I don't want to be the greater fool...
Discover more from Philip Palios
I recently took an interest in learning about the stock market. After about three months of research, I’ve concluded I want nothing to do with it. I realize this is counter to conventional wisdom (at least as it stands in middle-class America), so I thought I would share what I’ve learned that led me to this unconventional conclusion. At the end of the day, I don’t think I’m ‘right’ and people in the stock market are ‘wrong,’ but I do think it’s worth more careful consideration than some people give it.
The fee game
One of the first things I learned as I began my research was that fees can be deceptive and troublesome. It’s easy to want the theoretical (and historical) returns on investment of the market without having to do any of the work or know what is going on. The idea being that if you throw your money into this magical machine, even more will come out. All the warnings about risk be damned. And of course, there are plenty of brokers and fintech startups eagerly offering this promise, with disclaimers about risk and performance hidden in the fine print. But these folks that claim to make it easy want a slice of your pie in exchange for their services. How much? Oftentimes between 0.25 and 1.5 percent of your total investment. That doesn’t sound like much at first, small change when you’re expecting 10 percent gains. It will wash off with the tax-loss harvesting alone they tell you (hoping you don’t know nor ask about the detailed mechanics and risk of tax-loss harvesting).
But take a second and think about what you’re actually getting for that fee and how choosing to pay that fee means you will always under-perform the market. I will not go into the details here, but if this is nonsense to you, I suggest reading books like A Random Walk Down Wall Street, The Only Investment Guide You’ll Ever Need, The Little Book of Common Sense Investing or The Intelligent Investor. Basically, you’re paying a lot of money for someone to calm your nerves, put you in a diverse collection of funds managed by their company and re-balance your portfolio once or twice a year. The funds themselves tend to have fees of 0.02 to 0.09 percent, a much more reasonable amount of your money to exchange for their ability to manage a passive index-matching fund. Re-balancing is not rocket science and could easily be done yourself within a few hours once or twice a year.
At this point, one might conclude I am suggesting investing in index funds and managing your investments yourself - this is the conclusion of the books I just recommended, after all. No, that’s not my take on things - but if I was going to invest, I would certainly not be paying 1 or even 0.25 percent in management fees that are basically pure profit to the brokers.
The big picture
Most financial discussions tend to be about when and how to invest, not whether it’s a good idea or not. Assuming you have money to invest, it’s hard to find anyone who would tell you not to. After all, most Americans with retirement savings don’t actually have retirement savings - they have income they deferred in exchange for tax-deferred investments. In other words, they gave part of their income to a financial institution who promised to do great things with it for when they retire - and for most baby boomers this has proven true. But it’s only a recent phenomenon, with Bogle creating the first index fund in 1976 and Congress introducing the laws that provided for 401k deferral in 1978. For those that have been dutifully deferring their income over the past 40 years, they have seen the stock they purchased rise in value and earn dividends significantly more than if they had put the money in savings.
A recent WSJ article offered a graph demonstrating the share by generation currently invested in the stock market, unsurprisingly baby boomers make up a whopping majority. While the article explored the question of what younger generations are doing (or not doing) to save for retirement, seeing it made me wonder what will happen to the stock market as baby boomers enter retirement and begin drawing from their investments rather than adding to them. While some believe stocks are valued based on the performance of underlying businesses (value investing), I tend to be on the Greater Fool side of things.
The Greater Fool theory can be easily seen in cryptocurrency, where there is usually no physical business, economy or asset behind your ‘investment.’ It is a security constrained only by a limited growth rate (‘mining’) and backed by nothing. So we see vast swings in the dollar value of cryptocurrencies, not because of how the security is ‘performing’, there is no value to measure - it’s merely a measure of how many people are buying vs. selling the security along with the slowly increasing amount in circulation (which lowers the value). People who ‘invest’ in crypto are usually counting on a ‘greater fool’ to buy it for more real currency than they got it for down the road. I have no sympathy for these folks who lose their shorts in the crypto game.
But some people argue the Greater Fool theory also applies to the stock market, even though there are real businesses behind the securities. Ultimately, a share of stock is worth whatever someone else will pay for it, they say. Perhaps price is tied to the performance of a business, but oftentimes it’s more about speculation and hype.
The big boomer bust?
From what I can tell, no one is talking about this - so I may be completely off base, but it is a strong concern of mine and reason for wanting nothing to do with the stock market. If boomers are the only ones who have put significant investment into the market over the past 40 years and they are all beginning to draw on those investments, what happens? What if the ‘value’ increase has been primarily driven by ever-increasing demand for shares (via continued 401k contributions) that are limited in quantity. People were putting money in because they wanted gains in value, not because they wanted a stake in these companies (or even their dividends alone). For the market to continue growing, Milennials, Gen X, Gen Y, Gen Z (whatever) would need to be picking up the slack, buying at an equal or greater rate than boomers are selling to keep the price stable and heading in a positive direction.
But the evidence shows that younger generations are not investing the way their parents did. The cost of living, job instability, and lack of jobs even offering 401ks (or matching) make it less of an attractive or attainable offer. With median household income at $147,000 on Seattle’s yuppie eastside and average home prices at $1,200,000, even white collar families can’t afford a home, let alone save for retirement. The typical mortgage for the average home would eat up more than 50% of the average household’s pre-tax income, no bank would approve of that arrangement.
Renting is also incredibly expensive, but at least attainable - considering all the costs a typical family incurs, a 401k is a luxury. Robert Reich offers insightful information on how the screws have been turning on both the white and blue collar population of America since the 80s on a daily basis if my quick bites aren’t convincing enough.
So when boomers start drawing monthly from their investments, that means their broker has to find someone else to buy the shares and then give the boomer whatever they sell it for minus fees and taxes. Who is buying it? Boomers who are not quite ready to retire and have been growing their 401ks? What happens when the majority of people in the stock market are all looking to sell, rather than buy? Well, the values of the shares starts to decline, perhaps sharply.
If my theory / fear has any standing, then the only hope boomers have is to entice younger generations to buy their shares, with hopes that future generations will keep playing the game (and our country and economy have not collapsed in the wake of the climate crisis, China’s rise to power or some other war/disaster).
Part of me thinks I am way off base, because no one else seems to be talking about this potential. I suppose the counter-argument would be that rich and powerful people and institutions would keep the market going, that it doesn’t rely on investment from boomers as much as I think it does.
But even value investors like Bogle and brokers like (his) Vanguard have forecasted only modest growth over the next 10 years (approx. 3% annualized). In which case, the market could be outperformed by bonds and savings.
A safer, less exciting option
Given the bleak forecasts from value investors and my half-assed theory about the boomer bust, putting money into the stock market for anything other than speculation or seeking a greater fool just doesn’t make sense to me.
This leaves the far less hyped and historically less lucrative options of savings, CDs and bonds. All various forms of debt, rather than equity investing. But debt is easier for me to understand, and so long as you are ‘holding to maturity’ it is a very predictable and protected route to growing money. Some people trade (rather than hold) bonds, but banks like Silicon Valley Bank and First Republic have shown us how trading bonds can go wrong, even for the professionals.
CD rates are currently around 5% for 1-2 year terms and 4.5% or so for longer. Treasury rates are (unsurprisingly) comparable. Even a plain old savings account offers 4.15% with no fees or commitments. These are options I can understand: loaning money to a bank or government so they can loan or invest it for greater returns than they’ve promised me - I’m fine with that. It makes sense. Of course there is risk, but it is nothing like the risk of the stock market and there is also FDIC insurance to back it up.
For what it’s worth
Anyway, that’s my take on things after dipping my toes into the water. I hope it might encourage other folks to at least think twice and do a bit of research before jumping into the stock market bandwagon.