May 1, 2004
LOUSY, BUT BETTER THAN THE GOVERNMENT CAN MANAGE
The 4 Percent Solution: Why you're such a lousy investor (Ed Dravo, Slate, 4/30/04)
It is a principle of American life—practically gospel—that you know better than anyone what to do with your money. The idea of privatizing Social Security is based on the notion that you'll invest your savings better than the government would. The ascendance of 401(k) plans over guaranteed employee pensions has the same foundation—that employees will make informed and prudent decisions when they invest.If individual investors manage a 4% return on their retirement accounts, they are doing 200-400% better than Social Security. Also, Mr. Dravo is simply wrong about the reason for individual control of privatized social security accounts. It is not some superstitious "gospel" that individuals know best what to do with their money, but rather the need to prevent the federal government from controlling the economy through investment of social security funds.But what if it's not true?
Over the last 20 years, the stock market has averaged a 12 percent annual return. But according to a study by Dalbar Financial, individual mutual fund investors earned only about 4 percent. A survey by Vanguard finds participants in its 401(k) plans earn only about one-half the average—6 percent a year. It is almost impossible to believe, and unpleasant to contemplate, but practically all individual investors are below average.
Mr. Dravo is right, though, that individuals are lousy investors, but long sophisticated tutorials are not the answer. Rather, we all need three basic rules of investing thumped into our heads. First, risk and return are the same thing -- greater return can only be had by taking on greater risk. Second, no one can beat the market over time -- with most of your money, buy index funds and leave them alone. Third, the costs of trading reduce your return -- do not churn your account by routine buying and selling.
Posted by David Cohen at May 1, 2004 9:46 AMAnd, most important, DON'T BUY ON MARGIN DURING A BUBBLE.
Posted by: Dr. Cohen at May 1, 2004 9:52 AMIt's also why privatized Social Security accounts won't have many options.
Posted by: oj at May 1, 2004 10:01 AM... no one can beat the market over time ..
The ol' efficient market hypothesis. It isn't quite true, as Warren Buffett and Peter Lynch and a few others have proven, but a good enough rule of thumb for the rest of us.
Posted by: Bruce Cleaver at May 1, 2004 10:27 AMMoney in mutual funds is managed by professionals, not individual investors. So the underperformance cited in the article is really underperformance by professionals. The conclusion that "practically all individual investors are below average" may be true but it certainly doesn't follow from the evidence adduced.
Posted by: Jed Roberts at May 1, 2004 12:23 PMThe efficient market hypothesis, more strictly, says that you can only beat the market if you know something that everybody else doesn't. For people that are very well intelligent, well connected, and spent an inordinate amount of time finding out about things, it's possible to beat the market. (A few lucky guesses never hurts either.)
However, for the average person, this isn't the case. Nor for the average mutual fund manager, either.
Posted by: John Thacker at May 1, 2004 1:19 PMDON'T BUY ON MARGEN EVER.
I have a little on margin but only to cover possible overdraft on an associated money market (bank) account.
Posted by: Uncle Bill at May 1, 2004 3:41 PMJed:
Not necessarily. Probably what's happening is individual investors are switching funds at the wrong time, and buying into the funds with the best performance over the last two/three years (which are overheated & overvalued...)
Posted by: mike earl at May 1, 2004 4:52 PMIndex funds are flaccid for the most part - buy about 8 or 10 good stocks and sit tight. Sell when people start writing about Maria Bartiromo's sweaters and buy when Congress holds hearings on corporate governance.
Posted by: jim hamlen at May 1, 2004 6:06 PMDavid:
Your last para has worked very well for me.
It is a shame I couldn't do the same with all the money I have given away to Social Security. And, in 16 years, when push comes to 65, probably won't get back in any form.
Because the advice in your last para works so well.
Once again, government policy punishes virtue.
Posted by: Jeff Guinn at May 2, 2004 8:00 AM