What the decline of stocks means for you

February 15, 2011
Tim Duy asks me whether "the public is being pushed into a retirement dead end", and "how the average investor should manage their 401k plans in this environment". I have two answers to this; one's facile and the other's quite important.

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Tim Duy asks me whether “the public is being pushed into a retirement dead end,” and “how the average investor should manage their 401k plans in this environment.” I have two answers to this; one’s facile and the other’s quite important.

The facile answer is “I’m not an investor” — don’t ask me, because the one thing I know for sure is that my investment calls have generally turned out pretty badly, I don’t have the courage of my own convictions, and insofar as I’ve managed my own personal finances in a non-disastrous manner that’s more been a matter of luck than judgment. I could try to give you investment advice, but it wouldn’t be worth very much.

The more important answer is “I’m not an investor” — and neither are you. Just because you have a 401k plan does not, ipso facto, make you an investor. This is a serious problem with defined-contribution pensions in general: they place an onerous set of responsibilities onto individuals who are wholly unqualified to discharge them in a sensible manner. Already, such plans tend to have far too many choices, many of which are expensive long-only mutual funds which seem like a pretty bad idea for just about anybody. Trying to add alternative investments in private equity or hedge funds to the mix would almost certainly be disastrous — the dumb money coming in at just the wrong time, just like it always does.

So your 401k is going to be made up of stocks, bonds, and cash, just like it always has been. Those asset classes are, it’s true, only a subset of the full range of investment opportunities available to sophisticated investors. But you’re not a sophisticated investor, so there’s no point in feeling aggrieved. It’s possible that you might be able to invest some of your 401k funds in Pimco’s Total Return Fund, which is an active and sophisticated investor, and which happily uses very sophisticated derivatives on a regular basis to get extra return and to make money in down markets. But generally speaking, people with 401k plans should stop at big-picture asset-allocation decisions: beyond that, they’re way out of their depth.

It’s possible to argue ad nauseam about the equity premium and whether it exists; I’m very sympathetic to those who say it’s smaller than you might think. But if you’re talking about retirement money you’re not going to touch for at least a couple of decades, then stocks do look a lot more sensible right now than bonds or cash, neither of which are going to do anything for you. Are they expensive? Yes: everything’s expensive. And at some point stocks will surely drop alarmingly. But at least the earnings yield on stocks is vaguely reasonable, and you can expect those earnings to rise over time as the economy grows. And you’re certainly not sophisticated enough to try to time the market and buy on dips.

The good news about 401k plans is that you put a more-or-less identical amount of money into them every month, which means you’re dollar cost averaging quite impressively. And ultimately the best way to save up lots of money for retirement is the same as it’s always been: to save up lots of money for retirement. By far the most important number here is the total sum of dollars that you’ve put into your retirement funds over time; the annualized rate of return on those dollars is secondary. So the more comfortable you want to be in retirement, the more money you should save while you’re working. Don’t expect the market to come to your rescue, and you won’t be disappointed when it doesn’t.

There’s no point in blaming the world for its unfairness. Sure, it would be nice if you and I could buy hot pre-IPO tech companies — or at least it would be nice if we were able to pick the winners. But again, Sod’s Law says that if we could do that, the returns in that space would turn negative pretty fast.

And it’s possible that we’ll have a resurgence in the stock market, if and when the US economy starts making things again. Dorian Taylor sent me a thought-provoking email this morning which said that one of the reasons we’re seeing fewer companies tap the equity capital markets is that we’re in a phase where all of the buzz and excitement is in what he characterizes as “networked information services.”

“Relatively speaking,” writes Taylor, “these companies don’t really need a huge amount of capital at any given time because they aren’t buying stuff with it; they aren’t making or building or physically shipping anything.” (Yes, I know that datacenters are expensive, but this is broadly true.) Taylor continues:

I suspect emerging industries for which production (eventually) eclipses R&D (i.e. physically consumes stuff to make things) may still do well in the stock market. Metamaterials, space tourism, alternative energy or tissue engineering perhaps. Just not information services.

If the greentech (or any other capital-intensive) revolution ever arrives, in other words, maybe the stock market will step up and become relevant again. And for the time being, those of us with 401k plans should just continue to put our money into stocks, or target-date funds, or the like. Because we literally don’t know any better.


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