Our Notions on Investing – Getting a Little Banged Up?

Originally posted September 2010

Graham Browley writes in his August 21, 2010 article for the New York Times
(In Striking Shift, Small Investors Flee Stock Market) that  “The notion that stocks tend to be safe and profitable investments over time seems to have been dented in much the same way that a decline in home values and in job stability the last few years has altered Americans’ sense of financial security.” 

This recession has been unusually deep, with unemployment remaining stubbornly high as companies lay off workers and jobs move overseas to cheaper labor markets.  It’s not your “grandmother’s recession” (of the 1960s) or even your “mother’s recession” (of the 1980’s) for that matter.   In this one, the marked difference is that, from the late 1980s on, more and more Americans became investors in the stock market through their 401(k) plans.  As 401(k) plans took hold in the ‘80s and companies found that the balance sheet liability associated with pension plans was a drag on growth, a new standard practice took hold – the conversion to 401(k) retirement plans that shifted the investment risk to the employee, and away from the company.  

As 401(k) participation grew, along with account balances, corporate America and the investment firms managing 401(k) accounts were eager to advance participants’ knowledge around investing (in part due to regulation), anchoring their messages in conventional wisdom and always with the caveat that “Past performance is no guarantee of future results.”  Until 2008, investors could easily see that the stock market offered greater returns over time than say bonds and certainly greater long-term returns than money market or other cash funds.  But that return on investment came with a risk. And for the nearly 50 million Americans in 401(k) plans, that risk is borne solely – and not always comfortably – by them.

No question, when viewed over the very long term, the stock market outpaces inflation. But even Fidelity’s Q1 2010 Market Update  features  a chart optimistically titled “Stocks Followed Historical Pattern of Rebounding After Worst Decades” (page 48), showing that any investor in the S&P 500 prior to early 2008 lost all accumulated return (and even some principal).  For many individuals whose retirement savings were invested in the S&P 500, the prospect of a comfortable retirement has been delayed.

If this were still the 1960s or even the 1970s or even the early 1980s, things might be different.   As Grahalls’ Robert Cirkiel reminds us: Pension plans were once an attrition device. Retirement for aging employees was encouraged through these company funded pension benefits, making way for younger workers to move in or up the corporation.   Lack of employer-paid pensions and stock market losses in  401(k) plans have resulted in a “graying” of America’s workforce.  Robert says, "Combining voluntary contributions with lack of investment expertise and timing risk results in the situation we have today, where 401k account balances are very low, and aging employees can’t retire simply because there is not enough money."
 
For 401(k) participants, even after years of “investment education”, the problem persists that many still use an inverse logic of “buying high and selling low”. When the market goes down, investors transfer balances out of the stock market into cash funds, thereby “securing” their losses. The lessons of history never fully overcame the dictates of human nature.  Nor are they likely to now.
 
“The average 401(k) account balance as of the end of the second quarter [2010] was $61,800” according to an August 30, 2010 press release from Fidelity (Fidelity’s 401(K) Data Show Steady Savings Pattern By Majority, But Loans and Hardship Withdrawals on The Rise).  And guess what, that $61,000 is taxable when withdrawn from the plan.

$61,000 might sound like a lot of money, until you try to live on it for 20 years.

Here’s another skeptical view: Investing by the masses is simply the balancing force (for every action there is an equal and corresponding reaction).  Theoretically, there is a “transfer wealth from the elite to the masses through tax policies” and we can see that there has been a “transfer of wealth from the masses back to the elite” via Wall Street that was driven, in part, by a “following the herd” mentality on the part of small investors. . History consistently shows us the best way to make money is to be a contrarian.

But then, we’re still learning today that history is no guarantee of future results.