Sunday, October 23, 2011

Don't gamble with the grocery money

My grandfather loved to gamble. So, it is no surprise that my father likes to gamble. I confess that even I enjoy the occasional challenge of facing an opponent when both us have a little skin in the game. But my grandfather--who didn't always follow his own advice--gave my father some advice which he has taken seriously and passed on to me, to wit: Don't gamble with the grocery money.

It sounds simple enough. But the real trick is to figure out whether you are gambling with the grocery money. I began thinking about all this as I was seated next to a woman retiree on a train ride during a recent trip. We got to talking about the Occupy Wall Street protest, and we went on from there to talk about the stock market and retirement savings. I suggested to her that the retirement savings of the entire middle class of America are at grave risk. I explained that the seeds of that risk were sown back in the early 1980s when a then little-known provision of the tax code labeled 401k--which was designed to encourage supplementary retirement savings--was used to transfer all the risk of pensions from companies to employees.

Before the 401k craze (403b for nonprofits) companies with pension plans generally guaranteed a specific benefit, i.e., an amount per month that would be paid to retirees for life based on years of service, pay level and sometimes other factors. It was up to the company to figure out how to make that happen with money set aside usually through both employer and employee contributions. The company often hired outside money managers to invest the money based on the projected needs of retirees. Such plans are usually referred to as defined benefit plans, and they were the norm before the 401k. Now, they are rare.

The result has been that every person with a 401k has had to become an amateur investor. And, all seemed well from the early 1980s onward when such plans first came into widespread use. The world had just embarked on what would turn out to be the biggest bull market in stocks ever seen. As John Kenneth Galbraith once said, "Financial genius is a rising stock market." It became common wisdom that everyone should own "stocks for the long run." We were told we were in a "new era" of unprecedented technological progress. We were also told that monetary authorities had now mastered the business cycle through their clever manipulation of interest rates and other levers of finance.

(It is puzzling why anyone would continue to assign omniscience and omnipotence to central banks and governments after the Bear Stearns collapse, the 2008 crash, phase one of the European debt crisis last year, and now phase two of the European debt crisis. If central banks and governments are so powerful and all-knowing, shouldn't they have been able to prevent these serial financial implosions?)

Back to the poor woman sitting next to me on the train. I suggested that faith in the narrative described above was borne of a highly unusual period of history, and that one has only to go back to The Great Depression to find that it is possible for the stock market to decline 80 percent and not recover to its old highs for two and half decades. (I forgot to mention that today Japan's stock market is down more than 75 percent from the high it reached in 1989!) I suggested that the current system of retirement finance was largely concocted to relieve corporations and other institutions of their retirement obligations to employees and to enrich Wall Street. Wall Street, after all, gets its fees whether the client makes money or not.

I proffered that the game was a dangerous one for all but the largest players. Why? Three reasons: First, those players have access to information, connections and great gobs of capital that can move markets, and they are perfectly capable of making money when markets go down as well as up. Second, they have so much money that even severe losses will not prevent them from buying groceries and paying their mortgages and utility bills. Third, the government will step in to prevent them from going bust if it believes this means preventing a systemwide financial meltdown.

Were average people like her really in a position to compete with that? I asked. I thought to myself that this woman and so many like her are not playing with money they can afford to lose. They are gambling with the grocery money and they don't even know it! And, that's because they've been sold the idea that they are investing which sounds a lot nicer than gambling. But it amounts to the same thing.

Of course, if everyone took my advice tomorrow, the stock market would collapse. But my argument is that we should have never have gotten to this point. We should never have abandoned a system that makes retirees essentially indifferent to the level of the stock market. But because of the move to 401ks, many are now risking losing their grocery money and do not seem to know it.

Perhaps my fears are unfounded. But as I look at the amount of gray hair in the crowds at various Occupy Wall Street events, I wonder if a lot of damage hasn't already been done. The last 10 years have netted the average investor essentially nothing. And, the most recent market swoon has once again tested hopes that the casino profits in the market can continue.

With the Europeans outdoing the Keystone Cops as they slide toward an ineluctable default in Greece and a possible worldwide contagion; with a worldwide economic slowdown and possibly a recession already underway; with rumors arising nearly every day that one bank or another may soon go down; and with a severe property bust already evident in China, I fear there is worse to come.


Michael said...

Well...put your emergency savings in silver bullion coin and hope for the best...

A Different Michael said...

Gee, Kurt, you really know how to ruin an old lady's day. I'm kidding. I share some of your same concerns. But I tried researching your comment that the 'average investor' essentially has no gains over the past ten years, and can't find the data. I know I'm not 'average' (I pay attention to our money), but I've done much better than nothing. What's your source?

Kurt Cobb said...

A Different Michael,

By definition, of course, there are those who've exceeded the average and those who've underperformed it. You may have done better than average and I applaud you for that. But did you actually increase the purchasing power of your money in real terms? If you did this, then it means you are one of a very few who did and I again applaud you.

For perspective on what the stock market did in real terms, I suggest looking at Doug Short's plot of real inflation-adjusted prices for the stock market.

Even if you look at his plot for nominal stock prices, you can see that the returns are still negative from the 2000 peak.

If you invested in other types of assets--gold and silver come to mind--then you may have done better and may have had real as well as nominal gains.

I was assuming that the average investor was somebody following the standard advice of nearly every investment adviser, namely, stocks for the long run. That hasn't really worked out in the last decade.

A Different Michael said...

Thanks for that link, Kurt. I always forget to calculate for inflation. By that measure, I'm doomed: Total inflation from January 2000 to September 2011 is 34.41%. By that measure, I'd better see if Home Depot is hiring.