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Start Here: “The Ultimate Guide to Personal Finance”

Chicken Little and Kooks Who Don’t Know What They’re Talking About

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This post is long, but there are emails and comments from a bunch of nuts that I pasted, so don’t be intimidated. Today I threw all pedagogical goals out the window. My goal is instead to have you shaking your head saying “what the hell?” by the end of this.

See, every single day I write on here, I try my hardest to communicate the idea that personal finance is not very hard to get started with. There are a few strategies that time and research have proven work for making money. Yes, there are endless strategies to optimize, but for most of us, they’re irrelevant: The largest, most important problems are that we don’t get started early enough and we’re not disciplined enough. Unfortunately, that message isn’t sexy enough to sell magazines or satisfy kooks who want to wring their hands about the current state of affairs. As a result, we see people confusing global geopolitics with personal finance. They worry about how the oil shortage in Chechnya (or whatever) will affect the currency crisis that will affect their country’s immigration policy that will affect the unemployment numbers that, somehow, will affect the amount of money they’re able to save.

I hear these kooky tales and they infuriate me. Today made me rise out of my PBwiki cave and write this because we have half the financial pundits on TV freaking out about yesterday’s drop in the stock market.

Minor stock-market drops like this amuse me because we see these crazies come out in full force. On the Reddit page describing yesterday’s stock-market decline, for example, we see some very good comments (towards the top) and then many idiotic ones like these:

  • “The 10% return myth is nothing but Wall Street propaganda”
  • “500 points on teh dow in one day is a big deal. If that continutes for 1-3 more days it will melt down”
  • “Equities only got really good returns when most people were scared of them”
  • “The real history of US equities is just that there were three really big bull markets: in the 20s, in the 60s, and in the 80s/90s. Outside of those periods broadly investing in stocks has been a lousy plan, and for most of the 19th century it got you soaked.”

Here’s a tip: If someone starts using words that sound really big combined with accusing somebody of a Very Large Conspiracy, chances are they don’t know what they’re talking about. Also, you’ll notice that kooks use qualifying words like “broadly” and “in general” and “melt down” (what does that mean, exactly?). It’s hard to be wrong when you can’t be pinned down.

I have a serious problem with people using wide-eyed, handwavy geopolitical logic to explain what’s going to happen with their money. But one thing these short-sighted pundits forget to remember is that a market goes up and it goes down. YESTERDAY IT WENT DOWN. ALL DATA WE HAVE INDICATES IT WILL GO UP SOMETIME SOON.

* * *

A couple months ago, a friend of mine called me and started telling me about her personal finances. This girl goes to a Very Good Law School, so don’t dismiss her for being unintelligent. But I couldn’t help but feel rage as she started telling me the following things:

  • ”I’m not going to invest in the stock market because it’s not safe. The current crisis means our money will be worth less and less every day. When you factor in the immigration crisis, it’s virtually untenable.” I have to give her credit, though: It was a good use of the word “untenable.”
  • ”I really want to start my own company doing something I love. I think entrepreneurship is safer than investing.”
  • ”I want to stop working in 5 years and support my family financially (even though I’ll stay at home to raise the kids). So I have to start something successful.”
  • ”I don’t think 401(k)s are the way to go because there is a lot of risk and you can’t control your choices.”

We see someone here who doesn’t really know what she’s talking about. She’s not stupid, just misinformed. I told her that, too. These are not the reasonable conclusions of someone who’s informed about personal finance, but someone who’s cobbled together a shaky theoretical framework that ties personal finance, global politics, and entrepreneurship together. I wanted to die.

I probed a little bit. “Where did you learn this stuff?” I asked. She hemmed and hawed and finally said that she’d read “part of” Donald Trump and Robert Kiyosaki’s book (read some thoughts on the book here).

This made me so mad. Here we have someone who’s getting bad information—and then, only reading part of the book—and not comparing it to any information. While she was misinformed, she needs to take some responsibility for actually learning this stuff. Think how much time we spend on things like our email, our problem sets, or even reading US Weekly. Then think how much time we spend seriously learning about personal finances. Which affects us more? Which one will you complain about more for the rest of your life?

I was doubly frustrated that she was using one book as her gospel. Listen, if you use one place as your only source of information, you are a moron. I don’t care if it’s iwillteachyoutoberich or the Wall Street Journal. One source is not enough. You need to be reading multiple, research-based sources so you can compare what is actually happening, not just discussion groups on the Internet where people share their opinions about what’s going on.

If you do read sources that only confirm each other, you get something like this. Here’s an email I got recently that just blew my mind. This iwillteachyoutoberich reader uses the shakiest logic I have ever seen to paint the most dire picture of personal finances in America. Take a look:

“The blogs on personal finance have exploded since then. Good way to tell we’re at the cusp of a serious recession now, not that half-asssed one when the stock market dot-bombed.

Of course, that mini-recession hurt me badly, because there was a state budget crisis nationwide and I work in government. I couldn’t find a job. I’m working now so I guess I’m better off now than I was then. So, we’ll see.”

This is all I asked:

“Why do you think we’re coming up on a recession?”

And the handwaviness began:

“The housing bubble peaked in mid-2005, and construction jobs are dropping. The government picked up some of the slack in the 2000-2005 period by hiring people in defense, and of course many of the construction workers were illegals who are now leaving in droves. So unemployment isn’t bad right now. What’s on the horizon now is weaker consumer spending because the HELOC ATM is closed for business. Also, as the subprime lenders fail, a lot of money in the system is starting to vanish.

Loans are on the books for much more than the house (asset) is worth, especially in today’s dead housing market (huge inventories from overbuilding, houses spend months on the market). Debt was sold and resold, leading to a chain of insolvency that could bring us back to an S&L crisis type disaster. Check out the Mortgage Lender
Implode-o-Meter:

http://ml-implode.com/

Also, we have an inverted yield curve and the dollar has lost a lot of value in the last two years. This by itself doesn’t mean much but it could lead to government actions with a recessionary outcome–or (as many fear) stagflation.

With any recession, not all sectors are affected, and, from my reading about the Great Depression, even in a deflationary era those who were accustomed to hustling for their living–artists, musicians, insurance salesmen–continued to make a living, while those who expected a job to just be there for them ended up destitute.

Right now the warning signs are all in place, and the housing bust is beginning its drunken walk to the bottom. Vast amounts of wealth, as held in RE, are vanishing. Prices of certain commodities are dropping (=weak building/production/jobs outlook), while the price of food, which everyone needs to buy, is looking to go up, which will squeeze out the market for everything else.

Look at Ford. Look at SoCal real estate. Interesting times are ahead…”

I asked this:

“Out of curiosity, do you have any specific, measurable factors that you predict? Something you could be held to in 3 months, 6 months, etc?”

The response:

“Wow, put my money where my mouth is? Well, I’m not an economist, and I’m relying on other people’s analysis. I expect that this coming spring real estate season is going to be very painful for a lot of people, with the median sale price finally dropping as the cash-back lending scam is exposed to the light of day. (It’s already being exposed in AZ, which had one of the worst bubbles in the country in Phoenix.) But this is all old news–my mother tells me that home valuations in Massachusetts are already at 1997 levels.

In six months? Seriously, that is so short term. A lot could happen depending on whether Bernanke raises or lowers the Fed rate in the short term. Also, many major players are continuing to prop up the dollar. Japan wants a strong dollar so they can sell Sony and Toyota products, China wants a pegged dollars so they can sell cheap crap, and even Germany has a vested interest in a strongish dollar (look at where their trade surplus is coming from). Central banks won’t be able to keep this house of cards up forever, but they should be able to manage the next 6 months. So far (last year), there were some times went the dollar softened a lot, and certain central banks rushed in to prop it up. Hence the dollar see-saw.

Here is a pretty hard-and-fast prediction: food prices are going up. Wheat production has dropped in favor of corn for ethanol, there was a freeze in California and a freeze is coming Florida, ravaging vegetable crops. In the mean time, with the savings rate flat instead of negative, as HELOCs go away, there are going to be a lot of Americans who look at the high price of eating out and just say no (or seek bargains). Some restaurant chains (eg Don Pablo’s) are already in trouble; I expect more to be in trouble in 6 months as higher food costs (traditionally the cheapest part of the equation), and increasing wage demands run smack into lighter wallets. Middle class, keep-up-with-the-Joneses America is being squeezed here. Just look at the woes of Target last year. Look at 2006 holiday shopping (flat, YOY). Multiple middle/upper middle chains are in trouble; discount chains are also in trouble. High end had a great year, with all the huge profits from hedge funds and private capital lbo’s (legal thievery) and huge bonuses on Wall Street.

Some expect Toyota, Honda and other Japanese car makers to do well this year because foreigners do not like the new Japanese gov’t and are discounting the yen as a result. I don’t really know much about this, though.

Wall street: insiders say that everyone is in lalala denial mode, trying to get another quarter or year of profit before the shit hits the fan. For example, Bernanke right now has the power to unleash a bloodbath in the bond market (which is in bubble mode), but so far has hung back… However, that may be out of his hands by the time 2007 is over if Congress becomes deeply involved in credit tightening due to failed banks and Joe Sixpack anger over liar loans, suicide loans, rising ARMs, etc.

The stock market is a sleeping Cthulhu right now. Everyone is hoping that nothing will wake it. Many pin their hopes on high inflation, which will keep nominal values high even if true values plummet. Since there are contrary indicators out there (both inflationary and deflationary), but a strong gov’t bias towards inflation (helps the taxman and reduces the debt), betting on high inflation is probably the most rational course of action.”

By this point I was mentally exhausted.

“Ok–thanks for clarifying. I completely disagree but I was/am very curious to hear your reasoning, so I appreciate your thoughts.”

Her final response:

“They say that optimists do better in the end (in investing and in life), and your real asset is your entrepreneurial skills, not whatever stocks you own. For you, dumping money in a cheap index and forgetting about it will probably be fine because your earning power will only grow with time.

As for myself, I have lousy networking/leadership skills and I work in local gov’t which doesn’t pay so well (but the bennies are okay). I have inherited money which I need to preserve and grow to ensure I have a decent retirement (as traditional pension plans are in big trouble these days). I have a more pessimistic outlook anyway, hence
the extreme risk aversion.

Worries about the US stock market were keeping me up at night, so I had to do something. You have to do what works for you.

PS–I know I sound like a granny but I’m only 27.”

Ok…take a deep breath.

Can you imagine me saying something like that at work? “Hey guys,” I might say, “I really think the color blue makes people upgrade more often. No, seriously. You look at the sky and note the reflections of the moon off the ocean and the thousands of years of the Egyptian pyramid-makers causing sand to be blown hundreds of feet in the air, and you can understand that the long-term consequences make us cognitively wired to respond to the color blue. So I think we should make our upgrade text blue.” If I ever said that, David and Nathan, the other two PBwiki co-founders, would just put their hands in their pockets, stare at me, and blink. Then I would immediately commit seppuku in front of them.

PLEASE STOP MAKING STUPID GRAND GEOPOLITICAL ANALYSES THAT YOU THINK WILL AFFECT YOUR MONEY. PLEASE!!!

There are more important things to worry about. Are you saving enough? I’m willing to bet $100 right now that the people who make these handwavy arguments haven’t maxed out their retirement accounts, properly allocated their portfolio, and diversified. In fact, I bet these arguments are simply a misguided excuse to do nothing.

There is a simple way to point this out: ask them what they’re doing instead. This is where two things will happen: First, they will start talking about grandiose “alternative investments” like hedge funds, commercial real estate, and venture capital. Second, when you point out that most people can’t invest in hedge funds and venture capital, and that the stock market generally returns better than some of their other asset classes (“municipal bonds!!!”), they will start stuttering. Oh, there’s a third thing. You will want to kill yourself.

The people who make these kind of broad, sweeping statements (“The looming currency crisis will render retirement accounts worthless!!!”) are so far off base that I don’t even try to educate them. But they’re dangerous because they know enough buzzwords to convince novices that they might possibly be right–so, of course, they better hoard their money and do nothing because it’s too unsafe to invest!!!

If there’s one thing I really hate, it’s people taking advantage of others financially. (As a sidenote, there are over 30,000 words of Things I Hate on my other blog.) In any case, this post today is a plea to you: If you hear this kind of stupid, kooky reasoning from someone, call them out on it. If they think investing is so risky, what are they doing instead? What evidence do they have that their strategy will work? How do they explain away the last 70+ years of success in the stock market? What about the benefits of tax-free and tax-deferred growth (i.e., through Roth IRAs and 401(k)s?). How about the thousands of peer-reviewed research articles and hard data supporting sensible, long-term investing? Press them hard and watch their arguments fall apart. And remember: You can worry about the world’s political situation and the commodity price of salt in Hong Kong, or you can be constructively concerned with how to maximize your savings rate, how to live below your means, and how to invest for long-term growth to achieve your goals. Which one is more manageable?

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55 Comments

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  1. The woman in local government with the inherited money sounded really on the ball and very sensible to me.

  2. The major problem I have is that you dismiss her “handwavy” argument with one of your own. I’d like to see more constructive criticism than “I completely disagree.”

  3. Wow. She’s hot. She explains how the civilised world is going to crumble and suceeds at pluggin the name Cthulhu in it.

    This is arguable, but some of the things she said made sense.

  4. Hi Ramit,

    I wanted to write to add my opinion that that believing there is a recession coming or being worried about geopolitics does not necessarily imply all of the things these folks think it does.

    Quite a few people, among my favorite being Ben Graham the so-called ‘Father of Value Investing’, have shown that trying to buy the dips and sell the peaks is futile because you will almost always get it wrong, and that having a steady, regular investment strategy works out better for almost all.

    One step further in the Ben Graham school of investing, for those willing to put in the effort is to study the fundamentals of companies and not buy those that are overvalued relative to their actual earnings potential. The central tenant being that while they might continue to go up (think internet stocks in the late 90’s) the number one goal of investing is to preserve capital; yield is important but secondary. So instead of investing in internet stocks when they appear overvalued, you find something else that is being neglected and that, while it might not get your as stellar returns in the short run, will place your money at less risk.

    Bear in mind that this path is only for those willing to put in the time and effort to do the research; for most, buying indexes and/or mutual funds is a fairly safe and secure way to invest. However it does perhaps suggest a path forward for your chicken littles. If they think there’s a serious problem in a sector, perhaps they should stay away from that sector. For example, as you’ve noted before, housing has gotten crazy and extreme, so I’d say housing is and has been a poor investment in the last few years, despite the gains. Too much risk.

    In fact, I think some of the points your chicken littles have raised are real, though perhaps not well understood by them.

    There is a fair amount of evidence that we are in the midst of a serious correction (or sector specific recession) in housing and subprime lending. Defaults and foreclosures have skyrocketed, sales have plummeted, and a number of small mortgage lenders have gone bust. (For some graphs try here for defaults and here for new home sales.)

    However the conclusion to draw from this is not to stop investing, or saving, but to avoid those currently risky areas unless you’re willing to really do your research.

    Don’t stop saving, don’t stop investing or thinking about it, and don’t use these things as an excuse to not do anything.

    This turned out to be more long winded than I meant to, but basically what I’m trying to say is that it is not wrong to pay attention to the world around you, but rather to draw extreme (and in my opinion wrong) conclusions without doing lots of your own research and having convincing arguments to back it up.

  5. Whether or not there is going to be a recession is not only unpredictable, it’s irrelevant. You should have your money in the market for the long run. If you do, then you shouldn’t worry about or pay much attention to a “looming recession” (unless it you pay attention to it for the sole reason of buying more when the market is low.)

  6. awesome post KMB. I’ve not heard of Ben Graham but now I’ll be reading up on him!

  7. Index Funds.
    Tax deferred accounts.
    Automatic re-occurring investments into the fund(s).
    Forget about it till you want to retire.

    *****

    Attempting to explain why things are happening is at best laughable. The world (including financial markets) is more complicated than any single persons explanation can attempt to make sense of. The idea that you can explain or rationalize what is currently going on, and use that explanation to predict the future is ridiculous.

    Her explanation of why things are happening sounds amazing, but I’m more impressed with someone who realizes that they don’t understand something than someone who uses smoke and mirrors to act as though they can predict the future. The more intelligent you are the better sounding explanation – that is it. The wiser person is the one who doesn’t believe they know as much.

  8. you are right about getting your information from multiple sources. There seems to be a large circle of bloggers who are young and inexperienced giving out their expert advice on how to get rich. And who is the audience for these blogs? Young, inexperienced investors.

    As a culture we dismiss the wisdom of older people who have gone through the ups and downs of markets, business failures and successes.

  9. Holy cow, it’s like having money is magic and the only thing anyone knows how to do is buy home theatres.

    Stocks are good and bad. Your reader is currently very unhelpful because she is not consuming her money (thereby helping the rest of us get wealthier) nor is she putting her money anywhere that helps grow the world. She is just hoarding it because she’s scared. Speaking economically she’s really taking money out of circulation and only helping her self-fulfilling prophecy.

    Investment “systems” are garbage. They become either obviously correct or obviously wrong when you have understanding. At that point I wouldn’t call them a system anymore, just obvious. As well, just by putting a “system” out there you almost negate its effectiveness because if it’s good then many people will use it and you can’t make any money.

    The stock market is a reflection of the local and global economy. Buy and hold works because we are just getting richer over time as a group (though not helped by your reader). If she buys the stocks of other people who want to be rich then she will be dragged along. If she doesn’t, then she will be left behind.

    Trump and Kiyosaki can make themselves rich “under their own steam”, but she has to ride the wave of others by investing in them.

    Also, she needs some self-condfidence. Just because others don’t know how to do something doesn’t mean she can’t be the one who does. She seems smart and interested enough to study. She’s young yet so she just hasn’t put it all together in her head.

  10. I can’t talk about investing with my mother anymore – her main point always seems to be that “You’ve always been able to buy an expensive men’s suit with an ounce of gold,” therefore gold has kept pace with inflation, therefore investing in gold makes more sense than investing in the stock market.

    I did initially try to get her to explain the reasoning, but I didn’t get anywhere. So now I’m pretty much stuck worrying that my mother will have no retirement money because she’s just buying gold. (She owns about a dozen rental properties, though, so I think she’ll be ok in the end. I hope.)

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