These are the opinions of Bill Stant and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Diversification and asset allocation strategies do not assure profit or protect against loss.
In Episode 1 we explored the basic question: How Much Is Enough? In keeping with the theme of Basic Questions, this month we’ll explore another key question for investors and advisors: Why invest? I’ll apologize in advance. My answer is bleak.
First, investing involves the risk of losing money. You may not need to take this risk, especially if you can achieve your goals without it. If you know how much is enough, and you can get it without investing, then don’t invest. The problem is that, for most of us, even the most modest long-term goals may be unattainable without pursuing them through investing.
Why, then, do so many “middle-class” households have so much at risk in the securities markets? While this is a complicated question, we can at least start with a simple answer: Inequality. The distribution of wealth and income is so unequal that the resources available to the average “middle-class” household are inadequate to achieve reasonable goals without taking investment risk.
Now for a somewhat more complicated answer: “Middle-class” households risk so much because they’ve bought into the myth of the middle-class and the American dream. The greater the social inequality we experience, the more crucial to social stability is belief in these myths.
In my opinion stripping away illusions about one’s place in the world yields better financial advice through clearer answers to important questions. Strip away from the average middle- income worker the myths of “middle-class” status and the American dream and you are left with a worker indentured to the mortgage-banking industry for fear of homelessness.
Speaking of fear, now that we all know who we really are, we can get some straight answers. Why invest? Fear. Fear of financial insecurity. This fear has some roots in the not-too-distant past.
Since the 1970s nearly all large employers have divested from the obligations of traditional pensions, where the employer took on investment risk to fund part of the retirement income needs of employees. Most workers today don’t have pensions. A secure retirement is now exclusively their own responsibility.
You can just imagine the one-sided conversations from back in the day: “We’re truly sorry about your pension. But labor is just so cheap elsewhere. And our first obligation, you understand of course, is to our shareholders. But look: Here’s a 401k plan! Good luck! You’re on your own! Don’t forget to count your blessings!”
Among your blessings are financial insecurity, also known as fear. Fear of poverty in retirement is why we invest. Fear for our children’s future is why we invest our education savings and, if we are so fortunate, fear is why we hope, by investing, we might leave a little something for the next generation.
If you’re thinking, “This sucks! I don’t want anything to do with investing,” you should probably think again. This first reaction is rational. It’s not fair. Nobody wants to be on the losing end of a raw deal. But you are a worker in a capitalist society. Life is a raw deal. If it weren’t, society would collapse. You are left with a choice between, on one hand, fear of poverty in retirement, and on the other hand, doing something about it.
You can manage fear of financial insecurity by investing. You might still end up in poverty in retirement. But now that you are doing something about it, you might not. You take part of your pay and put it at risk in the securities markets. In practice this means, if you’re lucky, your employer matches your contributions to a retirement plan such as a 401k or 403b. If no such plan is offered with your job you can open an IRA.
These savings vehicles offer tax benefits. You can deduct Traditional IRA contributions from your taxes. If your investments grow, the growth is tax-deferred until you take withdrawals. With a Roth IRA you forego the tax deduction on your contributions. But your withdrawals are, provided certain conditions are met, tax-free.[i] There are income-based limits to tax deductibility and contributions, and age-based rules. But most workers aren’t paid enough to preclude opening either a Traditional or a Roth IRA.
Ironically, investing makes inequality worse. Stocks, bonds, and mutual funds, etc., respond to the law of supply and demand. Your purchase of investments increases demand. All else being equal, the value of invested wealth goes up. Most of this wealth belongs to a class other than the working class. The more we invest, the wealthier they get. Hopefully, however, our retirement savings grow too.
What if the securities markets go down? It depends on how you are invested. In theory, if your investments are diversified properly, they might not go down as far as they otherwise would. Different investors will be affected differently. There is no one-size-fits-all in investing. And recessions triggered by declining securities markets don’t treat everyone equally.
This is why it’s so important to have an emergency fund set aside to cushion the blow of a downturn. The stock market is usually a leading economic indicator. Bear markets are typically harbingers of recession. And a recession might threaten your job security.
Bull markets, however, have not recently been harbingers of recovery for all. They have been quite beneficial, however, to the owners of most of the supply of stocks. One of the reasons is that the rich aren’t as threatened by bear markets. Their privileges have been long secured. A sharp decline in the value of their stocks doesn’t cut as deep. Elites, however, are not without their own falsifying mythology.
The ruling class believes its own myths. Hence it behaves as if its time horizon is infinite. The rest of us should not be taken in by this illusion. Like empires, social orders do not last forever. And capitalism is getting really old. Perhaps its senility partly explains the absurdity of workers having to put part of their hard-earned pay at risk in the securities markets.
Financial advice premised on the notion that capitalism will last forever is bad advice.
To the barricades comrades!
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[i] After-tax contributions to a Roth, known as “basis,” can be withdrawn tax free anytime. The growth part of the account balance can’t be withdrawn free of a 10% penalty tax until age 59.5. And the growth part of the account can’t be withdrawn tax-free until the account has been open for at least 5 years. There are some exceptions. The most recent Internal Revenue Service Publication 590b, available at https://www.irs.gov/publications/p590b, is the authoritative source.
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