Monday, July 18, 2011
Wednesday, November 17, 2010
Friday, April 23, 2010
Your most important investment decision is whether to pursue an active or passive investment approach:
With active investing your odds of succeeding range from 0 to 10%. With passive investing, your odds of winning are about 90% after taxes.
So which is right for you?
You can think of active investing as the classic "Buy Low and Sell High" investing strategy. It sounds right until we realize that we are buying and selling from other people who also think they are making a smart decision. And normally these other people -- the ones we are buying and selling from -- are very smart, capable and hard working. We've entered what economists call a zero sum game. In order for one party to win, the other must lose. Then it gets harder. It's not just a matter of half the players winning and the other half losing. Because buying and selling costs both money and taxes, many more people lose than win. After considering transaction costs, about 30% of the players win. After taking out taxes as well, the number of winners falls to 5% - 10%. The rub, however, is that if you do win with active management, you will make more money.
Passive investing is typically a "Buy and Hold" investment approach. It emphasizes diversification and keeping your investments for the long term -- usually decades. The beauty of this approach is that you don't need a sucker at the other end of the trade. Everyone who invests this way can win because as the stock market grows along with company earnings, everyone's investments go up. Because you are not buying and selling, your costs and taxes remain very low.
No one can tell you which approach to take. The answer depends on your appetite for gambling and whether you believe that the 5-10% who win are there by luck or skill.
Said another way: With a $1 million investment, would you prefer a 10% chance of making $120,000 or a 90% chance of making $100,000?
Monday, November 23, 2009
The brokerage firms see this as the opportunity of the year. As Fidelity excitingly promotes "With more than $1 trillion in IRAs ... advisers who get to their clients and prospects first ... will gain competitive advantage." The same thing is happening at all the big brokers ... the Roth is being actively promoted as a "no-brainer" for anyone with money to pay the tax now. Its highly likely that in the next few months some-one will try get you to convert your IRA to a Roth.
Simply put a Roth conversion allows you to pay all the tax on an IRA now and then withdraw the funds tax free in retirement.
The argument is that taxes will inevitably rise and so paying them now is just smart. While there are some cases where conversion makes sense, they are relatively rare among people with high current marginal tax rates.
The reason is that your high marginal rate - say 35% federal- is a function of you working and earning several hundred thousand dollars per year. In retirement you stop earning money - and your tax bracket plummets. If you retire with no more than $5 million in investments including IRA's - your federal marginal tax rate probably won't be much more than 15%. Rates would need to go up dramatically before conversion makes sense.
It is possible that you are a good Roth conversion candidate but its not a "no-brainer". Before converting make sure your adviser gives a detailed projection of your taxes in retirement and compare the rates to what you are paying now.
Friday, September 18, 2009
I remember leaving an hour meeting last September and nervously checking the markets: The S&P500 had sunk over 10% during that hour. That's the way it was then. It looked and felt like the end of the world was arriving. Do you remember the forecasts back then - the Dow was going to drop below 3,000 and we were inevitably sliding into another great depression. Six months later the markets would hit bottom amid more talk of doom and gloom. (they've since risen about 35%)
For a while the pundits and forecasters seemed humbled. Virtually no-one had forecast the collapse and the few who had, had been calling for the end for so long, that they just came across as perennial pessimists rather than prescient thinkers. However times have changed. The pundits and forecasters are out again in full force making random and ever changing predictions about our financial future.
The best thing you can do is ignore them.
As Ben Stein explained in a funny article back in March, forecasters and pundits are entertainers - some very good at it - but still entertainers. In terms of making financial decisions, at best they are of no help, and at worst they are truly harmful.
Responsible financial decisions are based on sound, long term principles, not short term guesses.
Friday, June 19, 2009
While the 200 year flood is a very comforting metaphor, it's also dangerous, harmful and inaccurate.
The reality is that the recent bear market is one of 5 that saw stocks drop around 50% or more in the last 80 years:
Bear market (how much stocks lost)
1929 - 1932 (89%)
On average we have had one of these event every 15-20 years! Hardly a 200 years flood. In fact the last one ended in 2002 - a mere 7 years ago.
So what does this mean for investors?
It means that a critical part of investing is planning for and learning to live with floods: have realistic expectations, at least 3 years of living expenses in cash or AAA short term bonds, and a clear plan for riding out the next storm.
The stock market is still a great investment.
Even with all the corrections and bear markets, it normally delivers returns of about 10% per year. This is great - it means your money would double every 7 years or so! The key is investing with your eyes open and not taking risks you can't afford.
Wednesday, April 8, 2009
So, is it safer to buy after the market has gone up for a month? Actually, yes – at least a little bit. When the stock market is up over a month, there is about a 63% chance it will be up the next month. This compares to only a 58% chance of making money after a down month.
Does this mean you should back up the truck now that the market is up over 30 days and then dump it all after the next down month? After all, a 63% chance of success is better than a 58% chance of success.
Probably not a good idea. Even ignoring how taxes and expenses would eat up the 5% probability difference, you are still almost as likely to lose money as make money. However you look at it, investing on a month- to-month or even year-to-year basis is very risky. There is no way around the reality that you have a very strong chance of losing a lot of money.
Over a 20 year period, however, the stock market becomes a lot safer. If you commit your money for the whole 20 years, you have a better than 95% chance of making money – and that’s a conservative estimate. Including the great depression, there has never been a 20 year period where stocks have actually lost money.
In the end, safety in the stock market comes not from when you buy or sell, but from how long you stay invested.