As the continued volatility in the stock market gets more attention, and many oldsters saving for retirement have already lost nearly 40% in their 401ks, the question arises: Do ordinary small fry, whose only money is being saved from nearly stagnant wages, belong in the stock market?
Of course, the endless parade of gurus and pundits of high finance (e.g. Jim Cramer of 'Mad Money' fame on CNBC, until a couple weeks ago) have always issued the same mantra: Just invest and "dollar cost averaging will take care of the rest". When the stocks and whatnot tank and you buy on the dips, you get more shares! What's not to love?
Actually a lot! As the authors of The Great 401 k Hoax have noted, it is living in a fool's paradise to believe that if the companies you invested in are only increasing their profits at 2-3% a year, that you can be earning 7% or even 10%. In fact, what one has then is an aberration in which the gains are out of whack with reality. (This is one reason why real stock investors demand dividends, and refuse to forego them so fund companies etc. can use the money to do "stock buybacks" thereby artificially inflating the share price!)
Further, a Stanford University study some years ago- based on the median return of 62 mutual funds- showed that $1 invested in 1962 would have grown to $21.89 by 1992, on a pre-tax basis. The study disclosed that the $1 would have grown to only $9.87 on an after-tax basis. And the investor would have had to come up with $12.02 to pay the taxes.
By contrast the study showed that a “conservative” investor who put assets into a U.S. Savings Bond in 1962, had every $1 become $10.93 by 1992. It is easy to work out from these numbers which investor actually fared better over the thirty-year interval according to the study. Hint- hint: it wasn't the sucker in stocks.
Unless mutuals investors do the math and watch the numbers they cannot be aware of how little they're actually taking home. (A point also made emphatically in The Wall Street Journal, Nov. 27, 2003, page D1, 'A Harsh Truth: Most of Your Investments Won't Make Money- Even in the Long Term, after assessing stocks, bonds and mutuals).
It is also well for small investors to understand that, to a large degree, they are in a game with a 'stacked deck'. Not only that, but under current laws their investments are almost entirely blind. Like buying a pig in a poke.
This point was emphasized in a London Financial Times article (‘A Metaphorical Proposal’, Mar. 13, 2002, p. 11A) by Michael Skapinker. He cited remarks by Joseph Berardino – chief exec of Arthur Andersen- who noted how the current reporting system “fails to communicate essential information about the real risks facing companies” to the small investor.
If you don't KNOW what you're getting into, how the hell can you have any confidence that you will get anything back? You can't!
Skapinker quotes Berardino as noting how accountants can only issue ‘pass’ or ‘fail’ judgments on companies – but cannot disclose the red ink being bled by a company that’s been passed. (What's referred to as a “bleeding edge” company wherein auditors are actually resigning). As the author notes, to do so would precipitate a collapse in share prices.
Under such conditions, the small investor risks his money and security, by investing in ANY non-FDIC insured monetary device. Indeed, despite the bevy of risks and deceptions, some investors have been insane enough to take out 2nd mortgages to up the ante in the stock market, yet don't even know the role of NAV (Net Asset Value) in calculating net gains, losses.
In fact, the stock market's sole purpose, As E. Brockway observes (The End of Economic Man, 1990), is to steal capital from the poor or middle class (that can least afford losses) and give it to the rich. The technique hardly varies: Pundits, wags and paid shills hype the various stocks, funds or instigate a "buzz" about them - to get suckers to buy in.
The increasing buy-in inflates the price-to -earnings ratio (P-E ratio) and produces a bubble of high profits. The "Big boys" (large, institutional investors) get tipped 1-2 days in advance and cash out, leaving the little guys to sink. If they're lucky they may earn a few bucks. Not much.
The thievery works eventually because most manjacks are conditioned to "buy and hold" rather than fold when the share price dives below a certain threshold. (Which ought to be the tip off). Thus, there are always ample marks left at the end game to be properly fleeced. Amazingly, they're always ready to play the game again, and pile their newly saved up money in.
Lastly, NO American of any class or station (except possibly the super-rich that can afford stupid or reckless losses) has any business putting money into any investments at all unless s/he can pass with at least a 75% a basic investment test. My own version - developed by myself and a financial advisor brother - includes the following questions (no googling, crib notes or texts!):
1) What is a P/E ratio?
2) What is the maximum tolerable expense ratio, beyond which an investor shouldn’t invest in a mutual fund?
3)Distinguish between front and back loads.
4) Joe has $10,000 to invest and the fund is front loaded at 5%. How much is he really investing? How much must he gain the first year to reach break-even? How much must his fund earn to achieve a REAL 5% gain. (Assume the expense ratio is 2%)
5) Distinguish between bonds and bond funds?
6) How would you recognize collateral debt obligations (CDOs) in a bond fund? Interest only strips? Inverse floaters?
7) When investing in stocks, one of the worst tricks used by brokers or managers is collusion using ‘micro caps’ to keep their clients buying and selling stocks within a closed artificial market. (Source:License To Steal: The Secret World of Wall Street Brokers and the Systematic Plundering of the American Investor, page 211). Explain.
8) Small, individual investors in stocks are usually fleeced by brokers through “crossing”, “churning” and “parking”. Explain in turn how each of these would work.
9) WHY is the ADV form Part II essential before hiring a financial advisor? What key information therein would provide a sound basis for rejecting any FA?
10) Distinguish between money market accounts and money market funds. Why are the latter always riskier?
I seriously doubt 9 out of 10 middle or lower income Americans (particularly seniors putting their hopes in the market for retirement) could answer as many as five of the above correctly. And assuming that is so, its' a damned good thing "only 17 percent of households in the bottom 60 percent of income own any taxable stock."
If stocks aren't the answer, what are? Slow and unsexy saving! Then, take that savings by age 65 (say maybe $300,000) and parcel it into separate immediate fixed annuities to provide a safe, dependable income stream over your lifetime, as opposed to a variable money stream - based on the phantom money in the stock market.
As finance columnist Humberto Cruz has complained - and I do now- for some incomprehensible reason Americans would rather play the stock casino than go with dependable immediate fixed annuities. (Variables are not even on the table, as Suze Ormond has noted, they are "stupid" and a waste of time, as per her MONEY magazine interview). Combined with Social Security, a set of immediate fixed annuities is the sane and sensible answer to funding retirement today.
You certainly won't be rich, but then you won't have to sustain a diet of Alpo and Ramen noodles either, or work until your drop dead in your few years remaining on the planet!
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