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Showing posts from 2008

Confusing Volatility and Risk

You aren't smarter than the market. It really is that simple.

The recent stock market crash has reminded many people that there is risk associated with buying stock. But that is really the wrong lesson for people to learn at this point. What the crash has shown is that the stock market is volatile, it will go up and down. But how much risk that creates depends on your investment horizon. If you plan to hold on to your stock for another ten years, then the recent crash has few consequences. The price in the current uncertain market says very little about the price you will get ten years from now when you sell the stock.

In fact, the stock markets' hourly gyrations have very little import for most investors, regardless of their investment horizon. Volatility is relative. Monthly fluctuations have consequences for short term investors. The decline in market prices since July reminds us why we shouldn't own stock that we will need to sell in a couple months for our immediate liv…

Inanities in a crisis

You aren't smarter than the market. It really is that simple.

The media is filled with plain silly inanities these days as everyone is focused on the crisis du jour on wall street. Here is one that grabbed my eye:

"The Depression itself was a dynamic sequence. It wouldn't have happened if the Fed hadn't insanely tightened credit in response to the stock market crash, rather than the correct policy of easing interest rates."

First, that monetary policy lead to the depression is a highly controversial explanation favored by money-supply ideologues. But the Fed did not have a policy of "tightened credit". They simply couldn't expand the money supply by printing dollars because, at the time, each dollar had to be backed by gold bars at Fort Knox.

Where the government did act to make the problem worse was cutting federal spending in response to reductions in tax revenue. Essentially the folks in charge ran government like a business, cutting expenses in res…

Don't Buy a House Now

You aren't smarter than the market. It really is that simple.

There have been several articles lately that I suspect are part of a determined effort by the real estate industry to get people back into the housing market. The basic pitch is that higher interest rates will eat up any savings you get from waiting for lower prices. Even the New York Times has gotten in on this action.

The calculation always goes something like this. Say you have a house for 500,000 and you make a $100,000 down payment today with a $400,000 mortage at 6.5%. Now compare that to a year from now if housing prices fall by 10%, you would make a down payment of $90,000 and borrow only $360,000, but at a higher interest rate. If the interest rate is high enough, you will end up with higher payments and paying more total for the house than if you purchased it now.

There are two problems with that calculation. The first is that isn't really how people buy houses. People decide how much they can afford and then…

Walking Away from Your Mortgage

You aren't smarter than the market. It really is that simple.


The BBC has a story about how home owners who find themselves under water, owning more on their house than it is worth, are simply walking away. In most states, they have no obligation beyond what the bank gets from foreclosure. The result is that people who can still afford the payment are making a business decision to simply let the bank take the loss.

Housing prices are continuing to fall. There are some predictions that the ultimate floor on prices may be less than 50% of a home's peak value during the bubble. That means even people who bought with hefty down payments may find themselves owing more than they own. In addition, the premium for owning your own home over the cost of renting went up with the bubble and still hasn't come down again. So in many places, most people who own could rent some place similar for less money.

So does walking away make sense? If you look at it as purely a financial decision, …

Economics as Ideology

You aren't smarter than the market. It really is that simple.

This is a quote from a CNN Money online report on the debate over whether we are faced with inflation:

'president of the Federal Reserve Bank of Cleveland and a voting member this year of the Federal Open Market Committee, explained in a speech last month. "As consumers spend more money for higher-priced petroleum and agricultural goods," she continued, "they eventually have less money to spend on other goods and services. Other relative prices must then fall."''Well yes, prices are falllng "relative" to oil and food. But this is a clearly a statement of ideology rather than evidence based science. And it is clearly wrong. As people have less to spend, they buy less and producers produce less and lay off employees who now have less to spend, creating stagflation. From that same article:

"Automakers Ford (F, Fortune 500) and General Motors (GM, Fortune 500) have slashed their …

Don't buy a house, Sell if you can

You aren't smarter than the market. It really is that simple.

Remember the adage, "buy low, sell high"? That applies to the real estate market too. This may be obvious to most people, but apparently not to the financial advice industry. Buying a house right now is a very high risk investment. In fact owning a home is a high risk investment, if you think your home is an investment.

Of course, most people don't own their home as an investment, they own a home to live in.  But the cost of owning one's own home the last couple years has been very high in most markets.  And unlike past situations where real estate prices fell, this one preceeded the onset of a broader economic slowdown rather than resulting from it. A weakening economy should push prices even lower in the short term. 

Long term, the situation could be worse. The market fundamentals such as rents, household income and historic rates of appreciation all indicate the current market is still overpriced even…

Stop Saving for Retirement

You aren't smarter than the market. It really is that simple.

No matter how often the financial services industry repeats the message, it is still a lie. Young people should not be saving for retirement. You have an entire life to live before worrying about what you will do when you have had bypass surgery and no longer have the energy to even go to the grocery store. While the financial services industry needs you, you don't need them.

That doesn't mean you shouldn't be saving money. You should be saving for your wedding and honeymoon, to buy a house, to send your kids to college, to take that dream vacation or to buy a new IPOD. Of course, you can also just borrow money to do those things and pay it off later. For most young people that is more realistic and, frankly, a better idea. You are likely to earn more as you get older and it will be easier to pay off the debt you took on than to save the money now to buy stuff.

Of course, what you buy matters. A house is a pret…

Your Social Security is more Secure than your Securities

You aren't smarter than the market. It really is that simple.

Allen Sloan over at Fortune Magazine is making the case that Social Security will run out of money in 10 years. His are the crocodile tears of the very people who have looted social security, using the excess social security taxes to provide themselves and their rich cronies with tax breaks. He makes clear his new-found concern for social security is really an excuse to further raid the treasury with his suggestion for a solution: "We can still buy time by investing current cash surpluses in non-Treasury assets." I.e. we should use social security taxes to buy some of his rich buddies' fancy financial products.

To understand how this really works you need to start with social security taxes. The original idea was that the taxes paid by current workers would pay the current benefits for people who were retired. In turn, the next generation of workers would pay the retirement of the next generation of retire…

The recession is coming! The recession is coming!

You aren't smarter than the market. It really is that simple.

So you think we are headed for a recession and the market is going in the tank. You aren't alone. There are plenty of other investors out there with the same idea. And your opinions are already reflected in the current market price of stocks. While you could turn out to be right, it is equally or more likely you are wrong. Guessing what will happen next in the stock market is not an investment strategy, its a gambling strategy. The only advantage it has over Vegas is that the investment analysts and financiers usually take a smaller amount off the top than the casinos do.

So what should you do? The answer depends on whether you are a buyer or a seller. And that has nothing to do with what you think the market is going to do. It is a question of where you are in the investment cycle. If you are adding to your investments then you are a buyer. If you are at a point where you are moving money out of the stock market, y…

Media Investment Advice

CNN's Walter Upgreave today made clear why taking investment advice from the media is a bad idea. In his column today he takes a contrary view of "dollar cost averaging". The dead giveaway is this line:

"But while dollar-cost averaging has risen to the level of accepted truth in many circles, it isn’t the magic bullet it’s made out to be. Indeed, some of the claims are simply an illusion."

Put another way, his job is to provide something interesting for us to read and repeating conventional wisdom won't get you many readers. But there is a reason why dollar cost averaging is conventional wisdom and Upgreave is doing a huge disservice by encouraging people to ignore it. Sometimes conventional wisdom is wrong, but, if you really understand the role of investment mix or dollar cost averaging in risk management, you realize that Upgreave's argument has no merit. Here is the nut of his argument:

"Over the course of the year, you would have actually been…

You are NOT smarter than the market

You are not smarter than the market. Accepting this basic fact is the first step toward successful investing. That is counterintuitive to some people. There are lots of people out there who want to "beat the market". They hire financial advisers who claim that they will help them accomplish this allusive goal. There are also people out there who want to win the lottery, they buy lottery tickets. In both cases, you hear a lot about the "winners". What you don't hear is that there are a lot more losers and the odds are you will be one of them.

Now, financial advisers will argue that what they do is not really gambling because they can control the outcome. They claim that by being "smarter" they give you a leg up on the typical investor. That isn't really true because the market price of stocks in not set by the "typical investor". Prices are set by the collective wisdom of market professionals, many of whom manage billions of dollars each. …