Opinion

Felix Salmon

When long-term investors panic

By Felix Salmon
May 22, 2009

The WSJ published a rather odd column by Neal Templin on Thursday:

My company retirement accounts, despite what I thought was a relatively conservative mix, were down close to 35% in early March from the fall of 2007. That, in turn, forced me to do some painful thinking…

I have good reason to be fixated on the health of my 401(k). It took me 20 years — my entire time at the Journal — to accumulate it, and it represents all our retirement savings…

Since I told [my wife] a few months ago of our losses, she started tearing open the envelopes from Fidelity Investments to see “how much poorer I am.”…

The whole experience makes her wonder about my push to keep maxing out our 401(k).

“I think maybe I could have spent more and lived it up a little,” she says.

There’s a fair amount of pretty woolly thinking here. For one thing, retirement funds are just that — funds put away with the express intention of not touching them until a point pretty far off in the future. Because they’re so long-term in nature, people can invest in riskier instruments than they otherwise might do, since there’s no reason for them to sell when the market is low, and they can ride out periods of volatility: they have no immediate need to raise cash.

In that sense, anybody with a 401(k) has a huge advantage over hedge-fund managers, say, who live in fear of quarterly redemptions and who will be asked for money just when the markets are at their lowest.

Given that the single biggest advantage that Templin has over hedge-fund managers is that he didn’t need to sell his stocks after they dropped, what did he do? Sell his stocks after they dropped. “Holding 50% stocks was simply too risky in a turbulent era,” he says. “I concluded 30% was the right level.”

But here’s the thing: the riskiness of stocks is a function of how expensive they are. The cheaper stocks get, the less risky they become, and if a 50% allocation to stocks made sense when stocks were expensive, there’s a good case to be made that your allocation should actually rise when they become cheap.

What’s more, Templin and his wife seem to have a particularly unhealthy way of looking at their retirement savings. Does Templin add up all the money that he put into his 401(k) over the years and sorrowfully compare that sum to what the account is worth now? No — that’s a calculation he never makes, and for all we know it would show him still in positive territory. Instead, he picks the single point in time when the value of his 401(k) was at its absolute maximum, and then compares its current value to that peak.

If you invest in a risky asset class like stocks, your portfolio will nearly always be worth less than it was at some point in the past. You know that, when you retire, you can ruefully pick a date and say “we should have retired back then, we would have had more money”. But you still invest in stocks because you’d much rather have a portfolio go up to $3 million and finish at $2 million than you would have a portfolio which boringly and steadily rises to a final value of $1.5 million.

Unless, of course, you’re Neal Templin, who seems to think that in the first case he would have “lost” a million dollars, and that in the second case he’d be going out at an all-time high and blissfully happy. He doesn’t seem remotely interested in the amount he has accumulated over the course of his 20 years at the WSJ: instead, he’s only interested in the difference between that amount and its mark-to-market value on a certain date chosen to make him feel as miserable as possible.

As for his wife, she seems if anything even more ignorant: she doesn’t even seem to appreciate that the less money you save, the less money you save. If she had spent more and lived it up a little, then the drop in their retirement account would have been smaller only because the retirement account itself would have been smaller. The only way to get a bigger retirement account is to save more, not less.

All of which goes to reinforce my message to Justin Fox — the idea of long-term shareholder value is simply meaningless. If anybody should have an eye on the long term, it’s people with retirement accounts which can’t and won’t be touched for decades yet. But instead they obsess so much over a single year’s drop that they radically alter their entire asset-allocation strategy at the worst possible time, and choose to sell steadily into a rising market. That’s just human nature: you might think you’re a long-term investor, but when put to the test, it turns out that, really, you’re not. And if you’re not a long-term investor, then you should never have been investing on the basis that you were.

Comments
8 comments so far | RSS Comments RSS

What you say is true, I suppose, but it ignores the intrinsic pitfalls of tax-deferred retirement accounts:

1. They assume that tax rates in the future won’t go up (i.e., you’ll be in a lower bracket in the future).

2. Capital losses are useless for tax purposes.

3. Capital gains are taxed as earned income when you take the money out.

That’s why, despite the argument about being able to afford more volatility in those walled-off investments, I’ve actually followed a reverse strategy: equities in my non-retirement account and mostly fixed-income instruments in the SEP/IRA. As long as the money isn’t currently needed, why not?

Crazy, eh?

Posted by Larry G | Report as abusive
 

“Regret” is right up there with “hope” as far as wasted emotions go. But it does come into play when “buy and forget-ers” open their statements. Without a plan, emotions become the sole driver of one’s investment ethos. There is no security that is too high to buy, nor to low to sell short. And they don’t always come back – look at CSCO or the Dow Jones between ’71 and ’81. Have an exit strategy before you get in. Time the market. You can increase your RoR by a factor of 3 by missing the 10 worst days of the year if you’re an indexer.

 

“And if you’re not a long-term investor, then you should never have been investing on the basis that you were.”

20 years is a fairly long time. He has finite choices, retire now, move to a 10 year plan or wait another 20 years. What do you recommend? The first two choices require asset re-allocation, only the third satisfies your advice.

Posted by Mattyoung | Report as abusive
 

“And if you’re not a long-term investor, then you should never have been investing on the basis that you were.”

Precisely. And the balance in allocation is the so-called “equity premium” vs. govies or corporates or money-market accounts.

After 20 years of accumulation–guessing age around 45-50–he’s probably correct that he should be less than 50% in stocks, given that the 401(k) is their only retirement savings–and for the asymmetries of those accounts, as noted by LarryG. (401[k]s socialise the profits and privatize the risks.)

Yes, he rebalanced for the wrong reason, and I fear for the WSJ that it’s financial writers have such an impression of their 401(k)s. But we can take some heart in the idea that he finally looked at a statement and rebalanced to fit their lifestyle and needs–something that probably should have been done long before.

 

It’s not that you’re wrong, but it reads a little unfair. A petty complaint, agreed. 401ks and the like are sold as retirement savings (savings are supposed to go up) as opposed to retirement investing (which can go up and down). Bailing on 401ks and equities because you’ve had a bad run isn’t the best idea; but his piece doesn’t say he is… just a revised risk tolerance. Similarly, it’s not that his wife is ignorant, per se – knowing then what they know now (and thus opting for a different asset allocation) they indeed could have spent more, saved less (better) and ended up with the same 401k balance. A logical fallacy, fine, but not ignorant.
I think there is a real mistake in taking honest responses to honest emotions and deriding them as ill-conceived (that is, afterall, how most people live). It’s missing the point.

Posted by tegwar | Report as abusive
 

Here’s what I don’t understand: If equities have declined 30% and Templin isn’t investing in junk bonds, wouldn’t his asset allocation move toward 30/70 without having to sell any stock? What am I missing here?

Posted by Mike | Report as abusive
 

Contrary to conventional thinking, buy-and-hold is only for those who have a 20-40 year time horizon. It’s only over that length of time will investing in “good” company’s (i.e., large caps) at fair values allow the investor come out the other side of cycle bear markets in good shape.

For retirees or those close to retirement, you must become a “market timer” because no amount of diversification can protect you from major bear markets, those that come once every 15-20 years (and like the recent Tech Bubble and Financial Crises Crashes).

 

Felix, you write:”Given that the single biggest advantage that Templin has over hedge-fund managers is that he didn’t need to sell his stocks after they dropped, what did he do? Sell his stocks after they dropped.”

Yet, in the linked article, I read:
“Dropping my equities allocation to 30% would have meant selling a big slug of stocks at the bottom and locking in my losses. That didn’t seem smart. So I waited for the market to rise.”
So, did he sell them after they rose…or, as you say, after they dropped? Seems a little of both. In any event, it looks to me like, as tegwar noted above, he’s just rebalancing his risk allocation. Hardly what I would call “woolly thinking”…especially since it’s not at all clear that we are out of the woods yet. This depression could drag on for YEARS. If the guy wants less risk in his investments, why ridicule him? Does it make you feel superior?

Posted by McLovin | Report as abusive
 

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