The Great Stagnation a TED Talk

Tyler Cowen's perspective on our economy. I have listened to Tyler on a number of occasions as a guest on the podcast EconTalk. Here is a link to his recent TED talk:

http://www.youtube.com/watch?v=_93CXTt2K7c

He always has interesting insights, he also may be one of the most well read economists in the world. See this very interesting recent profile in Business Week:

http://www.businessweek.com/magazine/content/11_23/b4231066695798.htm

Lounge by the pool or follow Mad Money's James Cramer?

Jim Cramer's recommended trades since 1/1/2002 earned 39.2%.
But,
Simply holding the S&P 500 index fund since 2002 would have earned you 38.3%.

You could have bought the index and not looked at a thing, went on with enjoying life, or you could have followed Cramer's advice through a service - Actions Alerts PLUS and earned 39.2%.

To earn the 39.2% would have required an average of 774 trades/year over the last 3 years. Remember, with trades comes trading costs, taxes and the cost of the newsletter ($299.95 for the 1st year). Also, the return assumes you made all the trades when you were supposed to.

I would be surprised, if after fees, the Cramer advice outperforms the S&P 500.

The choice is yours, spend your time trying to beat the market year after year, or accept the returns of a well diversified portfolio and have more time to golf, read, lounge, be with kids, etc.

The above information is from Jason Zweig's  June 4, 2011 Intelligent Investor column in the WSJ:

http://professional.wsj.com/article/SB10001424052702304563104576363892725584866.html?mg=reno-secaucus-wsj

Just Capturing the Return of the US Mkt Would Have Earned You 10.5% Since 1973

An investor who simply held an index of the US stock market since 1973 would have earned 10.5% through 2010. Holding the US market since 1927 would have earned 9.8%.

How about an investor that got in the market 20 years  ago?  An index of  the US market would have returned 9.7% since 1991.

It gets even better, had you diversified into international funds and held 30% of your stocks in international indexes your returns since 1973 and 1991 would have been 13.5% and 11.7% respectively (global allocation and returns based on DFA Balanced Strategy).

These returns were simply a matter of buying and holding capital markets. No stock picking, market timing, sector allocation. No high paid gurus, quarterly meetings with your advisor and their crystal ball. Just investing in a simple allocation of global equities, re-balancing annually, and not touching anything.

This may not have the glamor of picking the next Google and getting rich overnight. But, I would argue that most investors wish that their overall return since 1991 was 11.7%.

20 years ago a friend of mine related a piece of advice his father gave him. His dad said: save regularly in the US total market index fund and don't worry until you approach retirement. His father was a successful broker for Merrill Lynch.

Some final thoughts from some pretty big minds in the investing world:

“The S&P 500 is a wonderful thing to put your money in. If somebody said, ‘I’ve got a fund here with a really low cost, that’s tax efficient, with a 15-to-20-year record of beating almost everybody,’ why wouldn’t you own it?” — Bill Miller, manager, Legg Mason Value Trust”

“Buying an index fund over a long period of time makes the most sense.” — Warren Buffett

“I can’t recall ever once having seen the name of a market timer on Forbes’ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.” — Peter Lynch, former manager, Fidelity Magellan

“Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.” — Peter Lynch

Increase Your Probability of Investment Success

Investing in stocks or bonds?

Why are you not investing with index funds?

Did you know that a recent study showed that the Total US Stock Market Index Fund beat over 72% of all US stock funds over a 20 year period?

Did you know that similar studies show a more profound superiority with specific sectors and bond funds?

Did you know that the laws governing trusts (Restatement 3rd of Trusts, Prudent Investor Rule 1992) consider index funds the highest level of of fiduciary care?

Did you know that the Federal Government Thrift Savings Plan offers only index fund options?

Have you read The May 13th NY Times "Your Money" column: Why 401(K)'s Should Offer Index Funds?

http://www.nytimes.com/2011/05/14/your-money/401ks-and-similar-plans/14money.html

Did you know that Charles Schwab will be introducing an all index 401K plan later this year?

Why not improve your probability of investment success by:
1.  Developing a portfolio that meets your risk tolerances
2.  Fund it with index funds -  they outperform more expensive actively managed funds over time.
3.  Re-balance annually

EconTalk on Parenting

Russ Roberts interviews Bryan Caplan on his new book Selfish Reasons To Have More Kids. I try to listen to EconTalks weekly podcasts. EconTalk is a weekly, open discussion on many topics. Generally business and economics related, almost always interesting and relevant. If you have kids I think this will be valuable time spent:

http://www.econtalk.org/

Hayek, spontaneous order and index funds

If I can use a picture of Salma to get one to click on this post and read a little about Friedrichs ideas, I have achieved a small victory in educating the masses. 

"in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process… will hardly ever be fully known or measurable."

The above quote is from the 1972 Nobel prize lecture of Austrian economist Friedrich Hayek who wrote brilliant works that explained the errors of fascism and socialism. He taught that the modern economy has too many variables for one person, or organization, to efficiently allocate its resources. Hayek argued that the price system does a better job of allocating resources than a government controlled system. Hayek's observations are part of his reflections on spontaneous order - which is the idea that order comes out of chaos when many self interested individuals are involved. This idea is played out in many areas. A recent example of spontaneous order is the open architecture software - Linux, which is written by programmers from all over the world who, in their spare time, add to the code. Linux now operates some of the fastest computers in the world and is the operating systems that runs many devices that we use in our daily life.

So how does this apply to investing?

The investing world is divided by those that believe they can predict economic and investment trends - the active managers, they believe they can predict which stocks to pick for your portfolio or mutual fund. Then there are those that believe that the stock market is too complex to make those decisions accurately on a consistent basis (the indexers). The indexers argue that the collective wisdom of all the investors in the world will average out to the best answer. The indexers, one could say, are Hayekian in their thinking. They would argue that if Wal Mart makes up 2% of the stock market, then an individual investor should own 2% of Wal Mart.

What is the collective wisdom of all investors in the investing world? Answer: index funds.

What is the record of index funds? Answer: Over time, they outperform active managers. Yes, year to year some active managers outperform the average. But it is not the same ones on a regular basis.

Spontaneous order seems to play out in stock funds. It explains why index funds outperform active managers. The collective wisdom of the many results in better investment performance than that of one or a few.

What does this mean for the average investor. It means that the best course of action has been to hold a well diversified, risk appropriate portfolio of the global stock and bond market, fund it with index funds, and rebalance annually.

For an analogous column, see Russ Roberts's 2004 Business Week column : "The Bagel and the Index Fund,"

http://www.businessweek.com/bwdaily/dnflash/jan2004/nf20040120_6180.htm

I recommend Russ Roberts's podcast: Econtalk, his blog: Cafe Hayek, and his books: "The Choice", "The invisible Heart", and "The Price of Everything."

Roberts is a professor of Economics at George Mason University

In another related article, see Jason Zweig's January 8, 2011 Wall Street Journal Column, in which he also cites Hayek in his explanation on why forecasters rarely get forecasts correct:

http://online.wsj.com/article/SB10001424052748703675904576064320900295678.html?mod=ITP_businessandfinan

Dopamine and Pattern Seeking and Your Investments

Insights from Jason Zweig's Your Money and Your Brain:

Why do we continue to believe that we can outperform the market when research continually demonstrates that we cant?

The answer partly lies in pattern seeking behavior and dopamine.

Pattern recognition: humans have survived because the brain recognized simple patterns in nature. Unfortunately, the investment world is governed by acts of randomness, yet we want to believe we can see patterns and predict the future. This pattern seeking behavior is unconscious and uncontrollable and we humans will leap to conclusions. Such as, when we observe two or three years in a row of superior mutual fund performance, we tend to believe that a pattern is emerging and expect a fourth year of good performance.Study's show past mutual fund success is not the best predictor of future success, yet we cant help ourselves, we choose past winners.

Then there is dopamine. Dopamine is a chemical that sends energy throughout the brain and turns motivation into actions. Dopamine is so powerful that a rat will starve to death rather than turn away from dopamine. Lay an MRI scan of a cocaine addict about to get a fix next to that of a person who thinks he is about to win money and they are virtually the same. We also know this about dopamine and rewards: dopamine is strongest when a reward is unexpected. That getting what you expected does not produce dopamine, and if the expected reward does not show up then the dopamine dries up. We also know that if the reward is big enough, dopamine seems to have a memory. This last point is huge. Investors who have received a large reward will experience a dopamine release if a pattern similar to the winning pattern is observed. This may result in the investor taking actions that are not sound.

What can you do to help protect you from yourself:

1. Stop predicting the market.

2. Ask for evidence.

3. Face up to base rates - long term outcome using a large sample.

4. Realize that correlation is not causation - there is so much information available that marketers can prove anything. ask yourself how the results would be if the dates were different or if the assumptions were slightly different.

5. Take a break - give your brain time to re-group

6.Don't obsess -the more an investor watches his investment the likelier he is to trade and thus decrease his long term return.