For me it is over. I will never again be stupid enough to invest my savings in something which value depends mostly on people’s superstition.
What will you invest in then? Bonds? CD’s? Or will you just stuff your savings under the mattress? Serious question here.
-XT
Well, as you probably already figured out from my post I am not very economically inclined, so I don’t have a good answer. I would think something with a fixed interest rate would be better. I am really disillusioned after losing quite some money due to something the people fears might happen. Or shares dropping when a company makes huge profits, but still a few million short of projected values. The market is way too knee-jerky to be relied upon. I guess it means I lose the chance of making big profits with little effort, but at least I won’t lose my money. It feels like a big scam anyway.
I hate to break it to you, but all value depends on people’s superstition. After all, what do you think money is? All your money could disappear tomorrow if China starts feeling like like the US can never repay its debt obligations.
Not that I own any dollars, but then again I’m sure it would still affect me somehow since the markets are way too dependent on each other.
Do you have any evidence that people can actually beat the market predictably? True, when the market does a random fluctuation we can assign a post hoc reason, unlike a slot machine, but on the other hand in casinos you can predict how much you will lose in the long run fairly accurately.
So that’s why I’ve always been suspicious of index funds! Many thanks for that clear explanation.
Depends on the index, don’t it? There are large cap indices and small cap indices, broad market indices and sector indices. You want to place a contrarian bet and you can do that, in a broad way, with indexed products as well.
Assuming someone is in the market, success can only be judged relative to the indices. By definition someone playing the broad market by indexed products cannot have either an outstanding or a sucky result. They get an average grade no matter what. Bear or bull. Now the question is how does that compare to managed funds or to individual stock-picking? Well the average player will do average, won’t they? For most funds (after management fees are taken into account) the answer is that the indexed products usually outperform, because those fees eat in over the years. Can an individual investor do better and avoid fees in the process? Sure, but when we do we take on more risk. Me, I like rolling my own and my big wins have offset my big losses to the point that I am just a bit better than the indices, but not by much. If I charged myself a management fee my return would probably be just right on par. But it’s a fun hobby. For someone who doesn’t enjoy the process and doesn’t have enough to diversify their picks and to afford a few whiffs on the way, the index funds are a dandy choice.
How much capital would a business raise if its investors were unable to sell their shares?
Given the turmoil over the weekend, a 4.4% drop seems pretty minor. Yeah there are issues, but what market won’t have them. Are there additional regulations you’d support? In general, the market is working fine. Institutions that screw up get clobbered, and investors who don’t pay attention get clobbered also. I don’t see the problem.
I was making an analogy. The lack of regulation has allowed companies to play with loaded dice. Research can only go so far, since there is so much off the balance sheets. Transparency is a thing of the past. The investor is only allowed a tidbit of the information that he actually needs. Cox, bless his little heart, goes and says that you can’t naked short sell 19 companies, while the practice runs wild elsewhere. He hasn’t gone after a single failure to deliver. He has failed to regulate the nakeds, because of his nearly fanatical belief against regulation.
Great posts, Scylla, but I need to comment on these:
Of course you can. The market and corresponding indexes are low now. I’m putting more money into my index funds this year than I was before. When the market recovers, I’ll put proportionately less into the index funds.
Index fund investments don’t do better than the market. But they don’t do worse, either. And their management costs are low. That can be a huge factor to someone with only little to invest.
For an investor with a small pool and not a lot of experience, they’re a great place to put money. Once someone has a larger pool to work with and better understanding of how the market works, they can start risking better returns with other strategies.
As I tell my friends when extorting them to start saving seriously: you don’t need to do a lot of research and try to beat the market, you simply need to beat your bank’s interest rate. And index funds do that with minimal risk and cost.
OMG! Cox just grew a pair! (several months too late)
Awesome post, Scylla. Very informative.
As someone who has worked in the field, can you tell us how pervasive the idea was that “I’ll take actions to maximize my bonuses in the next couple of years, bringing in millions for myself, and I don’t care if my actions will lead the company down a path that will destroy it in the long run”.
That is, do the traders at Lehman Brothers and Merril Lynch, who made millions and millions when times were good, care that their companies have collapsed? (Assuming they stored their money somewhere other than their company’s stocks)
Also, what the credit rating agencies did (give AAA rating to instruments they had no idea of how to evaluate) seems like gross negligence to me. Will they be held accountable by anyone for doing so?
Finally, given the fact that there are billions and billions of dollars in complex financial instruments that nobody fully knows how to value, and have caused a web of interconnectedness that threatens the whole financial system if one firm (like AIG) collapses, doesn’t that make you feel that there is something seriously wrong with how the stock market/financial system is currently structured?
Horse racing: You have information on the past performance of horses and jockeys, and have some information about their current state of health, so the outcome of the race is mostly deterministic, but there is always an element of chance, and people bet accordingly. Seems like it matches the stock market quite well.
Also, there are billions and billions of dollars in complex financial instruments that nobody knows how to value, and these instruments affect the valuation of many companies, and the value of these companies is interconnected (because they are interconnected through these complex financial instruments), so there is an unknown level of correlation in the unknown valuation of companies. That doesn’t seem like there is much “information” out there. So, it is much more like gambling than people let on.
Some choice quotes from Time
“You can read through every financial statement in the world and have absolutely no clue as to the risks they are taking”
"Confused? You’re not alone. The best case for the bailout seems to be that nobody has the faintest idea what the consequences of AIG’s failure for financial markets would be, but the fear was that it could lead to total chaos. "
If you’re looking at short-term fluctuations, yes. If you’re looking at the long term, there are many, many people who beat the market by investing on fundamentals and holding for the long term. Warren Buffett, Peter Lynch, me. Just because Joe Average keeps pulling the handle like it’s a slot machine doesn’t make it one.
I said the stock market is not a casino. Horse racing is also not a casino. Stock research is still more deterministic than horse racing anyway.
Anybody who buys stocks that they don’t know how to value is indeed gambling. This is not saying that the stock market is a casino or that investing is probabilistic gambling.
Again, just because Joe Average looks at the stock market and sees a slot machine and randomly pulls the crank, doesn’t mean he couldn’t be banking on a more deterministic outcome in the long term.
If you want to stick to the gambling analogy, when you buy into the market you’re buying into the house. Over the long run the house always wins, but there are times when there are people that cause the house to lose. When that happens all you can do is shrug and wait for the house to start coming up big again.
If you look at the market’s performance over the last century, if you got in and you stayed in you’re a rich man. It’s the people that bet the farm on a single pull of the handle that inevitably get hammered.
But my point was that, with the advent of these very complex financial instruments nobody knows how to value them, because of their complexity, and because of how interconnected everything is (so that when something fails, the repercussions are almost impossible to quantify, and thus the risk almost impossible to quantify). And if nobody knows how to value them, then everybody is gambling.
This is not me saying it (i.e. that companies using these instruments are almost impossible to value). I have read it in many finance related articles (like the one from Time I linked above). There are also many books out there, and IIRC, one was from one of the people who pioneered a popular form of complex financial instrument, and now he has written a book saying essentially"we have created a monster, and nobody knows what will happen once something starts failing".
Do you disagree with the assessment that these complex, interconnected, financial instruments are difficult to describe in terms of risk, and therefore are difficult to value? Or, even if the instruments per se are easy to value, do you disagree with the fact that the combination of such instruments in a web of interconnectedness that ties many companies together, makes the valuation of these companies almost impossible to quantify?
Yes… if you stayed in for a century.
If you bought an index fund for the Dow Jones on Dec 1965, when it was at 983, you would need to wait until Oct 1982 to start making money again.
That’s 17 years! That’s pretty “long-run” in my book.
Similarly, if you bought in on Dec 1999 (@11,500), you would be at a loss today(@10,700). That’s almost nine years, and you’re losing money.
I have never understood complex derivative vehicles and frankly I think they’re voodoo. Accordingly, I never invested in them, and accordingly I never lost money on them. Certainly everybody is feeling the falling tide lowering all boats because some large banks failed to observe such a commonsense rule, but the overall market has always to some extent been subject to unforeseeable circumstances (wars, shortages, bubbles, etc). Acknowledging the risk in market inefficiencies, the market is still beatable by staying informed and avoiding the obvious pyramid schemes that pop up from time to time. Ask Warren Buffett, Peter Lynch, and any other market-beating investor whether they think they’re completely at the mercy of random fate, or whether they just applied a consistent approach and stuck with it.