I get requests from local friends fairly regularly for aid in understanding their finances. While coming home from church recently, I mentioned to my wife that many were seeking my opinion in our congregation. Her response was, “So what else is new?” Then I began to list it, family by family, and the congregations that were seeking my opinion for their building/endowment funds, and/or borrowing needs. As I went down the list, my wife’s responses were “Not them!”, and “Them too?!” and “No!”
What can I say? My wife is the best wife I have ever heard of, but even married to me, economics is a distant topic. Her father was well-off, but humble, and I am well-off, and I try to be humble. You can be the judge there.
I say to my friends asking advice, “Remember, I am your friend. I will take no money, but I won’t hold your hand and guide you either. I will give you very basic advice, and it is up to you to learn and implement it.” I don’t want to be a financial planner, but I don’t want to leave friends in a lurch.
With that, the scenarios:
1) 90-year old widow, who lives with her daughter and son-in-law. Another son-in-law, given to incaution, is advising putting everything into gold and silver. What to do?
She has adequate assets to support her through the rest of her life. Her husband was responsible. I asked her if she needed more income, and she said no. I told her, then relax, ignore the other son-in-law (I know him to a degree), but if you want to, invest 3-5% in precious metals. She didn’t see the need, and I told her that was fine. She asked me what I would do in her shoes, and I said that it was a very difficult environment to be investing in, and that we could not tell what the government might do in a crisis, so the best thing to do was to stay diversified, and invested in companies which would have continued demand. But if you don’t need the money, don’t take the risk now.
2) 80-year old widow, assets in even better shape. Her husband was a great guy; an inspiration to me in many ways. He was a mutual fund collector, and left her a basket of 30+ funds, as well as two homes free and clear. What to do? I suggested that she harvest funds that had been doing particularly well and reinvest in funds that had lagged. I suggested purging certain funds that were likely mismanaged. I also suggested liquidating one property if she could get an acceptable bid.
3) 50-year old bachelor, never married. Funds are from TIAA-CREF. We decided on a 50-50 stock-bond mix three years ago. Recently we rebalanced to add more equities. He was disappointed that his portfolio had moved backward. I said “Welcome to the club.”
I will continue with more in part two, but 2008 blew apart many people’s expectations over what their assets could deliver. My stylized view of it stems from comments that I got at church. In 1999, my friends were people into equities, as I was holding back. In 2002, many said they were exiting equities, and moving to what they understood, residential real estate. I was adding fresh cash to my positions, and paying off my mortgage. By 2006-2007, they began getting interested in stocks again. By 2009, both stocks and residential real estate was tarnished, leaving bonds remaining.
Closing then, with three final notes:
a) The low interest rate policy is definitely hurting seniors, and I believe all investors. We all become worse capital allocators when there is no safe place to put excess funds. It tempts people to stupid decisions. If Bernanke wants to do us a favor, let him resign, and put John Taylor or Raghuram Rajan in his place. Tempting people to dumb investment decisions hurts the economy in the long run, it does not help us.
It may help the banks have a risk-free arb on short government bonds, but that’s not what we should want either. If they are sound, they should be lending. Raise short rates, and let the banks have a harder time, and give investors a place to put money while they look for better opportunities.
b) Average people, and sadly, many professionals, are hopeless trend-followers. They have no sense of looking through the windshield, rather they ask what has worked, and do that. Mimicry can be a help in much of life, e.g., finding where to buy good furniture cheaply, but is harmful with investing where figuratively the devil takes the hindmost.
c) People get caught on eras, and have a hard time letting go of them. The 70s biased many against inflation, and toward residential real estate. The residential real estate lesson got reinforced in the ’00s. The equity markets seemed magical from 1975 to 2007, and asset allocators increased their allocations to equities in response. Now you hear of “bonds only” asset allocations, just as the amount of juice available in most of the bond market is limited.
People got used to refinancing their mortgage every few years, and enjoying the extra cash flow. The modern era reveals the hidden assumptions on that: that property values would never fall.
The point: markets aren’t magic. They can only deliver what the real economy does. Stocks only do well over the long run if profits do well. Valuations come and go. Bonds make money off the stated interest (coupon) rate less default losses. Valuations come and go. Real estate is worth the stream of services that the land and improvements can deliver. Valuations come and go.
Now, you can play the “come and go” if you are smart, but with the “come and go,” for every winner there is a loser. But asset allocators need to be more humble in their assumptions for financial planning and not assume that they can earn more than 2% over the 10-year Treasury, or over expected growth in nominal GDP. The share of income that goes to profits and interest also tends to mean-revert over time, so humility is needed when:
- Illustrating an investment plan for a family
- Setting the discount rate for a defined benefit pension plan
- Setting the spending rate on an endowment
- or even, setting assumptions for the Social Security trust funds.