Do Americans Really Deserve The Mockery of the Money Men For Avoiding Stocks?

In a recent issue of MONEY magazine (September, p. 16) millennials and other demographics  were raked over the coals for their aversion to the stock market, say keeping their savings in cash instead of the stock market. The piece noted:

"Across all age groups only 16 percent said the stock market was the best place to keep money long term, despite its higher returns."

The short article goes on to single out millennials especially given 32 percent of them say cash is a superior investment to stocks.  Then adds: "If you had invested $10,000 in the Vanguard 500 stock index 10 years ago you'd have $20, 940 today."

But comments like these are easy to make with 20-20 hindsight and not knowing what events may lie ahead.  For example, what happens if a guy has been investing for some 25 years and just as he retires and needs that money  - which hitherto had been on paper- the market craps out? Well, depending on how severe the downturn he may be out of luck and have to live very frugally - even if not going back to work to try to recoup his losses. The wise guys at MONEY never tell you that part.

Or other aspect of the investment game.

Let's take the case of new investors rushing into Company "XYZ" which goes public and issues 10 million shares of stock to 2 million people, for $50 a share. The market capitalization here is therefore $500 million. This total capitalization is what determines payouts in the end. Say, for example, the original stock share plummets after ten years to 50 cents a share. The market capitalization has now decreased a factor of 100 ($50/ $0.5 = 100) to $5 million. If there are no 10 million investors, the share price can be no more than 50 cents a share and that is the maximal cashout (redemption) amount. Thus if all ten million stock holders cash out at once they will (theoretically) get 50 cents a share.

But since stock managers do demand  expenses, commissions, etc. the actual payout may be a lot less. Thus, what theoretically might look like 50 cents per share on paper, for an actual mass redemption, will really end up as probably only ten cents per share.  Think this is a nutso example? I have news for you! Back in 2011 according to The Financial Times yesterday, Marley Coffee had a share valuation of $6.50 (each). Two days ago it was down to 1 cent.

While all this is dreary news for stock pumpers, we haven't even gotten to taxes yet. Most people are abysmally ignorant in terms of the returns after taxes. In fact, given recent high share prices as indicated by the price to earnings (or P/E ) ratios,  a typical stock fund investor must wait an average of 28 years to double his profits, with taxes and expenses taken into account.

How badly do taxes eat up returns? Stock guru  John C. Bogle once provided an estimate ('Fund Fees Are Beyond Excessive', Mutual Funds, 10/ 98, p. 80: "In a normal environment, stocks give 10% nominal annual returns, but after incomes taxes, and after inflation, investors might get real returns of 5%. "   And we haven't even factored in commissions, other expenses yet!

A Stanford University study- 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.

Of course in today's low yield, zero interest rate (effectively) environment, most finance mavens such as run MONEY will regard anyone who goes for savings bonds today a dunderhead. But are they really?

Let us recognize that the market is already in asset bubble territory. Arch-forecaster Nate Silver, in his book, The Signal and the Noise- Why So Many Predictions Fail But Some Don’t  warns (p. 347):

"Of the eight times in which the S&P 500 has increased at a rate much faster than its historical average over a 5-year period , five cases were followed by a severe and notorious crash, such as the Great Depression and the Black Monday crash of 1987”.

Interestingly, two of the largest stock market dives have followed two of the biggest bubbles: the first of 37.85 percent and on the heels of the bubble that formed from Jan. 14, 2000 to Oct. 9, 2002, and the second of 58.78 percent that formed (mainly due to the housing bubble) from Oct. 9, 2007 to March 9, 2009.

Another warning alarm is traced to higher share prices arising from company stock buybacks, which really amounts to a form of liquidation (which I will elaborate on soon). WHY would a company need to buy back its own stock to create an artificial rise in share price if the company is genuinely doing well? It makes no sense. If a sound going to use any extra money for anything it ought to be for paying dividends, not stock buybacks!

But stock buybacks have been "going through the roof" lately.  A recent NY Times piece ('The Buyback Illusion.', Aug. 14, Business, p. 1) noted they are more often "a way for executives to make a company's earnings per share look better because the purchases reduce the amount of stock it has outstanding"  Also, "when per share earnings are a sizable component of executive pay the motivation to do buybacks only increases."  The problem is that ultimately this game amounts to a "liquidation program". In the scheme of reinvestment one has buyback in which a "shrunken pie is divided among fewer people" and actual reinvestment which "grows a bigger pie" via affirmative moves that benefit Main Street not just Wall Street..

Why aren't the little guys more aware of how they're being shafted? Maybe for the same reason, as former trader Michael Lewis has observed ('Flash Boys') , they're not paying attention to how flash trading is ripping them off via "millisecond" advantage and thereby gaining pennies on the dollar with each trade made. They essentially gain those pennies (which add up to billions over time) by getting shares redeemed before you can via that slight micro-time advantage.

Readers may recall high frequency trading (HFT) first came to light in the May 6, 2010  “flash crash” of over 500 points. This event brutally demonstrated the perils of so –called “flash trading”. Then we first learned of the high speed computers which use special algorithms to detect large buy and sell orders then adjust their trades to take advantage. Since the high speed computers can act in nanoseconds( to either buy or sell) with the flash information, they inevitably get the better of the more conventional (slower) investors. The “flash crash” likely occurred because a number of flash computers processed information too quickly or inaccurately inciting a mass sell off.

But we're still not done in terms of running the numbers of potential stock or mutual fund losses. To get down to cases, a stock – or mutual fund- that drops in share price from $20 to $10 has suffered a 50% loss. But for that $10 stock or fund share price to return to $20 it must gain 100%, or double. This may take not just two or three years, but more than TWENTY!

Many people who risk money in the markets do not  know that if a share of anything goes down by 20%, it requires an advance of 25% to get back just to the breakeven point. If the value of a share drops 40 percent (as has occurred with some recent mutual fund hits since 2013), you'd need a 66.7 % advance to break even. If the share drops 50% - as already noted- a 100% gain must be registered to return to ‘break-even’ (i.e. you’re not losing more than what you already paid).

Here's the deal: I don't care what your returns or share prices show on paper. That is just phantom money.  Phantom money is not real, spendable money until it is redeemed.  Until then you can't build a secure income stream around it because it's variable. - from day to day and week to week as the markets gyrate over every little thing.  The problem is that the odds of getting a clean redemption, i.e.maxing out your returns just when you want them, are less than 1/2 day out of 365  (or about 1.3 in 1,000)  according to the author of 'Surviving the Coming Mutual Fund Crisis'.   He notes that only 5 % of mutual fund holders manage to redeem their shares in time to reap maximal returns.

Michael Lewis, author of The Big Short, has noted the stock market  is "built on quicksand, and people who invest in stocks are not paying serious attention to the underlying fundamentals."  Instead they're being mesmerized by flickering numbers on crawl screens, and carried away by temporarily inflated share prices and think this will net them compile a hearty retirement nest egg.

Lastly, one of the most enlightening articles that ever appeared in The Wall Street Journal, had to be from Nov. 27, 2003, page D1, 'A Harsh Truth: Most of Your Investments Won't Make Money- Even in the Long Term.

That was the precise and exact header from the article, a copy of which I preserved.

The article noted what I have numerous times, that taxes (capital gains), fees, commissions and other expenses will essentially eat up any gains from most investments. And that is in a GOOD YEAR! Over time, even a long haul, the average gains are barely over 2% when taxes and expenses have been deducted.

Are the millennials dummies then for avoiding the stock market? Maybe not as much as the mavens at MONEY magazine believe. Of course, when I use the term "cash" I do not mean that literally as in stashing it in mattresses. I mean in terms of income, over speculative instruments. I.e. money market accounts, CDs or other safe income investments.

If, however, a person - millennial or other - comes into a windfall and can afford to part with a hundred thou in a loss without wasting time making it up, I say 'go for it'.  Make wise choices and perhaps pick an index fund but don't interact too much.  But if you  don't have the money to lose, never mind the green eyeshade types - you're best in conservative instruments. This is especially if - like Joseph Berardino warned in an FT piece some years back -the current reporting system “fails to communicate essential information about the real risks facing companies” to the small investor.

Berardino warned that 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). To do so would precipitate a collapse in share prices.  Who gets stuck by this 'black hole' of information? Why the little guy investor, of course, aka Joe Schmoe.  Under such conditions, the small investor risks his money and security, by investing in ANY non-FDIC insured monetary device.

A word to the wise: DO what feels right for YOU. Just be sure you're not just stashing cash in a mattress.

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Update:   As per a report in today's Denver Post Business Section (p. 15A) a participant in a Morgan Stanley 401k filed a lawsuit Friday against MS for "millions of dollars in losses" suffered by nearly 60,000 participants. Morgan Stanley was blamed for a plethora of fund offerings "with poor track records and high fees".

Don't Buy The "Sexy" Hype of Many Stock Purveyors

Since the early 1980s, we've witnessed the (almost - except for a few years) constant shrinkage of bank (pass book) interest rates, as well as on CDs - forcing vulnerable people (seniors, those near retirement) to chase yield in risky vehicles for which they were never prepared. The past five or so years with the Fed keeping interest rates near zero (0.25%) have been especially bad as they've had to endure volatile stock markets and next to nothing returns on savings.

This atmosphere drove millions of common, ordinary people into the 'market' who otherwise may never have ventured there. Just as before 1929, millions of ordinary folk were driven into the infamous 'investment trusts' that caused them to lose everything. These 'investment trusts' were the forerunners of today's mutual funds) and then - as now - touted as "the little guy's way to enter the stock market".

Meanwhile, an innominate former stock broker ("Timothy Harper") sounded a stirring warning in his 1999 book ('License to Steal: The Secret World of Wall Street Brokers and the Systematic Plundering of the American Investor' , Harpers) noting the cons and games used to lure the gullible into markets, whether stocks or mutual funds. One tactic noted repeatedly was the use of the language - with words like "stodgy", or "pedestrian" to describe those who stuck with safe investments (like CDs, or money markets or U.S. Treasurys) as opposed to words like "sexy" to describe those who ventured into the markets.

Never mind that a 20-year old Stanford University study- based on the median return of 62 mutual funds- showed that $1 invested in the best of them 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 same study showed that a conservative ("stodgy", "unsexy",) 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: it wasn't the sucker in stocks. Unless mutual-stock investors do the math and watch the numbers they cannot be aware of how little they're actually taking home. 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. (The Financial Times, ‘A Metaphorical Proposal’, Mar. 13, 2004, p. 11A by Michael Skapinker, noting "the current reporting system fails to communicate essential information about the real risks facing companies” to the small investor.)

Meanwhile, one of the most enlightening articles that ever appeared in The Wall Street Journal, had to be from Nov. 27, 2003, page D1, 'A Harsh Truth: Most of Your Investments Won't Make Money- Even in the Long Term. " The article observed that after paying fees, commissions and taxes most stock holders fared little better than CD holders over time, a fact made painfully clear to millions over the ten years from 1999- 2009 when the S & P barely returned 1.4% a year.

The situation in stocks hasn't improved since then, and indeed, an analysis of all the current market fundamentals disclose stock investors to be on risky ground indeed. So given this, why are the smart stock investors (those owning actual stocks that pay out dividends) still being mocked in snide ways as owning "shares for widows or orphans". Is there no end to the base resort to despicable language, despite the fact that this is exactly where most people need to be, if they own stocks at all?

Why are dividend -paying stocks derided as for "widows and orphans"? Well, because the high fliers who like to juice their own funds with derivatives and other toxins regard them as "stodgy" because of their steady but unproductive performance (in terms of delivering major share spikes during the years). But ah,...those major share spikes come with terrible downsides, such as major share nosedives! Then, when 401k or IRA little guys lose up to 40% of their nest eggs whose there to hold their hands? Not any of these slick, green eyeshade types, I can tell you! They are off counting all their ill gotten gains in terms of the commissions and fees with which they've soaked the little guys and have been doing since the year dot. See, e.g. John C. Bogle, Fund Fees Are Beyond Excessive, in Mutual Funds Magazine, October, 1998, p. 80.

As a point of fact, the fund fees at the time Bogle penned his piece were barely 75% of where most are now. Fleece much?

But the ones who ought to be laughing or at least jumping for joy are precisely those holding dividend stocks because they're getting something for their investment other than just statements showing losses. Currently, these "stodgy" investors are heartened by seeing dividend yields of more than 4% on many utilities, telecommunications and household goods manufacturers stocks. This is twice as much as the recent yields on 10-year Treasurys.

Most dividend stock experts think this good fortune will persist as long as general volatility, driven by Europe's debt crisis and the global economic stasis (low aggregate demand), continues to grip financial markets. For sure, stocks that pay steady dividends tend to fall less than others during down times, According to Jennifer Ellison, portfolio manager at Bingham, Osborn & Scarborough (WSJ, Dec. 18, p. C1):

"Investors are demanding the money back in one form or the other".


Indeed! In the early 90s, when markets were higher, it became an unwritten code amongst fund companies and stock managers that most investors would consent to do without dividends but then they had to see solid returns via higher share prices. When successive shit hit the investment fan, starting with the Asian currency crisis in 1997, then the 1999 dot com bust, followed by the 2001-02 9/11 collapse and then the 2008 credit meltdown, this word and bond became meaningless - as stock share prices plummeted across the board - and even now stocks' relative peaks exist only amidst the most combustible volatility.

Maybe it's a good time to ditch the "sexy meme" and more people - small guy investors - embrace "stodgy and pedestrian" if not "widows and orphans"!