Middle-class investors are at a disadvantage because experts give different advice to paying clients than they do to those who rely on free sources of investing guidance.
If I had to pick the one thing that I learned during The Great Safe Withdrawal (SWR) Rate Debate that most stunned and amazed me, it would be the nine words that Dallas Morning News Columnist Scott Burns wrote in his column from July 2005 reporting on the New School of SWR Analysis. In reference to the New School findings (that the Old School numbers that were used in millions of retirements are off by 1.5 to 2.0 percentage points from the numbers obtained from use of an analytically valid methodology), Burns noted that we don’t often hear these findings discussed in the media today because: “It is information most people don’t want to hear.”
Holy smokes! Ponder the implications of that one for a moment. The experts know that millions of retirements are at grave risk of going bust in decades to come but they don’t tell us this because they fear what our reaction will be to the news. Not good.
We’ve seen evidence that the experts are more inclined to tell the straight story to the wealthier clients who are able to pay them for their counsel. For example, there was a Wall Street Journal article published in December 2005 stating that many financial advisors have in recent years adopted the practice of telling their clients that the infamous “4 Percent Rule” (the Old School studies falsely claim that a 4 percent withdrawal is safe at all price levels) needs to be pared back considerably for retirements beginning at today’s valuation levels.
My guess is that financial advisors feel more comfortable talking straight when they can talk to a client face to face and respond to questions about the investing realities that are generally viewed as too hot to handle in widely published media reports.
Many middle-class investors cannot afford to pay financial advisors to help them with their stock allocation decisions. They assume that they are getting the straight story in reports they read in newspapers and magazines. To the extent that that’s not so, middle-class investors have been put at a disadvantage.
Middle-class investors are at a disadvantage because buy-and-hold strategies are far harder to execute for those with limited assets.
Middle-class investors are as a general rule naturally reluctant to invest too heavily in stocks. It’s a powerful phrase expressing a powerful idea that has coaxed them into letting down their guard during the recent bull market. The phrase is “buy-and-hold.” Follow a buy-and-hold strategy and you cannot go wrong with stocks in the long run, we have been assured.
Is it so? It’s partly so. Buy-and-hold really is a winning strategy for those able to stick to it through the wild bear market that always follows a wild bull market. Many of today’s middle-class investors are not so positioned. That group has been placed at a big disadvantage.
One investor has $3 million in assets and experiences a price drop of 50 percent. Another has $600,000 in assets and experiences a price drop of 50 percent. The first investor is left with assets of $1.5 million. The second is left with assets of $300,000. Which investor feels more pressure to break his buy-and-hold commitment and to sell? It’s the middle-class investor who is feeling far more pain in these circumstances.
Buy-and-hold has never been tested in a bear market. It may work for some wealthy investors who can laugh off the temporary losses experienced. It is unlikely to work for the majority of middle–class investors, investors who cannot afford to sustain large losses without suffering serious concerns about their financial futures.
Middle-class investors should be following buy-and-hold strategies. But they should not be using the same risk-assessment rules to determine how much money to put at risk in stocks purchased at times of high valuations. Panic sets in quicker for those with smaller portfolios. So middle-class investors need to take a more cautious approach to buy-and-hold for it to work for them.
Middle-class investors are at a disadvantage because they are more dependent on their investment portfolios to finance their retirements.
Wealthy investors often enjoy multiple income streams. Perhaps they own real estate as well as stocks. Perhaps they have a partial interest in a small business not traded on the stock market. Perhaps they have contacts that they can use to generate additional income to make up partially for losses suffered in a stock price crash.
Middle-class investors going with high stock allocations have all of their financial hopes riding on the spin of a single wheel. This would be risky even if stock prices were at reasonable levels. It is extremely risky with stock prices at the levels they are at today (this article was posted in September 2007).
Middle-class investors are at a disadvantage because their knowledge of financial affairs is limited.
Few of us have time to learn everything that we would like to learn. We specialize in the topics that are most important. For those with large amounts of money, learning about money is a top priority. Even wealthy investors with little natural interest in investing often know the basics just because these sorts of matters have been discussed at the kitchen table and by friends and relatives throughout their lives. That’s not the case for many middle-class investors.
Investing is an activity like few others in that for many of us it is forced. Say that you do not enjoy the process of learning about investing and would prefer not to engage in it. You have to do so whether you like the idea of not. All those who hope to retire need to earn money from investments. Sooner or later, we all need to break down and invest, regardless of how poorly prepared we are to do so.
There’s no rule that says that people must become informed before they put money on the table with a stock investment. What do you think that most ill-prepared middle-class investors do to make themselves feel more comfortable with their investment choices? They fool themselves into thinking that they are better informed than they truly know themselves to be. They take comfort in the good results they obtain in bull markets, allowing themselves to form expectations that those results can continue after the bull market comes to an end. They rationalize. They hope for the best. They become defensive when asked whether they are comfortable with their investment decisions.
In many fields of endeavor, poor preparation reveals itself quickly, before it can do too much damage. It’s not like that in the investing field. The least informed investor couldn’t help but make lots of money in stocks in the 1990s. Once the 1990s came to an end, though, things began to change. In the years ahead, being better informed will count for more. As a general rule, that puts middle-class investors at a disadvantage.
Middle-class investors are at a disadvantage because they don’t have as much personal experience of the great bear markets of the past.
High-school kids die in car crashes all the time. I remember the one from my junior-year class who did. When something happens to someone you know personally, it makes much more of an impression.
Middle-class investors know about bear markets. They’ve read something about them or heard something about them. The stories they heard did not hit with full force because they were stories of things that happened to people they did not know personally.
Middle-class investing is a relatively new phenomenon. Wealthy investors have had grandmothers and uncles affected by earlier stock-market blowouts. Many middle-class investors are the first generation of investors to put substantial amounts of assets at risk in the stock market. They know only on an intellectual level some things that wealthy investors know on a deeper emotional level.
Middle-class investors are at a disadvantage because they are more trusting.
Middle-class investors want to believe that investing analysts are on their side. I have witnessed this reality over and over again. I remember a poster on the Vanguard Diehards board who said that she thought of Vanguard Founder John Bogle “like a father.” Bogle is often referred to as “Saint Jack” among the middle-class investors who adopted indexing as their favored investing strategy in the 1980s and 1990s and made a bundle as a consequence.
Jack Bogle ain’t no saint. He’s smart enough. He seems to be a generally kind man. There’s a lot right about his investing strategy. But there’s a lot wrong about his investing strategy too. Like all mortals, he has his off moments as well as his on ones. He gets stuff wrong. I have caught him at this on more than one occasion.
Middle-class investors who follow Bogle don’t want to hear that he gets things wrong. Middle-class investors who follow other investing gurus don’t want to hear that their gurus get things wrong. That’s unfortunate.
Bogle isn’t going to make you whole when conditions change and all the things that made his strategy seem so right for one time come to make it so wrong for another time. Neither are any of the other gurus. We all need to learn from someone and it’s fitting that we feel respect and affection for those who help us learn. We need to draw lines, though. We need to respect what is worthy of respect and to be critical of what is worthy of criticism. We owe it to ourselves and our families to look out first for ourselves and our families.
I believe that many middle-class investors are aware on some level of their vulnerability in the investing area. I believe that some develop excessive levels of trust as a means of pushing feelings of vulnerability down to some place where they do not cause discomfort. I see this as a mistake. You feel vulnerable because you should feel vulnerable. You need to trust less and engage in hard questioning of gurus more.
Middle-class investors are at a disadvantage because bull markets are all about them and they don’t know it.
What’s a bull market? It’s a time when stock prices rise to absurd levels, levels that could never be justified by the economic realities that govern long-term returns. What causes stock prices to go to such absurd levels for a time? It’s the fooling of the middle-class investor.
My favorite investing question is one that often comes up in the wake of a big price drop. Some brave soul will work up the courage to ask a question that he fears will make him look stupid but which in reality is the key to understanding on a deep level what stock investing is all about. The question is: When stock prices fall, where does all the money go?
It disappears. It goes “poof!”
How can this be? It can be because there is no economic reality to bull market prices in the first place. Prices rise when the demand for stocks rises. Demand cannot remain at unusually high levels forever. It eventually falls back to normal levels. So prices fall to normal levels too. When people complain that stock prices are low, they often are complaining about prices returning to an objectively normal level that only appears low to those who for a time grew accustomed to prices that were absurdly high as the result of a temporary increase in the demand for stock ownership. Prices could fall for a long, long ways from where they are today and not be at a level that could reasonably be described as “low.”
Wealthy investors always own stocks. Middle-class investors often become interested in stocks after there have been lots of media reports about how well stocks have been doing in recent years. It is rising levels of middle-class participation in the stock market that cause bull markets.
And it is falling levels of middle-class participation in stock markets that cause bear markets. There comes a time when middle-class investors must cut back on their stock ownership levels because the experts (in whom we place too much trust) always overestimate the extent to which middle-class investors can afford to put their accumulated wealth at risk in this tricky asset class.
When we pull back, we hurt ourselves. But we must pull back. Because our participation in the stock market during bull markets is always overdone. It could be said that we middle-class investors have the power to set the prices of stocks. Unfortunately, it’s a power that rarely works to our good. We possess the power but we do not understand it. So we are always the last to understand why it is that we bought too much and why it is that we must in time pay a price for having bought too much.
Middle-class investors are at a disadvantage because big stock losses will leave them with limited assets to invest in stocks when prices return to reasonable levels
The upside potential for stocks is greatly limited today. The downside potential is huge.
How can it be then that U.S. stocks have a long record of providing a return after 30 years or so of something close to 6.5 percent? That would seem impossible if the value proposition of stocks long remained what it is today.
The answer to the puzzle is that it is not likely that the value proposition is going to long remain what it is today. Prices will be coming down as part of a natural cycle that has been repeating itself since the first stock market on Planet Earth opened for business. Then they will be heading back up again.
It’s when prices are reasonable that you can hardly miss by investing in a good percentage of your money in stocks. Will you be prepared to take advantage of the mouthwatering long-term value proposition available to us middle-class investors the next time prices are reasonable? Take a quick look a The Stock-Return Predictor. When the P/E10 level returns to 14, the most likely 10-year annualized real return rises from 0.84 (where it stand today) all the way up to 6.34. It’s the investors who enjoy those sorts of returns who experience the exciting side of this wonderful asset class to its fullest.
You’ll be ready to reap some big rewards if you can tune out much of the conventional advice directed to middle-class investors at times of high valuations and prepare for the better stock investing times to come for those who keep their heads about them when too many of their friends, neighbors and co-workers are losing theirs.
Happy investing, my fellow middle-class investor! Please stop by the blog from time to time and let us know how things are working out for you. We learn together.