Disclaimer: This post is not investment advice. Past performance is not indicative of future performance, blah, blah, blah…
The Stock Market is for suckers…. – Blog Maverick A year ago on January 3rd, one of my favorite bloggers, Mark Cuban, wrote a post called “The Stock Market is for Suckers…” in response to a comment that I had made on his blog.
Here’s a bit from the post below:
“I wanted to respond to Tom Hawk’s comments. Someone I respect a lot, but who I disagree vehemently on this topic,” wrote Mark. “Wall Street has done an AMAZING job of creating conventional wisdom . “Buy and Hold ” is the 2nd most misleading marketing slogan ever, after the brilliant “rinse and repeat” message on every shampoo bottle. We as a country have fallen for it. Every message from every marketer of stocks tell us. Young or old, if you can hold for the long term, things will work out for you.
That is total bullshit. Its for suckers.”
I rarely venture off into the area of personal investing, it’s what I do for a living and my blog has always been a place for me to get away from this part of my life.
Hindsight of course is always 20/20, but I wanted to take a brief moment to revisit the last year in the equity markets and talk about my own personal views on how one ought to think about personal investing.
The reason for my original comments were that I worried that Mark Cuban was giving people bad advice when suggesting that they keep their money in cash investments vs. the equity markets.
Cuban rattled off a lot of good objections as to why he didn’t like the market (many of which had to do with how it’s marketed and less with the core underlying investment value of it’s components which are easily bought today through low cost mutual funds and ETFs). His first objection though is one that I see time and time again and that is that the old argument for the emergency reserve.
In response to my objection that hoarding cash for a rainy day is a tremendously inefficient strategy, Cuban wrote:
“Tom I stand by what I said. You can have as long a term horizon as you want, but like most other long term plans we have, most peoples lives dont match up to their “horizons”. Its amazing how life intervenes. Kids, whatever. its a fortunate few that can just shell it away and never touch it. Your “horizon” hits a dead end when you have to put money into a checking account. I have never seen any investing research that deals with random withdrawls that represents real world. And boy oh boy, if life hits you hard when the market is down, you make a withdrawl and you wont ever catch up.”
So here we are a year later (and much too short a time horizon to matter by the way) and where would you be if you took $100,000 and followed Mark Cuban’s advice vs. mine.
For comparison purposes I’m going to assume that two investors both had $100,000 to invest on January 3, 2005. Had you followed Cuban’s advice (and I’m using the Vanguard Prime Money Market Fund) you would have today approximately $104,882.60.
Had you taken that same $100,000 and put it into the Vanguard Total Stock Market Index (a low cost basket of stocks that tries to roughly equate to the U.S. Market) today you would have approximately $113,890.00.
Now ask yourself this question. Did you have a real life emergency situation last year that required you to cash out?
That’s what I thought.
Oh, wait, you did? Whew! The market was up and you still likely came out ahead.
But what if the market had been down? Well, do you own a home (home equity), are your securities marginable (the Vanguard Total Stock Market index is) for a short term loan until you got back on your feet?
Bottom line is that in general the market has been up more years than down. But in the event of a down year there are other places to get cash for most investors. Now let’s say the market was down and you had no other place to go and had to sell your stocks in a down market. Well, at least the first $3,000 that you lost is deductible against ordinary income taxes.
So last year following Cuban’s advice could have cost you about $9,000 on your $100,000 retirement nest egg. But is that all it would have cost you? Do you know what $9,000 would be worth in 25 years compounded at 8.42% (the return of the S&P; 500 over the past 10 years which includes the most brutal 3 year in a row market correction of most of our lifetime)? $9,000 compounded at 8.42% over 25 years turns it into $67,916.86.
But the point is that it’s only been a year since Cuban said stocks were for suckers. He still may be right, so we will check in with this post once a year to see how things go along in the longer term.
So, where are we at today? Today the Price to Earnings ratio on the Standard and Poor’s 500 trades at 17.76 times last years earnings and 16.14 times next years projected earnings (Google, by the way sits at 56 times last year’s earnings).
Historically, if we go back the last 20 years, the high on the P/E ratio of the S&P; 500 was around March of 2002 when it traded at about 62 times earnings. The low was in December of 1988 (a good time to invest) when it was trading around 11.59 times earnings. The average for the past 20 years is about 22.67 times earnings. The real time to have backed up the truck of course was in December of 1974 though, when the P/E ratio of the S&P; 500 hit a low of 6. (And that’s exactly how Warren Buffett made his fortune, by the way, backing up the truck on low P/E stocks in the mid 70s).
So at least in relative terms to where we have been in the immediate past (and if you believe in a reverting to the mean type philosophy) the market still feels attractively priced.
I don’t know if Mark Cuban still feels that stocks are for suckers or not. Hopefully we’ll hear from him on this. Despite my disagreement with Mark over investment strategy it’s worth noting that he’s a billionaire and I’m not. He also is a strong proponent of HDTV, something I also think holds a lot of promise for the future.
Oh and one more thing. That $104,882 that you would have grown your money to in that money market fund? Well had the investment been in a taxable account $4,882 of that would have been subject to ordinary income tax. Assuming a 28% Federal rate you would have been left with $103,515.04. Yep, you had to pay $1,366.96 in taxes.
Your $113,890 that you held in the Vanguard Total Stock Market index also would have been taxed, but only the dividends. Most of your growth would have been the result of an unrealized long term capital gain. Dividends of course are taxed more favorably than money market interest (15% at present) so you would have paid about $270 in taxes leaving you with $113,620.
So here’s a little free very general advice (not investment advice, remember)
1. Your first home is the best investment you can make. Do everything you can to buy instead of rent your primary residence.
2. Put the maximum amount of money that you can into your company’s 401(k) each year (use the Roth 401k if your company offers it and you can afford it). Don’t invest in your company’s stock in your 401(k).
3. Try not to buy expensive things that depreciate (eg. cars, clothes, horses, vacations).
4. Never put more than 4% of your money into any non diversified investment unless it’s your primary residence.
5. Fees matter perhaps more than about anything else. Keep them to a mini
mum.
6. Individual stock selection is largely irrelevant. Asset allocation and holding a diversified basked of securities that approximates various market weightings will be far more responsible for your returns.
7. In a taxable account each year sell any security that declines in value by 10% or more irrespective of your investment outlook for the company. Take the proceeds and put it into another company in the same sector.
8. Don’t sell a stock with a capital gain in your taxable account unless it becomes more than 4% of your total liquid net worth. Then just keep trimming it to keep it at 4%.
9. Once you own your own home and have maxed out your company’s retirement plan, use your remaining money, if you have at least 10 years until retirement, to purchase either low cost index funds and ETFs or to build a portfolio of stocks which approximate market sector weightings.
10. Don’t day trade your account.
11. Don’t sell your stocks when things seem like they are at their worst. (The best time to invest in the past 5 years was right when we invaded Iraq and everyone was dumping stocks and pundits were saying the sky was falling).
12. Ignore the noise (CNBC, stock pundits, Cramer, Yahoo Finance, stock message boards, your neighbor Eddie down at the dog park, etc.)
13. Sometimes the best thing to do is to do nothing.
14. Sometimes the worst thing to do is to do nothing.
15. The “experts” don’t know much more than you do.
16. Avoid things that are “sold” to you.
17. If you want to save for your kid’s college education, use the lowest cost equity 529 plan you can find. If your state offers tax benefits for using their 529 plan, consider using their plan.
18. Don’t take out personal loans against your 401(k) (the interest is taxed twice) unless your are using it to buy your first home.
Ok, now that’s all from me on investing for the next year.
Happy New Year.
Update: Mark Cuban responds over at my Seeking Alpha post:
“Thanks for making me look smart Thomas. You make my point exactly.
The Market is for suckers. It takes a sucker to think the market will repeat any of its past performances.
It takes a sucker to think that out of thousands of choices, they are going to pick the exact right product, whether ETF, mutual fund, whatever. It takes a sucker to think that life wont interfere just when they least want it to and that borrowing against a fund or portfolio is the best way to do deal with an intrusion.
It takes a sucker to think that whoever is selling whatever to them has their best interests at heart.
Compare that to the 5.50pct CD rates you can get for your 100k these days.
what do you give up. No question , you give up some potential upside. Risk carries the potential for more gain. For all the risk and the swings and the ups and downs of 2006, in Thomas’s world, all the risk is worth it.
In my world, you sleep like a baby every night. You know exactly what you will earn. You are in a low inflation environment where you can get ahead.
In Thomas’ world. You now must decide whether to stay in or not. Is 2007 a year when the market goes up again, or will it go down , putting you in the hole ? Or should you just take profits and pay taxes ?
Sure your money could earn more. Or you could buy a CD, earn more than inflation and not worry about what those who follow Thomas’ advice worry every time they go to bed: Will they go to work and get a call from their broker saying “I have bad news”,or worse yet, will they check the asset value of the stock/fund/whatever at lunch and see something gone wrong, and get that feeling in their stomach where their world is about to turn upside down. At which point they call their broker or the fund and get a mouthful about how over 20 years…..Which of course doesnt help you pay for the kids school next year.
The market lives for amateurs. Funds advertise to try to get your money and they thrive on your lack of knowledge.
When there is a year when rates stop going up and there are a lack of options, the markets look good.
You know what they call someone who thinks that in the last 6 months of 2006 DJIA stocks got intrinsically more valuable… a sucker.”
Fair enough Mark, we’ll come back here January 3, 2008 for an update.
Don’t forget that Cuban didn’t become a billionaire because of any sort of good investment ideas. His fortune is as far from planned to the normal person as getting struck by lightning in your basement.
That’s some very good advice in there! Thanks for all that typing 🙂
Double taxation on a 401K loan is not a problem. You always pay taxes on the money you use to pay off all types of loans. You pay taxes on all of the money in your 401K when you withdraw. The fact that the two happen at the same time leads to people suggesting that it means you pay more taxes.
The fact that a few dollars are taxed twice doesn’t mean you pay more taxes than if you took a bank loan. Do the math.
Opportunity cost is the reason to not take a 401K loan. Not the myth of double taxation
If you had that hypothetical $100k and wanted to start investing tomorrow, how would you use it and thru what brokerage / investment house?
While I’m playing with a different starting number, I’m actually in this exact scenario and getting bogged down researching the endless list of options. Etrade or someplace I can walk in and meet with someone? What kind of funds? How much of each fund? AHHHHHHHHHHH! Need a swift kick of practical advice to get the money invested ASAP instead of continuing to sit on the sidelines.
Steve, it’s difficult to say without knowing your situation exactly or the amount of money specifically. But I’d consider a low cost equity based ETF or index fund or a diversified basket of stocks that approximate the same thing. The Vanguard Total Stock Market Index might be something worth exploring.
just as an FYI, i won multiple stock picking contests in the 90s, and my stock trading record was used to start a hedge fund in the mid 90s that we then sold to a larger hedge fund.
Before we started audionet, which turned into broadcast.com, i was retired and living very comfortably. Thank you very much.
i also started http://www.sharesleuth.com .
I still trade stocks, but far from actively. the stocks i own are typically stocks that are strategic to my businesses.
Mark, certainly you make some good points. But one thing to keep in mind is that there are very easy, well known and efficient ways to buy the market these days. Low cost index funds and ETFs cut out some of the noise.
Do keep this in mind though. If I’m sitting on 113,000 from my original hundred I’m probably sleeping very well right now. Even if my my 113,000 at this point drops to 107,000 I’m still probably sleeping well (I made 7% right?). But irrespective, we’ll revisit this matter and continue our hypothetical on January 3, next year. Cheers, Happy New Year and thanks for taking our difference of investment opinion well and in the way that the blogosphere should work as a forum of ideas.
Thomas,
I love reading your photo blog entries, but this discussion of finance leaves me with some new questions.
Do you mind offering one more opinion? YMMV etc…, not professional advice, just trying to get an opinion from a somewhat objective party.
I’m fortunate enough to have recently sold shares in a company I cofounded – however I am an engineer not a businessman). After taxes this left me with about $4.5M. For the last couple of years I’ve been having this money ‘professionally’ managed because I had little time to think about finances what with work and family life.
Your comment about fees being evil rings true to me. Does ‘just moving my money into low fee’ index funds make sense even for someone in my situation? My money manger firm talks in terms of managing volatility and harvesting capital gains, but do they really add that much value?
Previously I was happy with keeping my various index funds at Schwab happily working away. When I was faced with this windfall I didn’t trust myself to just select a broad set of funds and let the money ride.
I know you are not giving official advice – and I’ll certainly do more reading and talk with someone I’m paying before making a big move, but I’d love to read your totally non guaranteed thoughts.
Anonymous,
There is some wisdom and truth to the harvesting of gains. It’s actually harvesting of losses and it works something like this.
When you buy an index fund, lets use the S&P; 500 for example, you are buying an unmanaged basket of 500 companies. Let’s say that, like last year, the S&P; 500 provides you a positive return for the year. Obviously all 500 stocks in the S&P; 500 were not winners. Index returns are a result of averages, so if 400 of the stocks in the index were up and 100 were down you probably had a positive overall index return. But, when you buy an index that’s what you get and you end up with an unrealized capital gain and no losses.
Losses are good to harvest for a few reasons. The first is that you can deduct $3,000 per year of losses against ordinary income. What you have in excess of $3,000 you can carry forward indefinitely taking an additional $3,000 deduction every year as long as the loss carryforward remains.
Eventually though it is likely that you will realize a gain. This could take the form of a sale of real estate, or trimming a concentrated stock position that has grown over4%, actually changing your asset allocation as you get older. Other times you may own a stock that gets bought out for cash and not have a choice but to recognize your gain.
The point is that more than likely at some point in the future you can use losses harvested to avoid paying capital gains taxes.
You can’t do this with an index fund, you can do it with a stock portfolio though that approximates an index fund.
This is actually not that difficult to build. If you were to take the money you are committing to stocks and even buy random companies matching your sector and market cap weightings (random sampling works here) to an index fund (you could even look at an index funds holdings by percent and buy roughly the exact same stocks) and then each year sell the stocks that were down more than 10% while always letting your winners run you’d do pretty well at tax loss harvesting yourself.
Since as time goes on, theoretically, more stocks would be up than down, each year you’d have a smaller and smaller group of losers to trim.
With 4.5 million this is a superior strategy to buying an index fund outright. Why? Well you can harvest the losses but also with that much money you have enough money to properly diversify into say even 150 stocks — and if you did it right you could very well approximate an index.
The key would be to keep commissions low on your stock transactions by using a discount broker. Schwab would probably be fine via the internet.
Even at .20% (20 basis points) on an index fund, on $4 million investment that’s still $8,000 every year.
Assuming you were paying 1% for this management of $4 million that would be $40,000 per year.
Building a basket of stocks that approximate an index and tax loss harvesting is not that difficult. Once set up it’s mostly on auto pilot.
Any adviser that you are paying is unlikely to give you this advice. They will likely have lots and lots of reasons why this is a bad idea. It is not likely in their financial interest.
Brian. Let’s say you take a loan of $50,000 against your 401k at a rate of 6%. The $50,000 that you take out has never been taxed. As you pay the $50,000 back over time you pay interest on this loan. The interest 6% in this case is done with after tax dollars. Dollars that you’ve already recognized and paid taxes on. A $50,000 loan at 6% would mean roughly putting $3,000 of after tax dollars back into your 401k. Laster on when you pull these dollars back out you will pay tax on them a second time.
It’s best to avoid loans of any type against a 401k unless it is for something that will yield very substantial benefits for you. The only reason I think that generally works here is for the purchase of one’s primary home.
Thomas – thank you so much for your comments on index funds vs. harvesting losses. I’ll think carefully on what you’ve said and do a bit more research.
I’m 24 and just stepping into the world… what if the housing market starts sliding? Is a home still investment #1 if it’s lived in during a housing glut? Or is there something I’m not seeing here?
This site gives a clear information.and here i am linking you relevant site for more details.
lost cash, find cash