Wednesday, March 28, 2012

Investing in U.S. Stocks?

A couple of days ago, Tim Ferriss, an influential member of Gen X (who has built quite a following online of which I consider a member), sent out a Tweet with a link to an article by Auren Hoffman.  His Tweet alarmed me because he carries so much weight with so many people that uneducated readers might take his mention of this article as an endorsement and give it credit it does not deserve.

In this article, Hoffman explains why he won't invest in U.S. Stocks and offers six points as to why not.

  1. Retirement Savings
  2. Globalization
  3. Technology Companies
  4. Taxes
  5. Interest Rates
  6. You are already over-correlated to the stock market

After I read the article, I sent a tweet back to Tim Ferriss saying that this advice is dangerous.  US Stocks belong in a well diversified portfolio.

I'd like to address each of these, in turn.

1. Retirement savings
Hoffman argues, that with the Baby Boomers retiring, the stock market will be flooded with equities.  With more sellers than buyers, the price will drop precipitously.  This will devalue stocks across the board.  He even claims that "one of the biggest reasons the market has been flat over the past 15 years" is because of folks leaving equities for safer investments.
Does this look flat to you?
However, the market is up 92 percent from March 26th, 1997 (15 years ago). The bottom line is that stocks are priced based on a company's future earnings, and the number shares outstanding, not who owns them.  Yes Boomers will transition out of stocks and into more fixed-income (bonds).  I don't expect this to be a calamitous event, like Hoffman predicts.  Before I leave this topic, I must challenge his assertion of 'the last 15 years'.  The first Baby Boomers didn't turn 65 until 2011.  In 1997, the oldest members of that generation were still fully employed and should have been invested in the market.  Even if they did, it doesn't explain the near doubling of the market over that time.

2. Globalization
Hoffman argues that emerging economies will overshadow the U.S. economy and U.S. stocks 'could be the biggest loser' (and not the Bob Harper kind) over the next 30 years.  Hoffman is right that globalization is a two-way street.  What he fails to pick up on is that when these emerging economies take off, American companies will be able to sell higher-end goods and services into these countries. Are rising exports not good for the economy and American companies?  You bet they are.  In addition, American companies may be incorporated here, but they are already reaping the benefits of a global marketplace. Crack open the latest 10-K (annual report) of an S&P 500 company and you will see that much of their revenue comes from overseas (its just too bad they can't bring it back without being taxed on it again ... different rant, different blog post).  America is still THE place in which to conduct business.  How safe are businesses' property rights in Chile?

He also claims that as the world gets more interconnected, ' it is also getting much more volatile.'  I have no idea what data he is backing that up with (none, I am guessing) but global commerce has the opposite affect.  Thomas Friedman, in The World Is Flat, outlines the McDonald's rule where no two countries with a McDonald's have ever gone to war with each other.  This is used to illustrate how interconnected economies use means other than warfare to solve their differences.  Sounds less volatile, huh?

His last sentence is the most damning:  "This volatility is the enemy of the buy-and-hold investor who is at the whim of much more sophisticated global banks."  It is precisely this risk that demands a higher return.  Over time, these deviations produce much higher returns.

3. Technology Companies
Here Hoffman claims that Tech companies drove growth in the 80s, 90s and in the last decade.  Not sure which tech companies drove growth in the 80s, but it wasn't until 1999 when the tech bubble expanded before bursting a short time later.

The bottom line is that flash-in-the-pan tech companies don't drive long term growth.  The most boring companies that you could imagine are the ones to buy and hold for long periods of time.  Trading stocks to catch a ride on the next shooting star is a fool's game.  Long term investing in U.S. equities is not about picking hot, individual stocks.  It is about long-term growth.

4.  Taxes
You aren't going to avoid taxes.  What is the alternative?  Not investing?  Hoffman claims that long-term capital gains are at/near an all-time low.  Will they rise?  Under this President; you bet your ass they will.  But, is Hoffman claiming to so prescient that he knows the long-term rate in 20, 30 or 40 years from now?  I don't think he does.  Not investing in U.S. stocks now because of some phantom tax rate three decades from now is terrible, terrible advice.

5.  Interest rates
To Hoffman's credit (it only took me to point 5 to give him credit), interest rates won't stay low forever.  But, interest rates were much higher in the 80s and 90s, during one of the greatest bull markets in our history.

In 1985, interest rates were six times higher than they are now (Of course, that didn't stop the high-flying tech companies of the 1980s that he writes about).  He should be arguing that it is a terrible time to be in bonds.  As interest rates rise, current bond prices fall.  

6. You are already over-correlated in the market
This one (may) ring the most true.  Much like you shouldn't have all of the money that you invest in the stock of the company you work for, you should be 100% invested in U.S. equities.  Diversification is key.  To get on what's called the "efficient frontier", you need to have a variety of assets that are not highly correlated.

And, that right there, is the entire point that Hoffman is missing.  Much like Lucky Charms are part of a balanced, nutritional breakfast, U.S. equities should be a portion of an investment portfolio that contains Stocks (both U.S. and international), fixed income (bonds), real estate, precious metals, et al.  The percentage of these securities all depends on your risk tolerance.  If you are older, your risk is probably lower; if you are younger, it should be higher.  There is some risk you can diversify away (by holding assets that are negatively correlated) and some risk that you can't (that's called Market Risk).  

Not being in U.S. stocks hurts you in two ways.  One, you are missing out on a key piece of diversification and two; you are missing out on lots of potential long-term growth.

Please ignore the terrible, terrible advice that Auren Hoffman is offering you.

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