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.
Wednesday, March 26, 2008
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.
Subscribe to:
Posts (Atom)
