Friday Reading: The Dumb Money Myth

22 Comments on Friday Reading: The Dumb Money Myth

1. Matthew Amster-Burton on March 2, 2012
   
    

   I think there’s a way to set up a mental barrier to “protect” the balance of your reward checking account.

   Something I didn’t mention in the column is that I like to track my checking account to the penny, so I use Quicken and manually enter transactions that haven’t downloaded yet. Since I spend my allowance account down to zero every week, I entered a nonexistent check for $100, so if I forget to enter a receipt and overdraw the account by $5, it’s not really overdrawn.

   It’s kind of like setting your watch ahead five minutes in order to be more punctual, and for me, the trick works. If I had a reward checking account, I assume it would work just as well for $20,000 as for $100. Also, it’s a joint account, and my wife and I have the right to give each other hell if we abuse it.

   In other words–and they talk about this in the book–there are ways to set up rules so they require less willpower to comply with. What really drains your willpower is trying not to do something both appealing and habitual, like eating cookies. Using my debit card is habitual; using my credit card is not. Spending my account down to so-called zero is habitual; spending it beyond zero is not. These arbitrary barriers can be very effective.
2. edward on March 3, 2012
   
    

   TFB, speaking of BG, any opinion on TRXT? I think PTTRX is available
   through my 401k Fidelity brokerage link, but it looks like a $250K minimum.

   On the Harvard grads, did you read Yves’ take? I tend to side with her.
3. Don on March 3, 2012
   
    

   Dumb money is such an interesting topic. Here’s my take:

   1) The vast majority of people don’t know how to evaluate the true value of a stock
   2) Most people understand that stocks generally increase in value
   3) If 1&2 are true, then ‘buy and hold’ is an approach that most people follow
   4) The edge cases are the following:
   a) The pros who do know how to value stocks and make decisions daily
   b) The skittish who watch stocks daily and dive in and out willy nilly
   c) The folks who’ve invested but can’t afford to lose more than X and sell in a down market to ensure they have enough cash/investments to continue living on
4. TFB on March 3, 2012
   
    

   @edward – No opinion on TRXT. I don’t like bond ETFs in general. Arbitrage doesn’t work that well when the underlying assets aren’t as liquid. I’m afraid it’s going to have a large premium or discount to NAV.

   Yves Smith of Naked Capitalism? I found her blog post, skimmed it, but I couldn’t understand what her objections were. She’s saying people are being exploited when they are free to choose which fields they work in and which companies they work for?

   If making more money is a prime objective, I’m sure a Harvard grad is able to find a way to it. I know many career changers. They share one trait: they don’t take anything for granted. Working for a lower pay at a well known company for a while is actually a very good investment in one’s human capital.
5. Early FI on March 4, 2012
   
    

   I heard this myth on NPR again today while some guy was ranting about how all retail investors time the market incorrectly. I’m definitely in favor of buy and hold, but this myth is getting a little over the top.
6. TFB on March 4, 2012
   
    

   @Early FI – I heard that too! It was that guy.

   I just thought of an analogy. There is this big sand dune. At some inopportune times, a guy shovels some sand onto it. At some other inopportune times, another guy shovels some sand off it. However wrong they did their shoveling, it just doesn’t make much difference to the sand dune. So quit picking on the guys doing the shoveling.
7. Allan Roth on March 4, 2012
   
    

   Regarding your statement:

   “Mutual fund investors as a whole don’t time the market wrong to any significant degree.”

   I don’t get how someone can call themselves a finance buff without knowing about knowing about numerous and conclusive studies on mutual fund investor returns (dollar weighted) vs. fund returns (geometric weighted).

   Studies show investors undeperform mutual funds by about 1.5% annually.
8. TFB on March 4, 2012
   
    

   Hi Allan,

   Thank you for your note. No ad hominem please. My knowing or not knowing those studies or what I call myself is irrelevant to the issue at hand. I can’t believe that’s how a professional should behave when challenged by a different viewpoint supported by facts.

   If you are referring to studies like DALBAR, I wrote about it some time ago in DALBAR Study Overstates Investors’ Bad Timing and in Most People Don’t Sell Everything In a Panic.

   Statistics from Vanguard and Aon Hewitt show that the vast majority defined contribution plan participants don’t trade in and out of the market. That’s also where the vast majority of the money is.

   Can you please comment on the core issue here? Namely the size of the inflows and outflows relative to the total amount invested in stock mutual funds? How is it possible to underperform by 1.5% *annually* if investors as a whole are only moving 1-2% of their investments into and out of the market at wrong times? That would suggest they get a 100% loss on the money they move.

   Respectfully,

   TFB
9. Allan Roth on March 5, 2012
   
    

   TFB,

   Fair enough. I’ve also written about the overstatement of the Dalbar study which stated investor returns lagged funds by far more than the 1.5% annually I stated above. Fransaen & Sapp estimated a 1.5% annual shortfall in their 2007 paper and my own study based on Morningstar through 2009 came out with virtually identical results in a different period.

   If you read my piece, you will note I didn’t say the majority of funds were pulled from equity funds. I also didn’t address the high amounts going into bond funds when investors were pulling net amounts from stock funds. I only stated dumb money was pulling out when it was much better to have bought low. I’ve given some much stronger data during the 08-09 crash.

   Could you kindly give me the reference supporting your statement:

   “Mutual fund investors as a whole don’t time the market wrong to any significant degree.”

   I want to understand your statement that I fell for the dumb money.

   Thanks.
10. TFB on March 5, 2012
    
     

    The simple fact that the “dumb money” is a tiny proportion of the total amount invested. Reference already given in this and other linked posts. ICI publishes total mutual fund assets. The studies looked at the money that moved and investors who made moves. I’m suggesting we should look at broadly money that stayed put and investors who didn’t make moves. They are the vast majority and therefore “mutual fund investors as a whole don’t time the market wrong to any significant degree.”

    Take my sand dune analogy in the comments above. You are looking at the guys shoveling sand and showing how they did it wrong. True, but look at the sand dune!
11. Allan Roth on March 5, 2012
    
     

    TFB,

    I hope you don’t mind me repeating the question.

    Could you kindly give me the reference supporting your statement:

    “Mutual fund investors as a whole don’t time the market wrong to any significant degree.”

    I’ve given you data that show the average dollar investing in stock mutual funds underperforms the funds themselves by 1.5% annually. That data refutes your claim. Do you have data that supports it?

    Thanks very much.

    Allan
12. TFB on March 5, 2012
    
     

    I hope you also don’t mind my repeating the facts. More than $5 trillion are invested in mutual funds. Fund flows during volatile times come out to a few percent of that. Do you dispute these facts? The one sentence you asked about repeatedly comes directly out of these facts.

    Comparing the average dollar invested in stock mutual funds with the funds themselves is apples to oranges when the time period studied had better returns in the beginning. As shown in the linked post, the average dollar suddenly got smart when the time period had better returns in the end. Please construct a model to make the total money invested underperform by 1.5% per year when more than 90% of the money stay in the market. Educate us. Note we are not talking about fees.
13. Allan Roth on March 5, 2012
    
     

    TFB,

    Regarding your comment:

    Please construct a model to make the total money invested underperform by 1.5% per year when more than 90% of the money stay in the market. Educate us. Note we are not talking about fees.

    I’ve given you sources from Morningstar to an academic study. There are many others as well. The phenomenon is very well known. I”m just asking for one source to support your statement:

    “Mutual fund investors as a whole don’t time the market wrong to any significant degree.”

    Could you give me just one?

    I really appreciate it.

    Allan
14. TFB on March 5, 2012
    
     

    Allan – We will have to agree to disagree. I gave the data. You don’t accept them. I have nothing more to add.
15. Matthew Amster-Burton on March 5, 2012
    
     

    Guys, may I jump in and try to summarize? Because I think you’re talking past each other.

    TFB is saying: some investors may time the market badly, but since the aggregate balance in stock and bond funds doesn’t change much, there’s no way most investors can be chasing in and out of asset classes, or you’d see dramatic swings between stock and bond funds rather than small swings.

    Allan is saying: That doesn’t explain why a number of studies–not just the DALBAR one, but better ones–find that investor returns consistently underperform investment returns.

    And may I add:

    1. What are we talking about when we say “mutual fund investors”? Only retail investors in individual accounts? Retail investors in individual accounts and DC plans? Retail and institutional investors? It’s not clear to me. If we’re including institutional investors, then it’s quite possible for the “sand shovelers” to account for a huge proportion of individual investors. But I assume we’re only talking about retail investors. Right?

    2. Assuming we’re only talking about retail investors, self-defeating market timing could still be a serious problem even if the flows are relatively insignificant, because we don’t know how the behavior is distributed. Most people don’t die in car crashes, but car crashes are still a serious problem. I personally know people who made terrible market timing decisions in 2008-09. If they represent a small minority of all investors, who cares? As finance writers, isn’t it our job to focus on the people who are doing something wrong and tell them how to fix it?

    That said, maybe the message “most investors don’t market-time” could be effective in the same way as “most college students don’t binge-drink.”
16. TFB on March 5, 2012
    
     

    @Matthew – Thank you for chiming in. All great points. I don’t have the studies in front of me. I’m guessing when they look at the funds level, they are not distinguishing the ownership (retail, participant-directed institutional or non-participant-directed). We don’t know who’s trading more actively. Maybe it’s actually the non-participant-directed institutional money causing the flows or plan fiduciaries chasing performance and forcing participants to go along. If we are only talking about retail — studying trades in brokerage accounts — we should also take into account their assets in DC plans.

    Car crashes being a serious problem, true. But it’s a stretch to say drivers as whole don’t know how to drive safely.
17. KD on March 5, 2012
    
     

    TFB, I was reading http://www.ici.org/pdf/2011_factbook.pdf and noticed on pg. 129, a measure of turnover in terms of new sales, redemptions etc, on pg. 130, total assets, on pg. 184, a great breakdown, on pg. 28, turnover rate. Could you please summarize those pages? I think those pages do tell a fascinating story of movement and accumulation of money. I would say, out/in flows by themselves can be difficult to evaluate. The effect that they have on the bottom line is more important in my opinion.
18. TFB on March 5, 2012
    
     

    @KD – Thank you for pointing out those pages in the ICI fact book, a 250-page document full of all kinds of data.

    p.129 – Big movements between funds groups. Don’t know what are driving them. Performance chasing must be a contributing factor; don’t know how large. If investors are dumping one stock fund for another stock fund, they are not timing *the market*; they are timing the fund manager or sub-asset classes.

    p. 130 – Need to overlay this with market performance. It looks like investors are just taking the ride in stock funds. They don’t rebalance. The flows data tell a better story. I think the real story here is not how much investors pulled out of stock funds but how much investors rediscovered bond funds. Bond funds assets jumped 40% between 2008 and 2009. Investors didn’t sell stocks low in 2008 but the risks scared new money into bonds. Again, new money makes up only a small percentage of the total assets. Call it $500 billion new money into bond funds. It’s about 5% of the total assets. 95% of the assets stayed put.

    p. 184 – Individuals rule! Individuals control 85% of all fund assets and 91% of stocks funds assets. Most of the institutional money are in money market funds.

    p. 28 – I think it’s talking about the turnover rate within the fund’s portfolio, weighted by the size of the fund. It’s down from the ’90s, up from the ’70s. Story: fund managers are churning the holdings. Assets in low turnover total market funds are still low. Not sure how relevant it is to this discussion.
19. Allan Roth on March 5, 2012
    
     

    Matthew Amster-Burton,

    Great points as always. It’s difficult to seperate institutional from retain. Three points:

    1) I’ve written about the TD Ameriritrade Advisor platform when TD Ameritrade showed average allocations at the height and the bottom of the market.

    2) I was very surprised to see the difference in investor returns vs fund returns for DFA, near all of wich is either advisor managed or institutional.

    3) While it’s clear that mutual fund investors (broad use including ETFs) underperform stocks due to timing (beyond costs), the great mystery is that, becuasue it must be a zero sum game, who is profiting? The investor can panic and sell the stock fund but then the stock fund must sell stocks (eventually). Someone must buy that stock the fund has sold.

    Any ideas on #3?
20. edward on March 6, 2012
    
     

    To my reading, Yves’ point was that employers are exploiting the myth of meritocracy.
    Half a century ago, the CEO may have started in the mail room, but those days are
    gone, despite the willingness of some to believe in the possibility.
21. TFB on March 6, 2012
    
     

    @edward – I think she took it too far. Her piece gave me the impression she just wanted to pick on Adam Davidson. Does anyone really think any company operates on pure meritocracy? I doubt it. If a Harvard grad believes in meritocracy, the mailroom is really the wrong place to start. Enduring a few years and some long hours with McKinsey, BCG, Accenture, Big 4 accounting firms and the like is probably a much faster path.
22. Matthew Amster-Burton on March 6, 2012
    
     

    Allan Roth: “the great mystery is that, becasue it must be a zero sum game, who is profiting? The investor can panic and sell the stock fund but then the stock fund must sell stocks (eventually). Someone must buy that stock the fund has sold.”

    I don’t know the answer. I think we’re all trying to tell a story based on confusing and incomplete data.

    Remember the famous Odean and Barber paper, “Trading is hazardous to your wealth”? They analyzed actual brokerage account data and found that the most active traders had the worst performance and the least active traders had the best performance. The reason wasn’t bad market timing, however: it was costs. They were looking at traders of individual stocks in taxable accounts.

    If we want to know whether individual investors market-time, there is really no substitute for tracking the behavior of a random sample of individual investors. And that’s very hard to do. Let’s take me, for example. If you want to know whether I’m doing any market timing, you can’t just look at my Roth IRA; you’d need to look across all of my accounts and look at my exchanges and also how I’m allocating new contributions.

    This sounds like a really expensive study. So it’s tempting to say, forget it, let’s just look at aggregate fund flows. Then you end up like us, arguing over who’s moving those funds and what it all means.

    That said, however, I find this, from Steve Utkus at Vanguard, pretty suggestive:

    http://www.vanguardblog.com/2011.08.11/98-stayed-the-course.html

    “we know from our research that during a financial crisis, few investors actually cash out their entire portfolios. Yes, there is always a small fraction of investors—3% in the recent financial crisis–—who sell everything, so there’s always someone to interview about getting out of the market. But they aren’t typical investors.” Also: “In the first eight trading days of August, including two of the most volatile days since 2008, just under 2% of 401(k) participants at Vanguard made a change to their portfolios.”

    Since most people have most of their investments in a 401(k), and changing your 401(k) allocation is a pain and most people never do it, that suggests that most people don’t market-time. Again, though, it’s only a suggestion, not a rigorous analysis.

    And, anecdotally, I’m still bummed about the guy I know who went to cash in 2009 just before retiring. A real shame.

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