfortably as possible.
Best regards,
Ken.
Friday, May 2, 2008
The—Ho-Hum—"Death Tax"
Podcast (.wma format)
Should federal estate tax law be reformed? I believe so, yes. Should any advocate of reform give retirees inaccurate information about the effects of the estate tax? Absolutely not.
My mother-in-law, Rose, received a mailing from an organization that's trying to change US tax law. With lots of italics and exclamation points, the letter screams that her family could be hit with a 55% tax bill.
I found this letter—and its passionate request for a donation—to be nothing short of a shamelessly disingenuous attempt to raise money from retired working-class seniors so the richest Americans won't have to pay estate taxes. It's not that I oppose reform of the federal estate tax—I support it. I believe that estates of less than $5,000,000 should be exempt. But some of those lobbying for a complete repeal seem to me to be using deceptive tactics.
To understand why I say this, first let me tell you about what I read in the solicitation letter, about what the estate tax law actually says, and about Rose.
A scary letter
The letter warned her:
What's really happening in 2011?
Permanent reductions in estate taxes had been passed by Congress under the Bill Clinton administration. Before those reforms could fully take effect, more aggressive reforms were passed in 2001 during George W. Bush's first term, when he had slight Republican majorities in both houses of Congress.
But the best Bush could get was a tax that sunsets—it expires—after he leaves office. When those reforms expire, the less-aggressive Clinton-era reforms will resume their effect.
I interpret this to mean the increase in taxes isn't the responsibility of today's 110th Congress. It's the responsibility of 2001's 107th Congress, and of President Bush, who signed the bill into law on June 7, 2001. I believe the long expiration date was a sadly-typical political attempt to make the unpopular "tax increase"—actually, just a return to the prior law—look like it was someone else's fault, to mask the political failure of being able to pass a permanent repeal.
Will it hurt?
When the Bush reforms expire, will the federal estate tax rate return to 55%? Yes, that's the maximum rate. But there's an amount that's exempt. It works just like your income tax in this respect. The vast majority of income tax filers are entitled to at least a standard deduction and personal exemption, so some portion of their actual income isn't subject to any income tax.
And for taxable estates, the first $1,000,000 is not subject to the federal estate tax. For families with more than $1,000,000 in taxable value, there are a number of estate tax reduction techniques that can reduce or eliminate their tax burden.
So who does the estate tax affect? How many estates get hit when federal estate taxes begin after $1,000,000? For 2003, the last year for which the federal estate tax had a minimum threshold of $1,000,000, the IRS (at http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96442,00.html) reported 1,013 taxable estates in Ohio. For that same year, the Ohio Bureau of Vital Statistics (at http://dwhouse.odh.ohio.gov/datawarehousev2.htm) reported 108,590 total Ohio resident deaths. So less than 1% of Ohio's year 2003 decedents' estates were subject to the federal estate tax. It's actually about one out of every 107.
Looking nationwide, IRS reports that 33,302 taxable federal returns were filed for 2003. The Centers for Disease Control and Prevention report that 2,448,228 deaths occurred in the United States that same year. So about 1.36% of decedent's estates—about one out of every 73—were taxable. A more widely reported figure was that 2% of estates—one in fifty—would be taxable.
Help us out, Rose.
These are, of course, the richest 2% of Americans. But I don't see that mentioned anywhere in the letter that Rose received, with its impassioned plea for a monetary donation.
And let me tell you a little bit about my mother-in-law. Rose is a widow who gets by on a modest pension and Social Security. Her late husband was a hard-working engineer who always provided well for his family, but whose career was cut short by a chronic illness that overshadowed the last 19 years of his life. As a result, the family's opportunities to save were limited.
Rose's entire fortune is relatively modest—her taxable estate will be well under $500,000, including insurance proceeds and her home.
Rose has never had anywhere near the $1,000,000 threshold for federal estate taxes. But it was to the household of this woman that an organization sent its solicitation for funds to support a permanent repeal of a tax that won't remotely affect her—a detail mentioned nowhere in the letter.
Where have all the farmers gone?
Remember how the letter said the tax destroys family farms? This was a highly-publicized component of the 2001 estate tax reform lobby. It has been reported that despite desperate attempts, advocates of estate tax reform in April 2001 were unable to produce even a single farmer or rancher who had lost a farm to the estate tax.
Rose's late husband owned one of those farms. When he sold it, it didn't bring his fortune to anywhere near $1,000,000.
Think about it: how many people do you know who've lost their family businesses because of estate tax burdens? Most of us can't think of even one, and there's a simple reason. Even before the 2001 estate tax reform, there were protections in the law for bona fide working family businesses.
What you might not have known.
When I talk to groups about estate taxes, they're amazed that the federal estate tax probably doesn't apply to them.
For years, the income tax code has said that if you inherit property that's gone up in value (like stock or real estate), when you sell it you don't pay as much as the deceased owner would have paid in capital gains tax. This is called date-of-death step-up in basis, and it means that those who sell inherited property don't have to try to figure out what great-granddad paid for his AT&T stock.
As of January 1, 2010, taxpayers from all income brackets will have to know how much great-granddad paid for his stock, and pay tax on the same gain that great-granddad would have.
Is it any wonder I have little patience for estate-tax repeal advocates who say, "We already got a tax break, but we want the tax eliminated," and then ask my pensioner mother-in-law to give them money so their descendants won't have to go to work?
I support estate tax reform.
Yes, federal estate taxes should be reformed. I believe the threshold for federal estate taxes should be set at somewhere between $5,000,000 and $10,000,000, and then adjust for inflation. This would reduce the estate tax burden by raising the threshold to the highest level it has ever been to date. I wouldn't even be terribly concerned if the tax rate were lowered somewhat.
But let's be honest and forthright in our advocacy. There are enough arguments in favor of estate tax reform without scaring widows into thinking their limited fortunes are going to be decimated at their death.
In my professional opinion, most families from working-class to upper-middle-class would do far better to spend their time and money on efforts to reduce their individual income tax burden, or their credit card debt.
Should federal estate tax law be reformed? I believe so, yes. Should any advocate of reform give retirees inaccurate information about the effects of the estate tax? Absolutely not.
My mother-in-law, Rose, received a mailing from an organization that's trying to change US tax law. With lots of italics and exclamation points, the letter screams that her family could be hit with a 55% tax bill.
I found this letter—and its passionate request for a donation—to be nothing short of a shamelessly disingenuous attempt to raise money from retired working-class seniors so the richest Americans won't have to pay estate taxes. It's not that I oppose reform of the federal estate tax—I support it. I believe that estates of less than $5,000,000 should be exempt. But some of those lobbying for a complete repeal seem to me to be using deceptive tactics.
To understand why I say this, first let me tell you about what I read in the solicitation letter, about what the estate tax law actually says, and about Rose.
A scary letter
The letter warned her:
- that her estate tax rate is going up to 55%.
- that Democratic congressional leaders want Rose to give the IRS half of all she owns.
- that high estate taxes destroy family farms and small businesses.
What's really happening in 2011?
Permanent reductions in estate taxes had been passed by Congress under the Bill Clinton administration. Before those reforms could fully take effect, more aggressive reforms were passed in 2001 during George W. Bush's first term, when he had slight Republican majorities in both houses of Congress.
But the best Bush could get was a tax that sunsets—it expires—after he leaves office. When those reforms expire, the less-aggressive Clinton-era reforms will resume their effect.
I interpret this to mean the increase in taxes isn't the responsibility of today's 110th Congress. It's the responsibility of 2001's 107th Congress, and of President Bush, who signed the bill into law on June 7, 2001. I believe the long expiration date was a sadly-typical political attempt to make the unpopular "tax increase"—actually, just a return to the prior law—look like it was someone else's fault, to mask the political failure of being able to pass a permanent repeal.
Will it hurt?
When the Bush reforms expire, will the federal estate tax rate return to 55%? Yes, that's the maximum rate. But there's an amount that's exempt. It works just like your income tax in this respect. The vast majority of income tax filers are entitled to at least a standard deduction and personal exemption, so some portion of their actual income isn't subject to any income tax.
And for taxable estates, the first $1,000,000 is not subject to the federal estate tax. For families with more than $1,000,000 in taxable value, there are a number of estate tax reduction techniques that can reduce or eliminate their tax burden.
So who does the estate tax affect? How many estates get hit when federal estate taxes begin after $1,000,000? For 2003, the last year for which the federal estate tax had a minimum threshold of $1,000,000, the IRS (at http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96442,00.html) reported 1,013 taxable estates in Ohio. For that same year, the Ohio Bureau of Vital Statistics (at http://dwhouse.odh.ohio.gov/datawarehousev2.htm) reported 108,590 total Ohio resident deaths. So less than 1% of Ohio's year 2003 decedents' estates were subject to the federal estate tax. It's actually about one out of every 107.
Looking nationwide, IRS reports that 33,302 taxable federal returns were filed for 2003. The Centers for Disease Control and Prevention report that 2,448,228 deaths occurred in the United States that same year. So about 1.36% of decedent's estates—about one out of every 73—were taxable. A more widely reported figure was that 2% of estates—one in fifty—would be taxable.
Help us out, Rose.
These are, of course, the richest 2% of Americans. But I don't see that mentioned anywhere in the letter that Rose received, with its impassioned plea for a monetary donation.
And let me tell you a little bit about my mother-in-law. Rose is a widow who gets by on a modest pension and Social Security. Her late husband was a hard-working engineer who always provided well for his family, but whose career was cut short by a chronic illness that overshadowed the last 19 years of his life. As a result, the family's opportunities to save were limited.
Rose's entire fortune is relatively modest—her taxable estate will be well under $500,000, including insurance proceeds and her home.
Rose has never had anywhere near the $1,000,000 threshold for federal estate taxes. But it was to the household of this woman that an organization sent its solicitation for funds to support a permanent repeal of a tax that won't remotely affect her—a detail mentioned nowhere in the letter.
Where have all the farmers gone?
Remember how the letter said the tax destroys family farms? This was a highly-publicized component of the 2001 estate tax reform lobby. It has been reported that despite desperate attempts, advocates of estate tax reform in April 2001 were unable to produce even a single farmer or rancher who had lost a farm to the estate tax.
Rose's late husband owned one of those farms. When he sold it, it didn't bring his fortune to anywhere near $1,000,000.
Think about it: how many people do you know who've lost their family businesses because of estate tax burdens? Most of us can't think of even one, and there's a simple reason. Even before the 2001 estate tax reform, there were protections in the law for bona fide working family businesses.
What you might not have known.
When I talk to groups about estate taxes, they're amazed that the federal estate tax probably doesn't apply to them.
- They're amazed that an unlimited amount can pass from one US citizen spouse to another without any federal estate taxation.
- They're amazed that the trumpeted "repeal" of the federal estate tax lasts for only one year.
- They're amazed that on January 1, 2011, the estate tax comes back with a threshold of just $1,000,000.
For years, the income tax code has said that if you inherit property that's gone up in value (like stock or real estate), when you sell it you don't pay as much as the deceased owner would have paid in capital gains tax. This is called date-of-death step-up in basis, and it means that those who sell inherited property don't have to try to figure out what great-granddad paid for his AT&T stock.
As of January 1, 2010, taxpayers from all income brackets will have to know how much great-granddad paid for his stock, and pay tax on the same gain that great-granddad would have.
Is it any wonder I have little patience for estate-tax repeal advocates who say, "We already got a tax break, but we want the tax eliminated," and then ask my pensioner mother-in-law to give them money so their descendants won't have to go to work?
I support estate tax reform.
Yes, federal estate taxes should be reformed. I believe the threshold for federal estate taxes should be set at somewhere between $5,000,000 and $10,000,000, and then adjust for inflation. This would reduce the estate tax burden by raising the threshold to the highest level it has ever been to date. I wouldn't even be terribly concerned if the tax rate were lowered somewhat.
But let's be honest and forthright in our advocacy. There are enough arguments in favor of estate tax reform without scaring widows into thinking their limited fortunes are going to be decimated at their death.
In my professional opinion, most families from working-class to upper-middle-class would do far better to spend their time and money on efforts to reduce their individual income tax burden, or their credit card debt.
Wednesday, March 26, 2008
No Need to Hunt
Podcast (.wma format)
When people ask me what their first stock investments should be, I suggest they consider a mutual fund that follows a large stock index, like the S&P 500. Such funds are readily available and often inexpensive.
Most importantly, they're broadly diversified. The S&P 500 tracks the value of 500 companies representing about 75% of the US equities market, according to Standard and Poor's (which manages the index).
Of course, in times like these, with a volatile stock market, occasionally someone will ask me, "But what if all those companies go bankrupt?"
A very unlikely scenario
I tell them, "These are 500 of the largest companies in our economy. If they all fold, you won't need investments. You'll need to know how to hunt."
The recent market turmoil has people thinking about doomsday scenarios. But while stock prices may continue to drop in the short run (no one knows for sure), I don't believe there is any need to worry about broadly-based indexes becoming worthless.
When it comes to investments in equities—stocks and the mutual funds that own them—nothing is guaranteed. But in my professional opinion, only a complete breakdown of our economic system could cause a failure of all these companies at once.
Business has to work
Here's why that scenario is so improbable. A complete economic failure would mean that no one would be paying for cars, or paper, or food, or clothing, or rent. There would be a complete halt to trade, an end to most of the benefits of division of labor. So if I want a pretzel, I'd have to grow my own wheat, harvest it myself, mill it at my own mill, add salt that I mined myself, and bake it in my own oven with fuel I provided.
Do you really think that's what lies ahead? I don't. I'm not good in the kitchen, so it's better for me to buy a pretzel from someone who's good a baking them. He buys his flour from from the miller, who buys her grain from the farmer, who gets water piped to his south 40 by the county that collected taxes to pay for the water distribution system.
As long as people don't want to do everything for themselves, they'll be willing to trade something of value (money, for instance) in order to have what they want. And as long as sellers can make more money by meeting the wants of others than by putting their cash in the bank, businesses will be around to sell us goods and services.
Naturally, this makes it highly unlikely that our economy could collapse all at once. As long as there is still profit to be made by doing a job better than other people can do it, there will be people willing to pay for it. That's how business, and human nature, both work.
What works for business works for investors
When you buy a stock, you become a part owner in a business. When the company makes money, the value of your share of the company goes up. And as a part owner, you are entitled to a proportionate share of the company's profit. After all, profit is why companies are in business to begin with.
When you buy a broadly-based mutual fund, you are a part owner in many businesses. If your fund does a good job tracking the economy as a whole, then as the economy thrives, so does your investment. And if one company in the mutual fund folds, you'll almost certainly have many others that are still profitable holding up the value of your investment.
Tough times come and go, and these tough financial times will get better. No, I don't know when. But you don't need to learn to hunt just yet. The recent turmoil in the stock market isn't a sign of doom. It's merely the natural response to a challenging economic situation. Our economy has survived hard times before. I'm convinced it will survive this time as well.
When people ask me what their first stock investments should be, I suggest they consider a mutual fund that follows a large stock index, like the S&P 500. Such funds are readily available and often inexpensive.
Most importantly, they're broadly diversified. The S&P 500 tracks the value of 500 companies representing about 75% of the US equities market, according to Standard and Poor's (which manages the index).
Of course, in times like these, with a volatile stock market, occasionally someone will ask me, "But what if all those companies go bankrupt?"
A very unlikely scenario
I tell them, "These are 500 of the largest companies in our economy. If they all fold, you won't need investments. You'll need to know how to hunt."
The recent market turmoil has people thinking about doomsday scenarios. But while stock prices may continue to drop in the short run (no one knows for sure), I don't believe there is any need to worry about broadly-based indexes becoming worthless.
When it comes to investments in equities—stocks and the mutual funds that own them—nothing is guaranteed. But in my professional opinion, only a complete breakdown of our economic system could cause a failure of all these companies at once.
Business has to work
Here's why that scenario is so improbable. A complete economic failure would mean that no one would be paying for cars, or paper, or food, or clothing, or rent. There would be a complete halt to trade, an end to most of the benefits of division of labor. So if I want a pretzel, I'd have to grow my own wheat, harvest it myself, mill it at my own mill, add salt that I mined myself, and bake it in my own oven with fuel I provided.
Do you really think that's what lies ahead? I don't. I'm not good in the kitchen, so it's better for me to buy a pretzel from someone who's good a baking them. He buys his flour from from the miller, who buys her grain from the farmer, who gets water piped to his south 40 by the county that collected taxes to pay for the water distribution system.
As long as people don't want to do everything for themselves, they'll be willing to trade something of value (money, for instance) in order to have what they want. And as long as sellers can make more money by meeting the wants of others than by putting their cash in the bank, businesses will be around to sell us goods and services.
Naturally, this makes it highly unlikely that our economy could collapse all at once. As long as there is still profit to be made by doing a job better than other people can do it, there will be people willing to pay for it. That's how business, and human nature, both work.
What works for business works for investors
When you buy a stock, you become a part owner in a business. When the company makes money, the value of your share of the company goes up. And as a part owner, you are entitled to a proportionate share of the company's profit. After all, profit is why companies are in business to begin with.
When you buy a broadly-based mutual fund, you are a part owner in many businesses. If your fund does a good job tracking the economy as a whole, then as the economy thrives, so does your investment. And if one company in the mutual fund folds, you'll almost certainly have many others that are still profitable holding up the value of your investment.
Tough times come and go, and these tough financial times will get better. No, I don't know when. But you don't need to learn to hunt just yet. The recent turmoil in the stock market isn't a sign of doom. It's merely the natural response to a challenging economic situation. Our economy has survived hard times before. I'm convinced it will survive this time as well.
Saturday, March 22, 2008
No Need to Panic
Podcast (wma format)
Douglas Adams' The Hitchhiker's Guide to the Galaxy is a truly hilarious send-up of all things science fiction. The story is loosely based on a sort of electronic book of the same title. Helpfully inscribed on the cover of the book, in "large friendly letters," are the words "DON'T PANIC!"
So you see, sound financial advice for these volatile times can be found in unexpected places, even if it seems every passing day brings news of a bank in distress, or a major stock market index losing 300 points in a single trading day.
So how bad is it?
We're even hearing commentators comparing the situation to the Great Depression. Listen carefully, and you may hear them saying that the current situation is nothing like the Crash of 1929 and its consequences. But it may be that all that sticks in the memory after the newscast are the words "Great Depression."
It's easy to become anxious at a time like this, even easier because the media seem to trumpet the bad news more loudly than the good.
In my professional opinion, we're not very likely to be on the brink of another Great Depression. (There, you see? You've just heard those two frightening words again.) Here are a few reasons why.
This isn't 1929
We can certainly agree that we now have much stronger regulation in the money industry than we did 79 years ago. Banks must meet specific requirements for cash on hand, and our deposits are insured. Financial advisors, stockbrokers, and securities salespeople are subject to strict licensing and examination requirements. The Federal Reserve takes an active role in trying to moderate unhealthy trends in the economy.
Certainly, there are still excesses in the marketplace. There are still crooks who work in the industry. And while parts of the financial world are far more transparent than they used to be (for instance, the stock market), other parts remain opaque and, at times, hostile to the interests of the investor (the bond market, for example). This time around, as before, greed appears to be the main motivator in bringing about our current collective experience of financial anxiety.
But taken as a whole, the financial world is better prepared to respond to tremors in its landscape than it has been in the past.
So, too, with our social/societal structure. After the crash of 1929, an estimated one in four people in the workforce were without jobs. At that time, this meant something very close to 25% of households without any income from work.
The nation's workforce looks far different today. Many homes have more than one income-earner, and many workers have more than one job. If one job in the household is lost, there is a far greater chance today that there will still be some money coming in.
Of course, our social safety net is also far stronger than it was in the 1930s. I understand that there are those who would be terribly humiliated to have to ask for public assistance. And I realize that many families have felt forced to increase the number of jobs that bring money into the household, that having more than one income-earner wasn't their choice. I'm merely pointing out that in 2008, even a serious depression, though painful, is likely to be less crushing to the average family than it was in the 1930s.
Whither stocks? Or, stocks wither?
Yes, stocks are down, but only in the short run. As I write this, the Dow Jones Industrial Average, the S&P 500, and the NASDAQ Composite are all about where they were two years ago, and over the past five years are up by about 50%. Since stocks are a long-term investment (many advisors say you need five years for stocks—I say ten), they're still doing what they're supposed to.
We expect short-term drops in the stock market, as history has shown we should. So we plan for it, and don't put the money for the near term into equities.
What about banks? Will I lose my deposits?
Sure, subprime lenders are apparently in over their heads, and some banks are suffering. But not all banks are in trouble. Looking at the banking industry as a whole, the suffering of the subprime lender may be much like a cracked rib in an otherwise fit and healthy patient. The rib hurts so badly that the pain gets all the attention. Meanwhile, we forget that the patient is so strong he is likely to heal from this hurt, or from far worse injury, much faster than the patient who was out of shape when his accident befell him.
While it's becoming increasingly common for people to wonder whether they should take their money out of the bank, in my professional opinion, your mattress is a much riskier place to keep your cash.
Yes, banks in the US do fail. But when they do, FDIC insures the accounts of most depositors. (There are limits most accounts are far below, but you may want to check with your bank to see whether your balances are fully covered.) When a bank fails, it's very often re-opened by another bank that wants to take over the customer base. If a bank closes its doors on Friday, there's a good chance it will open again the next week as a branch of a different, stronger bank, with all of our deposits intact.
So the banking industry frequently buries its own dead. And while more banks are on regulators' watch lists than in recent years, the current numbers are still far lower than they were in the early 1990s.
Stay the course in unsettling times
If your money didn't need attention before the sub-prime loan crisis, it doesn't need any more attention now. While the usual periodic rebalancing continues to make sense, this is not the time for major strategic changes in a sound financial plan.
For many people, falling stock prices will mean that they now have too little of their money in equities, like mutual funds that own stocks. So while stock prices are down, they should consider buying more. When stocks recover—when, not if—they may end up with too much of them. If they do, they should trim back at that time.
And what do you know? That's buying low and selling high. What a great idea. It's far better than what happens to investors who are selling their stocks when they're down, and thus locking in their losses.
For others, times like these are best brushed off. If you have a secure income and secure savings and investments, the headlines may be of no interest to you. Maybe it's a good time to sit down with a science fiction satire. Your anxious friends may feel a little relieved to hear someone laugh, and you can remind them of the great advice from the cover of The Hitchhiker's Guide to the Galaxy: Don't Panic.
Douglas Adams' The Hitchhiker's Guide to the Galaxy is a truly hilarious send-up of all things science fiction. The story is loosely based on a sort of electronic book of the same title. Helpfully inscribed on the cover of the book, in "large friendly letters," are the words "DON'T PANIC!"
So you see, sound financial advice for these volatile times can be found in unexpected places, even if it seems every passing day brings news of a bank in distress, or a major stock market index losing 300 points in a single trading day.
So how bad is it?
We're even hearing commentators comparing the situation to the Great Depression. Listen carefully, and you may hear them saying that the current situation is nothing like the Crash of 1929 and its consequences. But it may be that all that sticks in the memory after the newscast are the words "Great Depression."
It's easy to become anxious at a time like this, even easier because the media seem to trumpet the bad news more loudly than the good.
In my professional opinion, we're not very likely to be on the brink of another Great Depression. (There, you see? You've just heard those two frightening words again.) Here are a few reasons why.
This isn't 1929
We can certainly agree that we now have much stronger regulation in the money industry than we did 79 years ago. Banks must meet specific requirements for cash on hand, and our deposits are insured. Financial advisors, stockbrokers, and securities salespeople are subject to strict licensing and examination requirements. The Federal Reserve takes an active role in trying to moderate unhealthy trends in the economy.
Certainly, there are still excesses in the marketplace. There are still crooks who work in the industry. And while parts of the financial world are far more transparent than they used to be (for instance, the stock market), other parts remain opaque and, at times, hostile to the interests of the investor (the bond market, for example). This time around, as before, greed appears to be the main motivator in bringing about our current collective experience of financial anxiety.
But taken as a whole, the financial world is better prepared to respond to tremors in its landscape than it has been in the past.
So, too, with our social/societal structure. After the crash of 1929, an estimated one in four people in the workforce were without jobs. At that time, this meant something very close to 25% of households without any income from work.
The nation's workforce looks far different today. Many homes have more than one income-earner, and many workers have more than one job. If one job in the household is lost, there is a far greater chance today that there will still be some money coming in.
Of course, our social safety net is also far stronger than it was in the 1930s. I understand that there are those who would be terribly humiliated to have to ask for public assistance. And I realize that many families have felt forced to increase the number of jobs that bring money into the household, that having more than one income-earner wasn't their choice. I'm merely pointing out that in 2008, even a serious depression, though painful, is likely to be less crushing to the average family than it was in the 1930s.
Whither stocks? Or, stocks wither?
Yes, stocks are down, but only in the short run. As I write this, the Dow Jones Industrial Average, the S&P 500, and the NASDAQ Composite are all about where they were two years ago, and over the past five years are up by about 50%. Since stocks are a long-term investment (many advisors say you need five years for stocks—I say ten), they're still doing what they're supposed to.
We expect short-term drops in the stock market, as history has shown we should. So we plan for it, and don't put the money for the near term into equities.
What about banks? Will I lose my deposits?
Sure, subprime lenders are apparently in over their heads, and some banks are suffering. But not all banks are in trouble. Looking at the banking industry as a whole, the suffering of the subprime lender may be much like a cracked rib in an otherwise fit and healthy patient. The rib hurts so badly that the pain gets all the attention. Meanwhile, we forget that the patient is so strong he is likely to heal from this hurt, or from far worse injury, much faster than the patient who was out of shape when his accident befell him.
While it's becoming increasingly common for people to wonder whether they should take their money out of the bank, in my professional opinion, your mattress is a much riskier place to keep your cash.
Yes, banks in the US do fail. But when they do, FDIC insures the accounts of most depositors. (There are limits most accounts are far below, but you may want to check with your bank to see whether your balances are fully covered.) When a bank fails, it's very often re-opened by another bank that wants to take over the customer base. If a bank closes its doors on Friday, there's a good chance it will open again the next week as a branch of a different, stronger bank, with all of our deposits intact.
So the banking industry frequently buries its own dead. And while more banks are on regulators' watch lists than in recent years, the current numbers are still far lower than they were in the early 1990s.
Stay the course in unsettling times
If your money didn't need attention before the sub-prime loan crisis, it doesn't need any more attention now. While the usual periodic rebalancing continues to make sense, this is not the time for major strategic changes in a sound financial plan.
For many people, falling stock prices will mean that they now have too little of their money in equities, like mutual funds that own stocks. So while stock prices are down, they should consider buying more. When stocks recover—when, not if—they may end up with too much of them. If they do, they should trim back at that time.
And what do you know? That's buying low and selling high. What a great idea. It's far better than what happens to investors who are selling their stocks when they're down, and thus locking in their losses.
For others, times like these are best brushed off. If you have a secure income and secure savings and investments, the headlines may be of no interest to you. Maybe it's a good time to sit down with a science fiction satire. Your anxious friends may feel a little relieved to hear someone laugh, and you can remind them of the great advice from the cover of The Hitchhiker's Guide to the Galaxy: Don't Panic.
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