Citigroup paid $7 billion as part of a settlement with the Justice Department, but homeowners affected by toxic mortgages are still struggling.
Alejandro Bedoya, midfielder for the U.S. World Cup team, talks about blowing a paycheck, investment strategies, and an important money lesson from his father.+ READ ARTICLE
Bedoya on his biggest money mistake:
My first paycheck, I remember, I put in the bank. And the second one…you know, in Europe everybody is always…they want to look good…and it’s probably buying one of those brand name designer things that, I remember, for that month it was like probably my whole paycheck. Buying things like that. I mean, those things are cool to have, but it’s not really important.”
Bedoya on what he’s learned from his father about money:
He’s always taught me that it’s not what you’re worth, it’s what you negotiate. That holds true in every aspect. It’s really how you handle things and how you go about what you think you deserve. I feel like that has helped me out a lot with the opportunities I’ve gotten with money and investments.”
People in New York tell our Mannes on the Street where rising prices are impacting their lives the most.+ READ ARTICLE
Related: 3 Ways to Inflation-Proof Your Life
Money's exclusive survey reveals mixed emotions when it comes to our personal economy: We're feeling pretty good today, but worried about our prospects for the long run.
At first glance the Brough family of Dallas seems to have emerged from the tumultuous economic events of the past six years unscathed.
Sole earner Richard, 44, a project manager in software consulting, worked steadily throughout the financial crisis — even landing a new job that pays $45,000 a year more than his old one, which pushed his salary comfortably into six-figure territory. The value of the home he shares with wife Kelley, 46, and two of their four children (ranging in age from 15 to 27) has rebounded to pre-2007 levels, and so has his 401(k).
Yet five years after the official end of the downturn, Brough feels anything but confident about his finances.
“I’m more obsessed with security and worried about the future than I was during the recession,” he says. “Even though I was making less then, our money seemed to go further. I’m anxious about being able to pay for everything we need, anxious about our savings, anxious about staying out of debt.”
The results of MONEY’s new national survey of more than 1,000 Americans age 18 and older reveal that most people share Brough’s concerns: The Great Recession may be over, but a Great Insecurity seems to have emerged in its wake.
True, the majority of respondents acknowledge that their finances are better now than they have been in some time. About three-quarters report that their situation has stabilized or improved compared with a year ago; less than half felt that way when MONEY posed that question in 2009.
Indeed, in that earlier survey, only about 10% said they were doing better than the year before, vs. 30% now. And far fewer folks seem to feel as if they’re teetering at the edge of a financial cliff: Just 24% say their circumstances have gotten worse over the past year, vs. 51% in 2009.
Meanwhile, people are even more optimistic about the year ahead: Almost nine out of 10 expect that their finances will be the same or better 12 months from now.
Yet while the outlook for today and tomorrow has brightened, the day after tomorrow appears decidedly grayer. Six out of 10 respondents own up to being worried about their family’s long-term economic security, and even greater numbers register anxiety when getting down to specifics; they’re really worried about having enough money for retirement, how they’d manage if a financial emergency arose, whether safety net programs such as Social Security and Medicare will be intact when they need them, and how they’ll pay for health care.
Moreover, that undercurrent of anxiety cuts across virtually all groups: Young and old, men and women, married couples and singles, even the affluent — all shared the same concerns.
Some of the fretting may be the result of a lingering hangover from the financial crisis. “People are influenced by what is more recent and most vivid, and that is still the recession,” says behavioral finance expert Meir Statman, a professor at Santa Clara University in California. “We fear that what happened in 2008 will happen again.”
The current state of the economy is also cause for continuing concern. “The unemployment rate is still pretty high, and there are a lot of questions about what the government is going to do,” says Olivia S. Mitchell, a Wharton economics professor who has studied the impact of the financial crisis on U.S. households. “We’re in an environment of pervasive uncertainty that’s not going to go away for years.”
What is causing the most agita about our financial future — and why? How has that affected the way we manage money? And what are the best steps to alleviate our anxiety and move forward? The answers follow, along other insights from the 2014 Americans and Their Money survey.
We’ve regained some stability — and faith
When MONEY polled Americans about their finances in 2011 and 2009, the nation was hunkered down and wrestling with post-recession panic. Families had pulled back drastically on spending, postponed vacations and major purchases, and even curtailed giving to charity. People were deeply worried about losing their jobs or getting a pay cut, concerned about the eroding value of their homes, and anxious about big losses in the financial markets.
Five years ago, when asked whether they’d be better off putting money under the mattress or in stocks, half of the respondents chose the bed.
Now that home values and stock prices are up and unemployment is modestly down, a lot of that fear has abated. This year, for instance, 71% of those surveyed opted for stocks instead of the mattress. Folks are once again comfortable tuning out the daily movements of the market: Only about a third of those surveyed said they were laser focused on financial news, vs. two-thirds in 2009.
There’s also a greater willingness to stretch for risk: In the most recent poll just over half of Americans said it was more important to keep investments safe than to aim for a higher return. While that’s a substantial number, it’s down from 64% three years ago. In general, concerns about losing money in the market, declining home values, and being laid off have dropped to close to the bottom of the collective worry list.
Other signs bolster the notion that Americans are backing away from the financial bunker mentality that swept the nation after the recession. A Challenger, Gray & Christmas analysis of employment data, for instance, found that more Americans are quitting their jobs, reflecting growing confidence in their ability to find a better position elsewhere.
After years of relative frugality, Americans are loosening the purse strings a little. Sales of big-ticket items such as cars and new homes recently hit six-year highs, and the fourth quarter saw the largest quarterly increase in outstanding credit since before the recession.
Among those feeling calmer is Ralph Schmitt, 69, of Fortson, Ga., whose savings fell by a third in the crash.
When the recession arrived, Ralph, who had planned to retire in 2008, decided to postpone that step. He and his wife, Kathleen, did not sell any investments, however, and by late 2009, with their portfolio growing again, Ralph felt confident enough to quit for good.
“I was still worried about the uneven recovery and our retirement savings,” he admits, “but I believed in the resilience of the U.S. economy and the momentum of the stock rebound.”
Besides, he says, he and Kathleen, 67, who stopped working in 1993, felt they could live on less, having drastically cut back on their spending for travel, fine dining, and theater.
Today the Schmitts’ portfolio is back to where it was in 2007, and the couple have “kicked up” their spending accordingly. “I wanted to travel extensively with my wife while we still had our health,” says Ralph.
Good habits have held
We may be opening our wallets again, but that doesn’t mean we’ve abandoned the fiscally prudent practices adopted after the crash. Nearly three-quarters of those in the MONEY poll reported that over the past three years they’ve been cutting back on luxury purchases and eating at home more often — a modest drop from 2011, when consumers were still shell-shocked from the financial crisis, but a big increase from the 2009 survey.
Nearly six in 10 say they feel guilty about buying something they don’t need, virtually unchanged from three years ago. And six in 10 say they’re trying to beef up their emergency cushion, a huge jump from 2009, when less than a quarter said the same. Indeed, the national savings rate, while down from its post-crash peak, is now 4%, about where it’s been for much of the past three years and substantially above the 1% rate of the pre-crisis boom years.
Whether we’ll be able to maintain that restraint for good, however, is unclear. “We’re not back to a status quo environment that would allow you to make those kinds of judgments,” says Scott Hoyt, senior director of consumer economics at Moody’s. He thinks consumers will let loose eventually: “Underestimate the desire to spend at your own peril,” he says.
It’s particularly tough to assess the long-term trend while the recovery is still so uneven, notes Caroline Ratcliffe, a senior fellow at the Urban Institute, pointing out that some groups, such as high-income baby boomers and retirees whose wealth is tied to the stock market, are feeling more flush than others these days.
Jim Durkis says the improving economy has not changed his habits — yet. The government lawyer and his wife, Deborah, an elementary-school teacher, both 50, were looking to buy a bigger house near where they now live in Albuquerque but decided against the move when housing values in the area declined.
Since the recession, the family, which includes Jason, 22, and Kaja, 21, have switched insurance companies, delayed vacations, and cut cable — though they signed up again last summer after Deborah, a former-spender-turned-bargain-hunter, found a good deal.
Though both spouses are working and he has a solid pension plan, Durkis says he’s still focused on saving. “I’m not convinced there’s been a true recovery,” he says. “I’d rather have extra money, just in case.”
Most Americans believe that the Great Recession is over, according to MONEY magazine's new national survey. But a Great Insecurity seems to have emerged in its wake.
Many of us are sticking to the good financial habits we adopted after the crash — a trend explored in Part 1 of this story. One reason for that: Once you look beyond the immediate future, optimism fades and it becomes clear that Americans remain deeply worried about their long-term economic prospects.
Consider: In the MONEY survey, nearly two-thirds of those earning less than $100,000 and roughly half of those making six figures said they were worried about their family’s economic security; roughly six in 10 Americans were anxious about how they would pay their health care costs.
The majority fell behind on their savings, given their stage of life, and almost three out of four were concerned that their money wouldn’t last through retirement. Other recent studies have found similar concerns: New research from the Consumer Federation of America, for instance, found that only a third of Americans feel prepared for their long-term financial future.
Why does the outlook seem so scary? Some experts think the events of the past six years have shaken the belief in our ability to accumulate wealth over the long haul.
“When the housing market fell, that really scared people,” says Michael Hurd, a senior researcher at Rand, who studied the effect of the recession on household finances. Hurd found that a decline in home values caused people to cut back on their spending more than a similar drop in the stock market.
In addition, the erosion of trust in our financial system will have a lasting effect, says Tyler Cowen, professor of economics at George Mason University.
“If you don’t believe that your environment will persist, you’re not willing to stake out plans,” Cowen notes. “For example, you won’t buy a home based on the premise that in five years you’ll be earning more money. The volatility of the stock market and the government shutdown have only made it harder.”
Speech pathologist Janel Butera, 47, is one who isn’t counting on anything. A divorced mom of two sons, ages 12 and 13, from Corona, Calif., Butera has made reducing spending and boosting savings a priority over the past five years. Out went the gym membership and vacations; packed lunches and day trips to the beach are the new norm.
“The economy as a whole — I don’t put a lot of faith in it,” she says. “I’m not counting on getting any retirement help, not even Social Security.”
Butera is proud that she’s managed to rebuild her finances after suffering the twin hits of divorce and the recession but is still anxious that she might one day become a burden to her boys. “I worry about them having to provide for me when I’m older,” she says.
Her concern is shared by many: In the MONEY poll, one in five Americans with children said they would probably need their kids’ financial support someday.
We’re living close to the edge
One reason we’re not feeling so hot: While our 401(k)s may be flush again, our emergency savings are not. Half of the respondents in the MONEY poll confessed to living paycheck to paycheck; roughly six in 10 felt they didn’t have enough money set aside for emergencies and didn’t think the family’s breadwinner would find it easy to get another job if laid off.
And almost all people, it seemed, felt like they’d need a higher income than they now earn to really be financially secure — even those who currently bring home a six-figure income. No wonder that anxiety about how we’d cope with a real financial emergency tied with concerns about outliving retirement savings as the most prevalent money worry.
In fact, money has gotten tighter for many lately. Household income, adjusted for inflation, has dipped 4.7% since the recession, economist Cowen points out.
One thing’s for sure: All this stress isn’t helping our love life. The MONEY poll found that finances are both the most frequent source of spats between couples and the cause of the most serious arguments — far ahead of the second-place finisher, household chores, and snoring, which came in third.
Edward Martinez of Tyler, Texas, is one of the many who are worried about not having an adequate cushion. Though Martinez, 44, made $140,000 working for a military contractor in Iraq after the recession, he now earns less than six figures as a technical specialist with the Smith County appraisal district.
He and his wife, Jennifer, 38, a professor at the University of Texas, have an 18-year-old daughter living at home and also help support Martinez’s 22-year-old daughter from his first marriage.
Right now the family has only about a month’s worth of savings, which could easily be wiped out by a run-of-the-mill financial emergency, Martinez acknowledges. He’s in the process of getting a pharmaceutical degree, which he hopes will boost his earning power a few years from now.
Like Martinez, many parents these days are helping grown kids, making it even harder to save. More than a third of the parents of children 22 and older in the MONEY survey are helping out at least one of their brood; of those, three in 10 are shelling out $5,000 or more a year. And that’s not likely to change anytime soon: In the survey, parents providing such support believed their adult child wouldn’t gain full independence until age 30; adult kids supported by a parent put that age at (gulp) 32.
The kids may be all right in the end after all
Such findings are in keeping with alarms many experts have sounded predicting that young adults would bear the most lasting scars from the Great Recession, just as the Depression had a lifelong impact on the way people who came of age at that time managed their money.
Certainly millennials have had a tough slog so far: The job market for this youngest generation of workers is grim (nearly half of those unemployed are under 34, a Demos study has found), and the average student-loan debt for recent college grads is $30,000.
Atlanta resident Courtney Clemons, 25, has a typical millennial story. The Georgia State University grad interned at a travel agency while in school and was hired there full-time after she got her degree. But her earnings, ranging from $25,000 to $35,000, depending on bonuses, aren’t enough for her to get by on her own. So her parents provide about $500 a month to cover her car and health insurance, cellphone bill, and some spending money. Contributing to the problem: She has $90,000 in student loans.
“The jobs you get after graduation aren’t conducive to living on your own,” she says. Morley Winograd, co-author of Millennial Momentum: How a New Generation Is Remaking America, agrees. “Millennials are a very economically stressed generation, and that stress will last for their lifetime,” he says.
Yet MONEY’s survey, among others, shows a more mixed picture. Today’s younger folks do seem at least as value-conscious as their elders, and maybe even more so: A greater percentage of millennials say they are eating at home these days than they were in 2011, for example, while the numbers had dropped slightly for the general population. And for now at least, younger investors also seem more nervous about the stock market, keeping a greater percentage of their portfolios in cash than older people do.
When it comes to other attitudes about spending and saving, however, millennials seem to be pretty much like everyone else. They are just as likely to covet new, innovative products. And they aren’t cutting back on luxury spending or postponing vacations with any greater frequency than their elders either. Nor do they place more importance on saving; almost everyone, young and old, affluent or not, says that saving money is more important to them now than it was a few years ago. And for all the lamentation about how dim the prospects are for this generation, younger folks are surprisingly upbeat about their future: The vast majority (86%) expect to live as well as or better than their parents.
For now, though, while millennials may be having difficulty leaving the nest, no one seems particularly unhappy about it.
“Boomers created a helicopter parenting style and went out of their way to be friends with their kids,” says Winograd. “Many are delighted to have their adult children home.” The kids apparently don’t mind either. A recent Pew study found that 78% of adults ages 25 to 34 who were staying with their parents said they were satisfied with their living arrangements.
Some experts believe this turn toward family may be one recession-induced change that truly lasts. Reality is causing more people to let go of the postwar expectation that living standards will naturally just keep getting better, says Stephanie Coontz, a professor of history and family studies at Evergreen State College in Olympia, Wash.
Many may end up caring less about keeping up with the Joneses and more about being with the people who matter the most to them as a result. And indeed, almost 80% of the respondents to the MONEY survey say spending time with family is more important than ever to them, an increase of 10 percentage points over the past five years.
Janel Butera is one of them. The speech pathologist and mom felt her financial situation was secure enough last year to cut back her workweek from five days to four, so she went for it. “Sure, I could use the money,” she says, “but spending time with my kids is more important.”
Participants in an exclusive Money magazine survey reveal how they feel about their finances. Although the Great Recession may be over, they’re not all that confident about their prospects for the long run.
Who: Janel Butera, Corona, Calif
Profession: Speech pathologist
How she’s faring: Over the past five years, Butera, a divorced mom, has focused on spending less, saving more, and teaching her sons, Shane and Seth, how to be responsible and resilient when it comes to managing money.
“It hasn’t hurt to cut back on the things we were spending on. We figured out what really mattered to us with the recession.”
Who: Jennifer and Edward Martinez, Tyler, Texas
Professions: Professor, technical specialist
How they’re faring: Edward Martinez, who provides about $250 a month in support to his 22-year-old, says the family feels too squeezed to save as much as they should. So he’s changing careers — he’s in pharmacy school now — to bring in more income.
“If we have a bad accident or a health emergency, we’re not prepared,” says Edward. “We don’t even have three months of income saved.”
Who: Courtney Clemons, Atlanta
Profession: Travel agent
How she’s faring: Struggling under the weight of $90,000 in student loans, the 2011 Georgia State graduate relies on her parents to help pay her insurance and cellphone bills and provide a little spending money.
“You pay all this money to get a degree, then can’t find a job that pays well enough to really live on your own. It’s tough.”
Who: Richard and Kelley Brough, Dallas
Professions: Project manager and homemaker
How they’re faring: Despite working throughout the financial crisis — and landing a new job that paid $45,000 more than his old one — sole-earner Richard feels anything but confident about his finances looking forward. He’s very worried about his family’s future economic security.
“If something were to happen to me,” says Richard, “I would have to raid my 401(k) to carry my family through a six- or nine-month loss of income. I could be back at square one, the same as an 18-year-old just starting out.”
Who: Ralph Schmitt, Fortson, Ga.
How they’re faring: Schmitt saw his savings drop by a third in the crash, but didn’t sell any of his and his wife Kathleen’s investments, believing in the economy’s resiliency. His faith was rewarded: Today, the couple’s portfolio is above where it was in 2007 and they feel secure enough to fulfill their retirement dream of traveling extensively.
“When the financial crisis hit, I continued working longer than I had planned, and we cut back on fine dining, theater, and travel,” says Ralph. “But once I felt the recovery was underway, I retired, and we began to kick up our spending to do the things we always wanted to do in our retirement.”
Who: Jim and Deborah Durkis, Albuquerque, N.M.
Professions: Government lawyer and elementary-school teacher
How they’re faring: Jim and Deborah were looking to buy a bigger house near where they now live in Albuquerque but decided against the move when housing values in the area declined. Since the recession, they have have switched insurance companies, delayed vacations, and made other cost-cutting moves.
“Before the economy started turning down, I felt like I had enough,” says Jim. “Now I watch every dollar and where it goes. I always try to save something just in case.”
Facing a stock market that has doubled in price over the past five years—and with memories of the last market collapse still vivid—you can’t help but wonder: Is another disaster lurking around the corner?
Holding vastly different opinions are two strategists with decades of insight and experience. Richard Bernstein, former chief investment strategist at Merrill Lynch, now an adviser to funds for Eaton Vance, is bullish. James Montier, who helps manage $117 billion at GMO — itself an adviser to two Wells Fargo funds — is bearish.
Both make strong arguments — ones that may challenge your view of today’s investing climate.
THE BULL: RICHARD BERNSTEIN
Are stocks overpriced?
The market is priced roughly at fair value. You have to look at valuations in light of inflation. Our firm uses sophisticated models for that, but a rule of thumb is that the price/earnings multiple and the inflation rate should add up to less than 20.
Inflation is now at about 1.5%. The P/E for stocks in the Standard & Poor’s 500, as we speak, is about 17, based on trailing earnings. So a little below 20, or roughly fair value.
Stocks are not cheap, but that doesn’t mean the bull market is over. Pension funds in the U.S. have their lowest equity allocations in 40 years. Wall Street strategists recommend an underweight of equities. I’ve found, over three decades, that the consensus asset allocation is a very reliable contrary indicator of where the market is headed.
A version of the P/E that carries a lot of weight now is the one championed by Yale’s Robert Shiller. By that measure, based on 10 years of earnings, P/Es are very high.
In the past, when these high Shiller P/Es signaled an overpriced market, we’ve had much higher rates of inflation than we do now.
When interest rates and inflation decrease, P/Es tend to expand. When rates or inflation rise, P/Es contract. The theory is that inflation eats away at a company’s future value, for several reasons. Earnings might rise, but inflation-adjusted earnings might not. Earnings quality tends to decline, in part because you’re simply paying off debt with cheaper dollars. And overall investor confidence tends to deteriorate. So you have to adjust for inflation, but professor Shiller doesn’t.
If you do adjust for lower inflation, it predicts normal returns — about 8% to 9% a year. We look at more than valuation, though. For example, sentiment is still attractive. We actually think you’re going to get above-average returns — say, 10% to 15% a year over the next several years.
Two years? Five years?
I think we’re halfway through one of the biggest bull markets of our careers. The stock market has been up for the same reason it always goes up in an early-cycle environment. Expectations are extremely low, monetary and fiscal policies kick in, and the economy begins to grow. That’s what happens every cycle, and it happened this cycle too.
Now we are entering a mid-cycle phase in which you get the tug of war between rising rates — a bearish sign — and unanticipated improvement in the economy — a bullish sign. Sentiment isn’t exactly ebullient, and the economy keeps improving.
But when your readership believes there’s no risk in equities, the bull market is almost over. And in the kiss of death, the yield curve inverts, meaning that long-term interest rates drop below short-term rates. In other words, people are so desperate to lock in long-term rates that they pay more for them than for short-term rates.
Watching for an inverted yield curve will keep you out of trouble. That simple little indicator suggests the bond markets are beginning to expect significantly weaker growth. Generally this occurs before the stock market begins to anticipate slower growth. And we haven’t seen it yet.
You’ve noted that a classic sign of a bubble is increased use of borrowed money to invest. Margin buying of stocks is at a record high.
Nobody knows how much of that is long — betting that stocks will rise — and how much of it is short — betting stocks will fall. In the past, when individuals played a greater role in the market, you assumed that margin was used to be levered long. Today hedge funds are a much bigger force, and my research suggests they’re relatively neutral. Some of that margin is being used for shorting. So I don’t think increased leverage is driving up prices.
What other bubble indicators do you look for?
When sentiment becomes overwhelmingly bullish to the point where people jettison diversification, that is very, very worrisome.
You see that now in highflying tech, social media, some biotech. Valuations are so out of whack with reality. You’d think that people would have learned from the hot stove.
What do you say to analysts who worry that equities are inflated by the artificial suppression of interest rates by central banks?
I get that question all the time. The point of stimulative monetary policy has always been to artificially inflate asset prices. Interest rates are lowered so that people take more risks and multiples expand. Companies get a cheaper cost of capital, which they can then use to invest.
The notion that the Fed is the only reason the stock market is up is what people claim during the early stages of every bull market. The time to worry is when the Fed inflates asset prices too much and the characteristics of a bubble emerge.
What happens if earnings — the “E” in P/E — drop to historical norms?
Profit margins are at an all-time high. There’s no doubt about that. But profit levels are also a function of sales. When margins compress, companies generally start to fight for market share. We think earnings forecasts for large-cap multinationals may be way too optimistic; we are concerned about emerging markets and the impact they could have on multinationals’ earnings. But domestic U.S. manufacturing is gaining market share. I’m not talking about 3D printing. I’m talking about ball bearings and grease. Small- and mid-caps.
I’m not a stock picker. But we believe investors should probably focus on more domestically oriented stocks and avoid emerging-market stocks as much as possible. In addition, since profit margins around the world seem likely to contract, investors should aim at market-share gainers. We like U.S. small-cap industrials. If you know the name of the company, the odds are that they have too much international exposure.
Also, I think that high-yield municipal bonds are a tremendous value play right now.
They yield more than high-yield corporates for the first time in history.
So when will you know your portfolio is overpriced — that it’s time to get out of small-cap industrials or high-yield munis?
We look at gaps between perception and reality. Over the past several years, the sentiment toward small-cap stocks, despite their superior performance, has been quite poor. But ultimately that gap between perception and reality will begin to change.
There will be more negative-earnings surprises because expectations get too high. Flows into small-cap funds will pick up. We’ll hear people talking about how cheap they are, as opposed to how expensive they are. [Laughs.] Then we’ll find other investments that look more attractive.
THE BEAR: JAMES MONTIER (cont.)
THE BEAR: JAMES MONTIER
Are stocks overpriced?
There is no doubt that the U.S. stock market is exceedingly overvalued.
What makes you so sure?
The simplest sensible benchmark is the Shiller P/E. Right now we’re looking at a broad index like the Standard & Poor’s 500 trading at something like 26, 27 times the Shiller P/E. Fair value would be 16 or 17 times historical earnings.
But bulls say the Shiller P/E doesn’t look so bad if you adjust it for interest rates or inflation.
It doesn’t make any sense to do that. The history of stock prices shows that they are good long-run inflation hedges. That’s because companies can generally raise their prices when their input costs rise, which protects their profits and dividends from inflation. And since equities are valued based on profits per share, equities are largely immune from inflation too.
Adjusting for interest rates is even more bizarre. Empirical horseraces show that valuation ratios — say, P/Es — unadjusted by current interest rates have predicted long-run returns far better than valuations adjusted by interest rates.
What if you look at P/Es based on expected earnings for the next year?
I spent nearly 23 years working at investment banks surrounded by analysts, and I have to say I think analysts probably were put on this planet to make astrologers look like they know what they’re doing.
The idea of basing a valuation on a forward earnings number is laughable. Most analysts spend all of their time being spoon-fed by company management and thinking about the next quarter’s earnings release — a horizon that is just not meaningful.
But maybe rising profits will justify higher stock prices. Maybe corporate profit margins will be higher than they used to be.
It is possible. We spend a lot of time worrying about that: What could prevent margins from falling?
[GMO co-founder] Jeremy Grantham puts it very well. For most investors, he says, “This time is different” are the four most dangerous words. But for value investors [who buy stocks they think the market has undervalued], “This time it’s never different” are the five most dangerous words. They lead to simple-minded extrapolation — an unchecked belief that the future will be like the past.
For a really good example of that, think of value managers who bought financials in 2008 because they were “cheap.” They failed to understand the dangers posed by the bursting of the credit bubble and the way in which earnings had been inflated during the housing bubble.
But profits as a percentage of gross domestic product have indeed been elevated for a sustained period. Now the data show profit ratios are not increasing anymore, and that may be the first sign that they’re beginning to peak. Looking forward, more federal budget cuts are coming, which should reduce profits.
Are we in a bubble now?
The technology bubble of ’99 was a good old-fashioned mania. People really did believe this time was different — that the dotcoms would change the way the world worked forever. I think what we are seeing today is more of a near-rational bubble.
When you have central banks around the world setting interest rates below the rates of inflation, effectively telling you that cash will earn nothing, then you tend to seek out other vehicles for investing. That distorts pricing across a wide range of assets.
I’d call it a foie gras market, in which investors are the geese being force-fed risk assets by central banks. It isn’t pleasant, but it may be the best that you can do given the alternatives that are available to you.
So what should investors do?
Personal investment advice is not our business. But when you look at the S&P 500 at today’s valuations, our return forecast is negative 1.5% annually after inflation. Cash will earn something like minus half a percent over the next seven years.
It’s hard to find bits of the market that are actually attractive. So we look for high-quality stocks, which have three features: high profitability, stable profitability, and low leverage: the Johnson & Johnsons JOHNSON & JOHNSON JNJ 0.03% , Procter & Gambles PROCTER & GAMBLE COMPANY PG -0.08% , and Microsofts MICROSOFT CORP. MSFT -0.55% of the world. They’re certainly not cheap. But they are the best of the bad bunch.
And outside the U.S.?
Globally, European value stocks also probably deserve a place in a portfolio. So do some emerging markets, which is probably a brave call given the events that are unfolding around the world. In our unconstrained portfolios, we have just under 50% in equities spread among those groups, and then the rest in a combination of things like Treasury Inflation-Protected Securities and cash.
You don’t want to be fully invested or else you give up the ability to take advantage of shifts in the opportunities you face. Also, we have found that if you shift assets depending on your opportunities, you’ve greatly reduced the risk of lifetime ruin — running out of money before you die.
Does that mean timing the market? Or simply having a global portfolio and rebalancing once a year? That is, selling the asset that’s performed the best and buying the one that’s done the worst?
Rebalancing is the simplest of all valuation-based strategies and a really good start. But I think one absolutely should try to market-time based on valuation.
Ben Graham actually said that in Security Analysis [a classic investing book co-written by David Dodd and first published in 1934]. He said, “It is our view that stock-market timing cannot be done…” and that’s the bit everybody quotes. But he goes on to say “unless the time to buy is related to an attractive price level,” which I think is exactly right.
Any tips on how to market-time?
My colleague Ben Inker says you should smoothly and slowly enter and exit markets. Rather than trying to pick the top or bottom, which you’ll never do, move maybe 5% or 10% of your portfolio in or out each quarter. That’s what we’re doing.
We are slowly drawing down our equity exposure in recognition of the fact that the markets have been expensive. If they get more expensive, we may sell a little faster, and if they get less expensive, we may stop selling.
Being patient is a massively underestimated virtue when it comes to investing because there is nothing worse than sitting there watching your neighbor get rich because he’s been invested and you haven’t because you think the market’s expensive. But if you can be patient, a valuation-based framework is exactly the right way to do things.
Jim Irvine had his compass set on an ideal retirement. With two generous pensions and a 401(k) that he maxed out every year, the American Airlines pilot had been on track to retire by 60 and live out his dream of sailing around the world with his family.
Then a fierce squall hit: AA filed for bankruptcy in 2011. Subsequently one of his pensions was frozen, the other paid out. Suddenly Irvine’s retirement dream hinged entirely on his growing his 401(k).
“It’s all up to me to invest well,” says Irvine, now 48.
Not surprisingly, people who fly aluminum canisters at nearly the speed of sound 40,000 feet above the earth tend to be fairly confident. “We’re goal-oriented, take-charge guys,” says Irvine. So rather than buying mutual funds to hold for the long haul, he responded by ramping up his already aggressive trading style in hopes of growing his money faster.
Irvine took most of his cues from a newsletter called EZ Tracker that he had begun subscribing to a few years earlier. The newsletter had reported solid returns, and Irvine loved the convenience. He could easily follow EZ Tracker’s recommendations — making about two dozen trades a year, including a few of his own — and not give up much of the free time between flights that he’d rather spend with his wife, Lisa, and four young kids (ages 4 to 8) in Cleveland.
He didn’t pay much attention to his returns as his balance rose, and he had no idea that trading activity was attracting attention of its own. The first indication of this came in 2012, when he got a warning letter from his 401(k) administrator saying his trading activity was “disruptive” to the T. Rowe Price funds in his plan. Undeterred, Irvine continued to buy and sell on EZ Tracker’s advice — until January 2013, when a second letter informed him that he was prohibited from trading into any of the plan’s four T. Rowe funds for a full year. “I couldn’t believe they actually did it,” he says. “It was like one of my kids throwing a tantrum.”
He wasn’t the only one to get such a letter. From 2011 to 2013, some 1,300 AA employees were barred from trading into T. Rowe funds in their 401(k) plans — some for a year, some for life. Vanguard recently acknowledged that it’s had a similar issue with airline workers: For years, the company says, it’s been telling Southwest to inform its staffers that their purchases could be blocked if they trade on the advice of investing newsletters.
A strange set of cases, yes — but you may have more in common with these highflying investors than you think. While only 15% of 401(k) participants in the U.S. initiated a trade in 2012, according to benefits firm Aon Hewitt, nearly a third of MONEY readers polled made more than five trades last year, and 17% made more than 10.
Even if you’re not trading as often as the newsletter subscribers, you’re hardly immune to the pressures that drove them to do so. The percentage of Americans enrolled in traditional pensions is now only 14%, down from 38% in 1979, according to the Employee Benefit Research Institute, leaving workers increasingly reliant on 401(k) savings. And most are falling behind, countless studies show.
So is it really all that wrong that these airline workers took their plans off autopilot in hope of getting a boost? The fund companies argue that it is, since the kind of trading they’re doing can hurt long-term investors (that is, most of you reading this). Meanwhile, subscribers contend they should be able to invest any way they please. But they’re missing a more important point: Frequent trading probably won’t give them the lift they’re hoping for. “The terrible irony,” says Frank Murtha, co-founder of MarketPsych, a behavioral-finance consulting firm, “is that by trying so hard to achieve superior returns, you virtually ensure that you will underperform.”
Where the trouble began
The curious tale of AA trading bans starts in 2002 with two men: Mike DiBerardino, then an AA pilot, and Paul Burger, who’d just left his job as COO of an ad agency in Philly. The pals had met while working as securities dealers in the ’70s.
Long after changing careers, DiBerardino often found himself advising his airline colleagues on retirement investing. “I’d show them what I was doing, and they’d say, ‘Send me that!’ ” he recalls. After he mentioned this to Burger, the two hatched a plan for a newsletter aimed at helping AA employees pick funds in their 401(k). Thus was born EZ Tracker.
Today the AA newsletter has more than 3,000 subscribers, and EZ Tracker’s publishers — who both work at it full-time since DiBerardino’s retirement in 2007 — also produce separate editions for employees of Southwest, JetBlue, United, and US Airways, as well as for pilots of UPS. For pilots, a one-year subscription costs $100; for flight attendants, $85.
On the last Sunday of every month, subscribers get an email containing a link to the newsletter. Each issue offers a market overview, news on plan changes, and, of course, investment picks. Readers can model their investments on one of three portfolios — aggressive, moderate, and conservative — each consisting of about six to eight funds from the plan’s offerings (which, in AA’s case, number 30). And every month the newsletter recommends a handful of trades.
While DiBerardino and Burger don’t like the terms “market timing” or “momentum investing,” their advice is essentially that: They suggest buying funds that have performed well over the past 12 months and selling those that are cooling off. To make picks, they look purely at price, rather than the fundamentals of the underlying holdings. They also employ a basic asset-allocation strategy to ensure a diverse mix.
EZ Tracker’s publishers are not registered investment advisers. They also acknowledge that they are not offering anything the airline employees couldn’t find out for themselves. But they say they save workers time by doing the research.
“We’re not gurus,” says Burger. “There is no crystal ball. We don’t know where the market is going, but we can tell you what are the best-performing funds right now.”
Their results, which aren’t audited by any third party, certainly look impressive. Over the past 10 years EZ Tracker reports an annualized return of 10.7% in the AA aggressive portfolio, compared with 7.4% for the S&P 500. The newsletter’s hallmark year — and the year after which subscriptions “took off,” the founders say — was 2008, when the aggressive portfolio fell just 14.6%, vs. the S&P 500’s 37% plunge.
Why airline employees bit
Some time after the debut of EZ Tracker, its publishers noticed the appearance of a competitor called 401k Maximizer, that is today targeted at employees of AA, Southwest, US Airways, and Delta. (The publication’s founder, who’s been reported to be an AA pilot, did not respond to requests for comment.)
Mark Hulbert, who as editor of the Hulbert Financial Digest has studied the investing newsletter industry for three decades, says it’s unusual to see a publication focused on one company’s retirement plan because it limits the audience. Yet the airline industry seems to be able to support not one but two newsletters for active 401(k) traders. How come?
Ego is probably one factor. People in high-achieving fields like aviation often have the kind of type A personality that makes them think they can beat the market by trading, says MarketPsych’s Murtha. He points to a 2011 study by the University of California showing that investors with an inflated sense of their abilities tend to trade more.
Mike Close, a Southwest pilot from Cape Canaveral, Fla., agrees with Murtha’s assessment of his peers: “We all know how to solve the world’s problems — we know the answer to everything,” jokes Close, who has subscribed to 401k Maximizer for six years and was among those who received a warning from Vanguard. “This makes a pilot a horrible person to take advice from, especially investment advice,” he adds. (Nevertheless, he says, he’s been happy with how he’s done with Maximizer.)
Meanwhile, a culture of trust and conformity may make pilots more inclined than others to put blind faith in advice from a peer, says Andy Simonds, a pilot for a major airline and a writer for Future & Active Pilot Advisors, a career and financial advisory service. Because they must entrust their lives to co-pilots who can be strangers, he says, it follows that they’d trust colleagues with lesser decisions, like investing.
The reasons Brigitte Laurent, 49, an AA flight attendant from Playa del Rey, Calif., started subscribing to EZ Tracker eight years ago could apply to anyone. Until co-workers suggested she try the newsletter, she had her whole nest egg in a single index fund. “But I always felt like I could do better, like I was missing out,” she says. “I feel like I’m more in control now, even though I’m following their advice.” And after the AA bankruptcy froze her pension, cut her pay, and cost her vacation days, the 25-year vet of the airline says she needed that sense of stability more than ever.
Sometimes when feeling out of control, we reach for a narrative that will help us feel like we’re in the driver’s seat, says Dan Ariely, a leading behavioral economist, whose latest book is The (Honest) Truth About Dishonesty. “We don’t like randomness,” he adds. “We try to force order on life around us, so we tell ourselves a story.”
The story the newsletters tell is that by trading you can beat the market. Our neurons compound the problem: Studies have shown that the pleasure centers in our brains are activated more when we do something to earn money rather than passively receive it. Add in diminished expectations — such as those following the market plunge, pension cuts, and pay freezes suffered by AA employees — and the temptation to act gets even stronger. “When people expect to achieve a certain level of wealth, they can get emotionally anchored to it,” says Murtha. So when your actual wealth falls below where you think it should be, you can get an itch to do something to rectify the situation.
But with investing, as with flying, our instincts can be wrong, warns William Bernstein, the neurologist-turned-investment-guru who also has a pilot’s license. “When a pilot comes in for a landing while flying slowly and descending rapidly, the instinct is to pull the nose up, but you actually need to point it to the ground to get enough airspeed to fly again,” he says. “Investing is the same way: We instinctively react to danger with fight or flight, which is a useful instinct in nature but all wrong in finance. You shouldn’t sell when the fund goes down; you should hold on and do nothing.”
Why they were banned
Cole Seckman, 58, an AA pilot since 1990 and EZ Tracker subscriber since 2002, was among the first to be barred. Ignoring a warning letter received in fall 2010, Seckman followed EZ Tracker’s advice in June 2011 to sell T. Rowe’s Science & Technology Fund. That September he was blocked from transferring money into T. Rowe funds for a year. “It was the most ridiculous thing that’s happened to me,” he says.
T. Rowe won’t say how many letters were sent, but DiBerardino and Burger believe that everyone who made that particular trade soon after the issue was published got barred. (A mutual fund has no way of knowing which of its investors are newsletter subscribers, of course, but it can see which participants in a 401(k) are making the same trades at the same time.)
The editors were defiant. “Who the hell are they to tell us how to run the portfolio?” says DiBerardino. So a month after the first ban ended, in August 2012, they advised buying T. Rowe’s New Horizons Fund, and three months later advised selling it. Seckman made those moves — and was promptly barred for another year.
Laurent, who was also banned twice, but on a different timetable, asks the question that plagued many of her fellow subscribers: “T. Rowe Price is huge. How can we disrupt the performance of their funds?”
How indeed? In response to MONEY’s inquiry, the company sent a statement: “Collective trading of fund holders acting on the recommendations of others, such as the advice of a newsletter, could cause large cash flows in and out of the T. Rowe Price funds …”
In other words, it’s not the frequency of trades that’s a problem, but that so many people are trading at once.
AA employees have nearly $11 billion in their 401(k)s, and pilots specifically have an average balance of $370,000, according to BrightScope, which ranks retirement plans. So if many of EZ Tracker’s AA subscribers buy one of the T. Rowe funds in the 401(k), the funds’ managers may have to invest in lesser-quality companies or park money in cash. Lots of sell orders, meanwhile, could force managers to unload assets before they reach peak value and drive down the market price of those assets. Buy or sell, managers also incur fees for executing trades. All those moves eat into a fund’s return and hurt investors who stay put.
A similar dynamic is responsible for Vanguard’s frustration with Southwest employees. The company’s pilots can generate up to $45 million in trades in a given fund the week after 401k Maximizer publishes, according to John Nordin of the Southwest pilot union’s 401(k) committee. “Equity funds are long-term investments,” says Michael Buek, a portfolio manager at Vanguard. “If everybody traded like that, our performance would be horrible.”
Regardless of whether a plan has specific rules governing “collective” trading — as T. Rowe now does — a fund company can block purchases at its discretion. By all accounts, though, bans such as those received by the airline employees are very unusual. Most 401(k) plans and funds do have rules to curb market timing. But enforcement actions on those are rare too: Only about 0.25% of Fidelity’s nearly 13 million 401(k) participants received warning letters for too-frequent trading in 2013.
What’s the real damage?
As it turns out, a ban sounds worse than it is: Those who’ve been barred are still allowed to sell holdings in T. Rowe funds, since by law mutual funds are not allowed to stop a sale. They can even buy into the funds through regular pay-check contributions, since those amounts are smaller and predictable. So the only thing barred employees can’t do is transfer an existing balance into the funds. But with 26 other funds to choose from, it’s not as if they’re out of options.
The real harm of frequent 401(k) trading isn’t the trouble you could get into from a fund company, but the fact that you’ll likely end up behind the market, says financial adviser and Pace University professor Lew Altfest. To beat benchmarks, you have to time two trades well — selling high and buying low. And that’s a hard bar to clear. Individuals tend to move at the wrong times. Even pros have terrible timing, evidenced by the fact that 61% of actively managed U.S. stock mutual funds underperformed indexes over the five years ending in 2013, according to Standard & Poor’s.
EZ Tracker — and most investing newsletters for that matter — chases returns, according to Hulbert. But there’s a reason the phrase “Past performance is not indicative of future results” has become a cliché. In looking at investor returns from 1995 to 2010, investment firm Gerstein Fisher found that while stocks that rose in the previous 12 months tended to continue rising in the short term, the shares got bid up so much that investors ended up underperforming by one percentage point a year. Further, an analysis of newsletters from 1986 to 2010 by Hulbert found that they underperformed the S&P 500 by an average 2.6 percentage points. “About 20% of the newsletters I track will beat the market, and 80% will not,” he says.
MONEY asked Altfest to review EZ Tracker’s published results. His finding? “Their record isn’t terrible, but it could be better.”
The newsletter did well from its inception in 2002 to 2010, thanks largely to smart calls in 2008, and overall the 10-year annualized return for its aggressive portfolio topped the S&P 500’s by 3.3 percentage points. But from 2011 to the present, its cumulative three-year gain was 22%, vs. 50% for the S&P 500. “Thaaat’s the problem with a momentum strategy,” Altfest says. “You can have a favorable effect over short periods, but then there’s a change in the market, people start saying, ‘Get me out!’ and you can get bagged.”
Paul Burger acknowledges that market volatility hurt the newsletter’s returns of late but says, “If you look at the entire period of 12 years, we do outperform the indexes.” True, but as often happens when a money manager gets hot, investors piled in after EZ Tracker’s great 2008. Those subscribers don’t get the benefit of the outperformance.
Altfest also dug into Jim Irvine’s performance: In the five years since he began following the newsletter, his return was 9.1%, about half the 18% gain of the S&P 500. He didn’t follow EZ Tracker’s advice completely — a staunch political conservative who heads a gun-rights group, Irvine made some of his own trades based on his fears of a market downturn after President Obama’s reelection — so the newsletter had a better showing at 13.8%. But even a moderate asset-allocation fund in Irvine’s plan delivered 14.2% and an aggressive fund returned 17.5%. “Jim did entirely too much trading during the past year,” Altfest says. “401(k)s should be operated for long-term appreciation with only occasional judicious changes.”
Where they’ll go from here
Though EZ Tracker continued to recommend T. Rowe funds after the first round of one-year bans, DiBerardino and Burger stopped suggesting the company’s offerings after some subscribers were hit with permanent bans last summer. So now readers who follow the newsletter faithfully will miss out on high-performing funds like T. Rowe’s New Horizons T. ROWE PRICE NEW HORIZONS PRNHX 0.08% (33.7% return for the 12 months ending in March) and Science & Technology T. ROWE PRICE SCIENCE & TECH FD PRSCX 0.37% (37% for the same period). “We’re definitely at a disadvantage,” says DiBerardino, who has filed a complaint with the SEC. “But we’ve gained subscribers since this happened because of our long-term record.”
In spite of everything, Laurent (who reports a five-year annualized return of 15.1%) is unwavering in her loyalty to EZ Tracker. Seckman, too, is satisfied with how he’s done (15.3% over the same period). “I’m not trying to beat the market,” he says. “They’ve kept me out of trouble and given me reasonable returns.”
Initially Irvine was also committed to EZ Tracker and had shrugged off the ban — “I’ll just use other funds,” he said in his first interview with MONEY. But he had a different view after hearing Altfest’s feedback. The planner estimated that if Irvine continues to underperform, he’d need to work until 72 to hit his savings goal — an impossibility, since the airline has a mandatory retirement age of 65. Altfest suggested Irvine instead opt for a set-it-and-forget-it portfolio with 20% in cash and fixed income and 80% in equities, heavily weighted toward large-cap (38%) and international (25%) funds. With a reasonable 7% return, Irvine could retire at 64.
At first taken aback by the critique, Irvine soon saw Altfest had a point. In particular, the planner’s advice to buy three T. Rowe funds (now that his ban is over) made Irvine realize how much lingering anger was hurting him. “I was going to work longer just so I can not invest in their funds?” he says. “That’s cutting off my nose to spite my face.” His new investing plan in place, Irvine has been looking at boats — a 42-foot Jeanneau looks like a beauty — and made a spreadsheet to monitor his progress. “I lost track of the target,” he says. “It’s embarrassing because I’d never do that in an airplane. This has been a good wake-up call to right the ship.”
Make a trade now and again? You should know that the mutual funds in your plan may disallow or penalize certain actions; your plan administrator, with your employer’s input, may have set other rules.
Check with HR to find out what applies to you, but beware these often-restricted moves:
Making a “roundtrip” transaction
The rule: Funds or administrators may limit your ability to sell out of a fund and then buy back in within a short period, called a roundtrip.
For example, the first time you sell a Fidelity fund and then reinvest more than $1,000 into the same fund within 30 days, you’ll get a warning; subsequent roundtrips result in restrictions on how often you can trade in the future.
(The Fidelity plan at Time Inc. — MONEY’s parent company — limits employees to one trade a quarter after the third roundtrip.)
The reason: Roundtrips require managers to buy and sell assets, and therefore hike up administrative costs for the fund, says Mike Alfred, co-founder of BrightScope, which ranks 401(k) plans.
Selling soon after you buy
The rule: With certain funds, if you sell before owning for a minimum period — usually 30 or 60 days — you’ll pay a fee of up to 2% of the price of the shares.
The reason: Redemption fees are often levied on funds with holdings that are not as easily bought or sold, such as small-cap stocks and international equities, says Susan Powers, senior VP of investment consulting at Fidelity. The lack of liquidity could result in such funds taking a big performance hit as a result of short-term trading.
Buying too much company stock
The rule: Public companies often put a cap on how much employer stock that workers can own, says Powers. The restriction is usually built into the plan, so that you wouldn’t be able to invest more than, say, 25% of your money with your company.
The reason: In a post-Enron world, says Powers, 401(k) plans are designed to prevent employees from holding 100% of their portfolio in their employer’s stock.