When I started putting money into a 401K plan, the conventional formula assumed that a conservative investment mix would deliver about 8% per year.
Ha!
This was back when real estate values were expected to never retreat, the stock market was presumed an almost sure bet, and bonds were suggested as a kind of seasoning to the recipe, basically a head-nod to the faint possibility of risk, a demonstration of being a responsible investor rather than a speculator pinning one's star to the flighty fancies of the stock market.
According to US News, the average 401K account balance is now back to about where it was in 2007, before the latest financial unpleasantness. That's about $70,000, up about $20 K from the low in 2008. Of course, only a few people had the foresight to bet against the housing bubble and subprime mortgage gold rush. The breadth and depth of the bailouts required to keep the world's economy afloat are pretty strong evidence that most investors failed to see the end coming.
Efficient market theories assume that the price of an asset always reflects the perfect balance of valuations by informed investors acting out of rational self interest. Market behaviorists have recently shown that most investors don't qualify as perfectly rational or informed, and this is certainly even more true among the amateurs who make up the bulk of 401K owners. Since most actively managed funds fail to beat the market, even the experts get it wrong more often than right.
Recently, Steve Levitt and Thomas Miles at the University of Chicago demonstrated that poker is a game of skill rather than strictly one of chance. They showed that high performing poker players continue to perform well from year to year, while mutual fund managers' successes and failures are random.
It's ironic that online poker is outlawed in the US because it's considered to be gambling, while investments in mutual funds are a mandatory part of retirement planning.
Showing posts with label finance. Show all posts
Showing posts with label finance. Show all posts
Monday, May 30, 2011
Sunday, December 7, 2008
Financial Innovation
In a recent Business Week article ("Get Credit Flowing, Heal Housing", November 17), the CEO of Ernst & Young is quoted as saying, "It would be a mistake to regulate so strongly as to stifle innovation." It's easy to reflexively agree with this statement if you don't think about it too much. But let's think about it for a minute.
Recent financial innovations have included junk bonds, derivatives, no-doc loans, interest-only loans, mortgage-backed securities, and credit default swaps. Recent prominent financial innovators have included Michael Milken, Enron, and Long Term Capital Management. Financial innovation seems dedicated to finding new ways to privatize profits and socialize losses, and innovations spread and generate profits until they cause a crisis, require a government bailout, and become regulated. Perhaps the field of Finance is mature enough now that innovation is more likely to cause harm than good.
Recent financial innovations have included junk bonds, derivatives, no-doc loans, interest-only loans, mortgage-backed securities, and credit default swaps. Recent prominent financial innovators have included Michael Milken, Enron, and Long Term Capital Management. Financial innovation seems dedicated to finding new ways to privatize profits and socialize losses, and innovations spread and generate profits until they cause a crisis, require a government bailout, and become regulated. Perhaps the field of Finance is mature enough now that innovation is more likely to cause harm than good.
Sunday, April 20, 2008
Buried Lede
From Business Week, April 7, 2008, "China's Factory Blues", by Dexter Roberts (pp. 78 - 82):
"'Unlike in the last 20 years, when China exported deflation, from now on, China will export inflation,' says Peter Lau, CEO of Hong Kong retailer Giordano International, which has extensive operations in China. (p. 82).
The article describes how Chinese producers have hit the cost floor: the rising yuan, cancellation of preferential policies for exporters, and increased labor and environmental regulations are raising the cost of production in China. This is probably a good policy for China because it squeezes out the lowest cost producers who pay the lowest wages and contribute disproportionately to pollution. However, it's potentially bad new for us because low cost imports have kept inflation in check even as the economy expands. Now, with the economy contracting, the closing of this inflationary safety valve means that the Fed has less flexibility to stimulate the economy. Until now, the Fed has thrown considerable weight behind economic stimulus policies with a rapid series of large rate cuts. Now, that approach is much more likely to cause inflation.
"'Unlike in the last 20 years, when China exported deflation, from now on, China will export inflation,' says Peter Lau, CEO of Hong Kong retailer Giordano International, which has extensive operations in China. (p. 82).
The article describes how Chinese producers have hit the cost floor: the rising yuan, cancellation of preferential policies for exporters, and increased labor and environmental regulations are raising the cost of production in China. This is probably a good policy for China because it squeezes out the lowest cost producers who pay the lowest wages and contribute disproportionately to pollution. However, it's potentially bad new for us because low cost imports have kept inflation in check even as the economy expands. Now, with the economy contracting, the closing of this inflationary safety valve means that the Fed has less flexibility to stimulate the economy. Until now, the Fed has thrown considerable weight behind economic stimulus policies with a rapid series of large rate cuts. Now, that approach is much more likely to cause inflation.
Buried Lede
From Fortune, March 17, 2008, "The Man Who Must Keep Goldman Growing", by Bethany McLean (pp. 131 - 140):
"Goldman spotted the problem early because it is fanatical about pricing its holdings at their current market value - even at times forcing traders to sell part of a position to establish a price." (pg. 140)
Goldman Sachs was the only one of the major independent investment banking firms to make money from the subprime meltdown. The other banks have posted billions of dollars in losses because their subprime holdings have lost so much value. No one knows how much, because the banks can't sell them, so banks like Citi keep taking writedowns, hoping to find the true value of their assets at some point. The exception, apparently, was Goldman, apparently because they sold small amounts of assets periodically, even as they were rising in value, in order to determine what their real market values were. This allowed them to detect falling confidence in the assets before the other banks did.
"Goldman spotted the problem early because it is fanatical about pricing its holdings at their current market value - even at times forcing traders to sell part of a position to establish a price." (pg. 140)
Goldman Sachs was the only one of the major independent investment banking firms to make money from the subprime meltdown. The other banks have posted billions of dollars in losses because their subprime holdings have lost so much value. No one knows how much, because the banks can't sell them, so banks like Citi keep taking writedowns, hoping to find the true value of their assets at some point. The exception, apparently, was Goldman, apparently because they sold small amounts of assets periodically, even as they were rising in value, in order to determine what their real market values were. This allowed them to detect falling confidence in the assets before the other banks did.
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