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Afraid of These Two Things? Oh, Please.


first_imgHere are two things you don’t have to worry about. I keep hollering about the need to save and about the virtues of market tracking index funds. And those articles inevitably generate a slew of bizarre emails. My correspondents’ claim: If we all saved diligently and we all indexed, the American economy would collapse and the stock market would grind to a halt. There are all kinds of things that keep me up at night. I try to remember if I unplugged the iron. I fret about next week’s column. I wonder whether the New York Knicks have any hope of making the playoffs. But I’ve got to tell you: I sure don’t worry about a national outbreak of financial prudence. Limitless Desires Most Americans are hopelessly ill prepared for retirement. For instance, according to AARP’s analysis of the Federal Reserve’s 2001 Survey of Consumer Finances, the typical babyboomer household has total financial assets of just $50,700. If these folks are lucky, they will receive a traditional company pension, thus compensating for their puny nest eggs. If they aren’t so lucky, all they will have is Social Security and the prospect of a retirement spent pinching pennies. The solution, of course, is to save diligently, and I make that suggestion with monotonous regularity. This isn’t exactly a courageous position. Advocating saving money strikes me as a kin to defending brushing your teeth and regular showering. What’s not to like? Yet some of my correspondents argue that promoting thrift is dangerous stuff. I apparently run the risk of single handedly shoving the U.S. economy into a downward spiral of excessive saving and too little spending. One reader even suggested that my articles touting the virtues of saving were “subversive.” I have always thought of myself as a grumpy, uptight, nerdy personalfinance writer. Subversive? I like the sound of that. Unfortunately, however, it isn’t true. Back in the 1960s, 1970s and 1980s, Americans regularly saved between 8% and 10% of their disposable income each year and the economy continued to grow. Since then, we have turned into the world’s most profligate citizens. But other nations still save a decent amount each year, and their economies are chugging along just fine. To be sure, a high savings rate, like high taxes, drains money out of the economy. But that shouldn’t cause too much harm, just so long as we have offsetting investment and government spending, which put money back into the economy. Still, let’s suppose a big increase in the savings rate is indeed an economic danger. Should you spend like crazy, in a patriotic attempt to keep the economy afloat, even as you sacrifice all chance of a comfortable retirement? I don’t think so. My suggestion: We’ll let everybody else rack up the credit card charges and keep the U.S. economy firing on all cylinders. Meanwhile, you and I will quietly save for retirement. It will be our little secret. Endless Optimism When readers aren’t worrying that I will precipitate the collapse of the U.S. economy, they’re fretting that I will cause the shuttering of the New York Stock Exchange. What would happen, they ask, if everybody indexed? Frankly, we are so far from that point that it is hardly worth considering. Despite all the discussion of indexing, it’s still not terribly popular. Just 14% of stockfund assets are in U.S. and international index funds. Indexing is somewhat more common among big institutional investors, like endowments and pension plans. They have around 30% of their stock market money indexed. Overall, maybe 20% of the U.S. stock market is indexed, figures John Bogle, founder of Vanguard Group in Malvern, Pa.,and the fund industry’s most vocal advocate of indexing. Yet, even though we have 20% of shares that are rarely traded, the New York Stock Exchange has had around 100% turnover in recent years, implying a typical stockmarket holding period of just 12 months. As Mr. Bogle sees it, that is more than enough trading to ensure market efficiency. In the 1950s and 1960s, “the market went on perfectly satisfactorily with 15% or 20% turnover,” he notes. Thanks to today’s whirlwind of trading, we have a wonderfully efficient market. Not only do active investors keep stocks fairly priced by bidding up undervalued shares and selling pricey stocks, but also they provide liquidity. This means that whenever we indexers want to buy or sell, there’s never any problem finding somebody to take the other side of our trades. But here’s the astonishing part: In return for providing such a valuable service, active investors receive precious little reward. Most end up lagging behind the market, as their results are dragged down by all the investment costs they incur. Indeed, I like to think of active investors as capitalism’s philanthropists. They sacrifice their financial health for the benefit of the marketplace and those of us who index mooch off their good work. What if active investors wised up and indexing became wildly popular? Suppose we gotto the point where there was so little trading that the market became inefficient. In that scenario, indexing might look even more attractive. True, in an inefficient market, we would be likely to see a wider range of returns among active investors, as some folks handily beat the market while others lagged behind. That might seem appealing to active investors, and it would no doubt encourage more investors to try to beat the market. But there is a downside. Because the market would now be less liquid, trading spreads the difference between the buying and selling price on stocks would widen out, so it would cost even more to trade. That increased cost would hurt the returns of active investors, further bolstering the case for indexing. Don’t, however, count on any of this happening. As the sharp rise in trading over the past three decades has made abundantly clear, there are stil plenty of folks who are willing to try their hand at outperforming the market averages. “Hope springs eternal,” Mr. Bogle says. “Self confidence springs eternal. We all like to think we’re above average. Reports of the triumph of indexing are greatly exaggerated.” AD Quality Auto 360p 720p 1080p Top articles1/5READ MOREGift Box shows no rust in San Antonio Stakes win at Santa Anita160Want local news?Sign up for the Localist and stay informed Something went wrong. Please try again.subscribeCongratulations! You’re all set!last_img read more