I'm having a financial existentialist crisis

February 11, 2009 9:36 AM

Have I been wrong on my financial core beliefs?

I have had a worldview when comes to finances for over 15 years that I am now questioning.

1. I believed 8-12% return on your money over the long term was reasonable, conservative, and realistic.
2. I believed in No-load mutual funds.
3. I believed in dollar cost averaging.
4. I believed Technical Analysis does not work.
5. I believed in A Random Walk Down Wall Street.

First there was this segment from NPR(of all places!) that blew my mind: Technical Analysis actually works (at least for oil)
Then this article from Slate on Suzy Orman. The article disses No-load, and Dollar-Cost Averaging without any references.

Was NPR sinking to a major network level of reporting? Or does TA really work?
What is the mounting evidence against No-loads as part of a passive, long term strategy?

There is no other choice for me but to be an optimist for the long term health and prosperity of our country and by proxy, the stock market. Else, the best thing to do would be to stock up and canned food and guns, and that really isn't a nice way for me to live.
Why then is Dollar-cost averaging bad, if you are doing it in mutual funds, and doing it for the long term?

There are many books out know calling into question A Random Walk Down Wall Street. Is there any truth to them?

posted by MrMulan to work & money (22 comments total)

Technical Analysis is a self fulfilling theory - If the chart says the stock will go down, technical traders sell, which causes it to go down.

You also don't hear about the technical traders who loose all their money -there is a severe survivor bias.

You shouldn't get excited when you make more than 10-12% a year because years like this one offset it. It's hard to keep doing it, but consistency is what make dollar cost averaging work.
posted by bensherman at 9:41 AM on February 11 [2 favorites has favorites]

My understanding of the "random walk" idea is:

1) There are some mutual funds that will outperform the market. They may use strategies like technical analysis.
2) There are other mutual funds that will underperform the market. They may also use strategies like technical analysis.
3) You can't tell which funds are which, especially not based on past performance.
4) So you should buy an index fund, which will at least match the market.
5) You should buy a no-load one with low costs, because they are otherwise equivalent.

Has any part of that changed?
posted by smackfu at 9:53 AM on February 11 [1 favorite has favorites]

The only one of your assertions that is undeniably incorrect is 1. Way too high. Long-term stocks have returned around 8%. For most people that is the riskiest part of their asset allocation.

2 is almost always spot on

I happen to pretty much agree with 3-4, but can see why people would disagree. I think they are wrong, but can see their arguments.

5. I happen to disagree with and would point to the Fama-French work.
posted by JPD at 9:53 AM on February 11

I agree in part with bensherman. I think there is a degree of self-fulfilling prophecy to technical analysis, but I also believe that the theories did not come from nowhere. I think what hurts technical analysis more is the subjectivity, different people will spot double tops, flags, pennants, etc. in certain places where others will not. The main thing to remember with technical analysis is that it is just another tool, if one were to base all of his or her trades solely on technical analysis there is a good chance one will not be successful, but if used as a tool in part of a larger trading strategy I think it can only help one's odds.
posted by thenuts at 9:58 AM on February 11

I've noticed a little bit of a blogosphere hate-on about dollar-cost averaging recently, but most of those people at least complain that purchase fees eat up your eventual gains. If Salon's argument against it consists solely of "don't throw good money after bad" you probably don't have much to worry about.

Right now people are just freaking out about the economy and seeing previously safe bets not pay off. We all say we're in it for the long term, that we understand there are busts and booms and how it will all even out in the end, but i don't think any of us are going to sit around smiling when our portfolios are suddenly worth half of what they were. We're going to go run around yelling about how The Smart People were wrong and make up our losses in speaker's fees and book deals.
posted by soma lkzx at 10:01 AM on February 11

1) For a look at perspective, visit the IFA Risk/Return Calculator. You can find the average rate of return all the way back to 1928 (or any period in the middle). From 1928 to January 31, 2009 the average rate of return has been 9.03%. Of course, that's not a very useful number for anyone. What matters is how much money you have. Further, that number is very volatile (since the stock market is volatile!). You can get the closest to that number if you follow fiscally prudent strategies, even like those by Suzy Orman (even though I hate to admit it). Yes, the stock market may drop 40% in one year. However, that should not affect you much if you're sensible. For instance, don't have 100% of your money in stocks when you're 5 years away from retirement.
2) If you believe in a random walk, which I'm not too qualified to talk about, that's a logical conclusion. Why would you pay money for someone to predict a future that's impossible to predict? For what it's worth, 100% of my money is in no-load funds.
3) Dollar cost averaging is neither "good" nor "bad." It is merely a way to reduce volatility in the stock market. You won't make more or less money doing it. The way to make the most money is to put all your money in when the market is lowest. Unfortunately, that's really hard to do. Since people are human, dollar cost averaging makes it easier.
4) Refer to bensherman. Also, if technical analysis worked, everyone would do it, making it not work.
5) I'm not qualified to say too much about that. However, I do agree with you.
posted by saeculorum at 10:02 AM on February 11

Dollar cost averaging is neither "good" nor "bad." It is merely a way to reduce volatility in the stock market. You won't make more or less money doing it.

I agree with this in general, your returns for any money you have invested at any given point with a dollar cost averaging strategy won't be any better than with any other strategy.

One aspect of it that can be bad though, is if you purposely invest funds over time rather than in a lump sum. For example, if you inherit $12,000 in January and invest $1000 per month as part of dollar cost averaging strategy, you're going to have less expected returns than if you invest it all at once in January. Most dollar cost averaging schemes center around investing a certain percentage of each paycheck, though, which doesn't suffer from this problem.
posted by burnmp3s at 10:12 AM on February 11

JPD,

I don't have the source.
The reason I put a range is that you get those numbers if you do it time chunks of 5, 10, 15 and 20 years with different starting points. You never know where you'll begin, but it ranges from 8-12. A single number isn't very helpful, but a range is something a person can plan with.
posted by MrMulan at 10:20 AM on February 11

I don't understand? Long-term equity returns are about 8%. If you are going to be invested in equities assume 7%-9% for the range. You looking for a source for that? At some point it doesn't make sense to be 100% in equities so you have to assume returns are lower then the 100% equity portfolio

Look at stocks for the long-run - 1871-2001 real return on stocks was 6.8. The last 7 years drop that down to around 6.4-6.5, then assume some level of long-term inflation? say 2-2.5% - et voila. 8.4%-8.9%

You could also derive what you think long-term equity returns would be using an economic model. Try here
posted by JPD at 11:00 AM on February 11

I think the problem is with the concept that you can have an unshakable worldview with regards to financial matters. It makes much more sense to be adaptable and flexible to the current situation.

Take your statement:
I believed 8-12% return on your money over the long term was reasonable, conservative, and realistic.

Reframe this by choosing to tell yourself that for a while you were able to get a 8-12% return on your money, and while that was great, market conditions have changed.
posted by yohko at 11:23 AM on February 11

Standard & Poor's Indices Versus Active (SPIVA) - percentage of actively manage funds that lag their relevant benchmark.

Over five years ending June 2008, S&P 500 outperformed 68.6% of actively managed large cap funds, S&P MidCap 400 outperformed 75.9% of mid cap funds and S&P SmallCap 600 outperformed 77.8% of small cap funds.

posted by milkrate at 11:36 AM on February 11 [2 favorites has favorites]

yohko: market conditions have changed

Why?

For about 80 years, we've been able to get 8-12% return out of the stock market over time. I'm not so foolish to admit there's a possibility economic markets can fundamentally change. However, a three month stock decline (of which the majority happened in about three weeks) does not an economic revolution make.
posted by saeculorum at 11:36 AM on February 11

TA is good for secular trends, going to cash when the market is shitting the bed and getting back in when the waters are safer.

I (mostly) lurk in Karl Denninger's discussion forums and while I roll my eyes at the Elliot Wave theory counts and "fib[onacci] dates" and such I do think using TA defensively this way is a good idea -- as can be

"It's better to be out of the market wishing you were in than in the market wishing you were out."

Here's my advice for a previous related ask-me. Check out the 20/50 video in my following post there, too, for evidence that TAing the 20/50 SMA signal has worked well in the past.
posted by troy at 12:18 PM on February 11

or about 80 years, we've been able to get 8-12% return out of the stock market over time.

The boomlets of the 50s and 60s were due to unique postwar conditions that clearly do not apply now. The S&P started the 1970s at 90 and finished at 110. The baby-boom generation was turning 30 in 198x and will be turning 70 in 2020. These demographics will determine the money flows into and out of the market.

The party continued in the 90s due to the US turning from a creditor nation to a debtor nation.

Ten years ago the S&P was at 1300. While I think that is a fair valuation of our plant once all is said and done, getting back there from here is going to be an interesting challenge.
posted by troy at 12:28 PM on February 11

Counter to the Orman article you referenced
posted by jckll at 1:58 PM on February 11

Ten years ago the S&P was at 1300. While I think that is a fair valuation of our plant once all is said and done, getting back there from here is going to be an interesting challenge.

The 10 year S&P 500 chart is actually worth looking at for anyone who is freaking out. It dropped just as far last time it hit 1300.

(It's also worth noting that dividends are not reflected in these charts, so 1300 S&P 10 years ago is not really the same as 1300 S&P a year ago.)
posted by smackfu at 2:32 PM on February 11

Pretty much everybody was been wrong on thier financial core beliefs.
posted by theora55 at 3:38 PM on February 11

1. I believed 8-12% return on your money over the long term was reasonable, conservative, and realistic.

Seems a bit high to me, if "long term" means 30 years.

2. I believed in No-load mutual funds.

Depends on the structure of the fund and the incentives of the fund manager. A good fund with a load probably does better than a no-load fund with a manager whose only incentive is to make x% this quarter. That manager might make different, worse decisions for the long term.

3. I believed in dollar cost averaging.

I think there's your first mistake. DCA is a layer of obfuscation for the lazy investor. It specifically says not to pay attention to the price of this thing you are buying. It works better than being wrong, but not as good as being right. And it tells the investor that the market is made of magic and light, and you should just give it its monthly offering and pray for good results to come out the other end.

4. I believed Technical Analysis does not work.

Depends on what you are using it for. It works as a method for determining the health of a market, or for seeing that something is going on. It doesn't explain why, or what to do.

5. I believed in A Random Walk Down Wall Street.

I'm not sure what that means. That you can tell how the market is doing by what you see in people's faces on Wall Street? Or that the randomness of the market will win in the end?

Pretty much everybody was been wrong on thier financial core beliefs.

No, just the people who believed in a free lunch, and didn't believe in bubbles...
posted by gjc at 5:13 PM on February 11

This link is useful to answer the question of what long-term returns expectations are reasonable
posted by JPD at 7:41 AM on February 12

I'm not sure what that means.

It's a book.
posted by smackfu at 7:48 AM on February 12

2. If you believe in 5., then you want index funds, which are not necessarily the same as no load funds. Obviously, you want a no load index fund.

3. If you believe in 5., then dollar cost averaging is fine. But it's really more of a personal finance tool, than an investing tool. If you have a lump sum to invest, and you believe that stocks are long term positive (1.) and you believe you can't time the market (5.), then that implies you should just invest it all immediately.

5. I believe it's obvious that the efficient market hypothesis (Random Walk Down Wall Street) is almost true. By true I mean a guide to how to invest. Obviously, it can't be comletely true, because if everyone believed in it, no one would be exploiting inefficiencies. But trying to beat the market is by definition a zero sum game. So unless you're possessed of genius level sage financial acumen and discipline (Warren Buffet), or sophisticated tools, information and formulas (hedge funds?), then the market is efficient for you.
posted by jefftang at 8:29 AM on February 12

From another forum: 2 Questions on Don't Listen to Suze Orman Article
posted by smackfu at 9:50 AM on February 12