MONEY Behavioral Economics

Why You Shouldn’t Overplay a Hot Hand — in Basketball or Investing

Miami Heat's LeBron James
© Mike Stone—Reuters

New research says there is such a thing as a hot hand in basketball — like momentum in investing. Trouble is, hot hands lead to overconfidence, which leads to cold spells.

A couple of winters ago, Larry Summers gave a 30-minute talk to the Harvard’s men’s basketball team over pizza. During the peroration, per Adam Davidson in the New York Times, the former Treasury Secretary and Harvard president engaged in a bit of Socratic dialogue.

He asked the students if they thought a player could have a “hot hand” and go on a streak in which he made shot after shot after shot? All the players nodded uniformly. Summers paused, relishing the moment.

“The answer is no,” he said. “People apply patterns to random data.”

In this case, Summers may be wrong.

A new study by three Harvard grads — using data based on tracking cameras in 15 arenas that captured 83,000 shot attempts in the 2012-13 NBA season — found that “players who are outperforming (i.e. are ‘hot’) are more likely to make their next shot if we control for the difficulty of that shot.”

When you account for the difficulty of the shot, the authors discovered “a small yet significant hot hand effect.” To put a number on it, a player’s chance of making his next shot increases by 1.2% for each prior shot he made.

So what?

While your basketball skills may never carry you to the NBA, there is a lesson to be learned from the paper’s findings.

And it has to do with how you invest.

The study’s authors concluded the following: “Players who perceive themselves to be hot based on previous shot outcomes shoot from significantly further away, face tighter defense, are more likely to take their team’s subsequent shot, and take more difficult shots.”

This basically means when someone makes certain shots (think three-pointers) at a higher percentage than they normally do, the opposing defense reacts by guarding the player more closely. And as defenders start paying more attention to the shooter, he has to take shots from longer range, which are inherently more difficult.

What does this have to do with your portfolio?

Well, consider what’s going on. A player makes a few shots and gets “hot.” He’s in the zone, so he starts growing overconfident. Not only does he start to take more shots, but he starts taking increasingly difficult shots.

While he may be more likely to make those difficult shots at the outset since he’s on a roll, the more difficult shots come with a lower percentage of accuracy. Which means he will eventually start to miss more and cool down. In other words, his overconfidence leads him to take shots that eventually take him “out of the zone.”

This is a lot like momentum investing.

Momentum is a real force in the markets. History, for instance, shows that investors — at least in the short run — are much better off riding last year’s winners than the laggards, says Sam Stovall, managing director for U.S. equity strategy at S&P Capital IQ.

So investors who ride the market’s momentum invest in a winning stock or sector. Those investments rise in value. This trend repeats a few times and before long investors believe their skills as a trader are leading to the gains, rather than the momentum effect. Before long, these investors are trading more frequently to capitalize on their “hot hands.” But this has the effect of racking up trading costs and mistakes, which are a headwind to investors that eventually cools them down.

This doesn’t mean you should eschew momentum altogether. As MONEY’s Paul Lim noted in his March 2014 article, “A decent body of research suggests that entire asset classes that shine in one year have a better-than-average chance of outperforming in the next.”

The trick is to find a way to ride the hot hand without taking increasingly inefficient shots.

One idea is to minimize your trading costs by limiting your trading to just once a year. According to researchers at the asset-management firm Leuthold Group, a time-tested way to do this is to buy last year’s second-best performing asset class and hold that for a year (last year’s second-best asset class was large, U.S. stocks). Then repeat the process the following year. Historically, such a strategy returned five points more annually than the S&P 500, while experiencing only slightly more volatility. (Of course, you shouldn’t tilt your entire portfolio toward momentum sectors. Think 10%.)

By incorporating a little bit of the “hot hand” into your investing strategy, you should be able to book slightly higher returns. And you don’t even have to go to the gym.

MONEY Ask the Expert

Here’s How to Protect Your 401(k) from the Next Big Market Drop

140605_AskExpert_illo
Robert A. Di Ieso, Jr.

Q: Bull markets don’t last forever. How can I protect my 401(k) if there’s another big downturn soon?

A: After a five-year tear, the bull market is starting to look a bit tired, so it’s understandable that you may be be nervous about a possible downturn. But any changes in your 401(k) should be geared mainly to the years you have until retirement rather than potential stock market moves.

The current bull market may indeed be in its last phase and returns going forward are likely to be more modest. Still, occasional stomach-churning downturns are just the nature of the investing game, says Tim Golas, a partner at Spurstone Executive Wealth Solutions. “I don’t see anything like the 2008 crisis on the horizon, but it wouldn’t surprise me to see a lot more volatility in the markets,” says Golas.

That may feel uncomfortable. But don’t look at an increase in market risk as a key reason to cut back your exposure to stocks. “If you leave the market during tough times and get really conservative with long-term investments, you can miss a lot of gains,” says Golas.

A better way to determine the size of your stock allocation is to use your age, projected retirement date, as well as your risk tolerance as a guide. If you are in your 20s and 30s and have many years till retirement, the long-term growth potential of stocks will outweigh their risks, so your retirement assets should be concentrated in stocks, not bonds. If you have 30 or 40 years till retirement you can keep as much as 80% of your 401(k) in equities and 20% in bonds, financial advisers say.

If you’re uncomfortable with big market swings, you can do fine with a smaller allocation to stocks. But for most investors, it’s best to keep at least a 50% to 60% equities, since you’ll need that growth in your nest egg. As you get older and closer to retirement, it makes sense to trade some of that potential growth in stocks for stability. After all, you want to be sure that money is available when you need it. So over time you should reduce the percentage of your assets invested in stocks and boost the amount in bonds to help preserve your portfolio.

To determine how much you should have in stocks vs. bonds, financial planners recommend this standard rule of thumb: Subtract your age from 110. Using this measure, a 40-year old would keep 70% of their retirement funds in stocks. Of course, you can fine-tune the percentage to suit your strategy.

When you’re within five or 10 years of retirement, you should focus on reducing risk in your portfolio. An asset allocation of 50% stocks and 50% stocks should provide the stability you need while still providing enough growth to outpace inflation during your retirement years.

Once you have your strategy set, try to ignore daily market moves and stay on course. “You shouldn’t apply short-term thinking to long-term assets,” says Golas.

For more on retirement investing:

Money’s Ultimate Guide to Retirement

MONEY Google

10 Ways Google Has Changed the World

Google Earth view
Google

It's been a decade since Google went public. Here are 10 ways the company has transformed the market—and our lives— since.

Back in 2004, investors weren’t entirely sure what to make of Google, and skeptics abounded. Fast-forward to today, when we can look back at how far the company has come, in ways that inspire both awe and concern. Below are 10 examples of its influence.

1. It has changed our language. Despite Microsoft’s best efforts, there’s a reason “Bing” never caught on as a verb, let alone as a beleaguered anthropomorphic meme. The phrase “to Google” is so popular that the company is actually worried about losing trademark rights if the term becomes generic, like “escalator” and “zipper,” which were once trademarked.

2. It has changed our brains. Recent research has confirmed suspicions that 24/7 access to (near) limitless information is not only bad for human discourse—it’s also making us worse at remembering things, regardless of whether we try. And even if we aren’t conscious of it, our brains are primed to think about the Internet as soon as we start trying to recall the answer to a tough trivia question. Essentially, Google has become our collective mental crutch.

3. It set the stage for Facebook and Twitter’s sky-high valuations. Yes, lofty valuations based on mere speculation were also common back in the dot-com fervor of the ’90s, says Ed Crotty, chief investment officer for Davidson Investment Advisors. But Google broke new ground by proving that even just the potential for a huge audience could pay off in a big way.

“In the early days, when people were thinking in terms of web portals, the barriers to entry didn’t seem high for search,” Crotty says. That meant Google’s competitive advantage wasn’t clear. But “the tipping point was when Google was able to scale up their audience enough to attract ad agencies, and then further improve their algorithms, since those get better with scale. That’s partly why you see tech companies now willing to forgo profits for a period of time in order to build an audience.” And also why investors are willing to throw money their way.

4. It has taken over our cell phones. Since the first Android phone was sold in 2008, Google’s mobile operating system has bulldozed the competition. Today it claims nearly 85% of market share, nearly doubling its hold over the last three years. Next stop, self-driving cars?

5. It has transformed the way we use e-mail. Gmail was invented a decade ago, before bottomless inboxes were a sine qua non. It’s hard even to remember those dark ages when storage space was sacred—and deleting emails was as tedious-but-necessary as flossing. Today our accounts serve as mausoleums, housing long-forgotten files, links, and even whole relationships. Google itself has touted alternative uses for Gmail, such as setting up a virtual time capsule for your newborn—though in practice accounts can’t be owned by anyone under 13. But even that last point is about to change.

6. It’s changed how we collaborate. Back in 2006, Google acquired the company behind an online word processor named Writely. With that bet, Google created a world where it’s taken for granted that people can collaborate on virtually any type of document, whether for work, play, or (literally) revolution.

7. It has allowed us to travel the globe from our desks. Yes, MapQuest was popular first. But Google Maps (and Earth) has become much more than a tool for measuring travel routes and times. Since Google Street View came onto the scene in 2007, it’s been possible to “visit” distant destinations, give friends a virtual tour of your hometown, plan ahead of trips, and waste even more time on the Internet. Of course, the more popular a tool, the more useful it is to those who’d like to spy on us.

8. It has influenced the news we read. Ranking high in Google search results is serious business and can have a profound effect on the success of companies, media outlets, and even politicians. When I just Googled “how SEO affects journalism,” this link was at the top of my search results. How is that significant? Well, for one, that story itself has been so successfully search engine optimized that it still tops the list despite being four years old.

But most importantly, many of the concerns raised in the piece have not gone away—such as the pressure to “file some pithy blog post about the hot topic of the moment” at the expense of covering stories that would be prioritized based on traditional measures of newsworthiness. What that means for you, the reader: more headlines like this and this.

9. It has turned users into commodities. We all love free stuff, but it’s easy to forget that services offered by companies like Google and Facebook aren’t truly “free,” as data expert Bruce Schneier has pointed out. Remember that all of your data (across ALL of the services you use, and that includes Calendar, Maps, and so on) is a valuable good that Google is packaging and selling to its real customers—advertisers.

10. It’s changed how everyone else sees YOU. Unlike your Facebook profile, the links that turn up when potential employers (or love interests) Google you can be near-impossible to erase. Perhaps unsurprisingly, Google uses the fear of embarrassing search results to encourage people to manage their image through Google+ profiles.

Related:
4 Crazy Google Ambitions
The 8 Worst Predictions About Google

MONEY tech stocks

Which 80-Year-Old Billionaire Would You Trust With Your Tech Portfolio?

Diptych of Warren Buffett and George Soros
Mark Peterson/Redux (Buffett)—Luke MacGregor/Reuters (Soros)

Billionaire hedge fund manager George Soros and billionaire investor Warren Buffett are both buying tech stocks—but decidedly different kinds. So who would you bet your portfolio on?

Both billionaire investor Warren Buffett and billionaire hedge fund manager George Soros have had somewhat troubled relationships with tech stocks over the years.

Buffett famously punted on tech throughout the 1990s, declaring that “we have no insights into which participants in the tech field possess a truly durable competitive advantage.” So his investment company Berkshire Hathaway severely lagged the S&P 500 in the late 1990s — but at least it missed the tech wreck in the early 2000s. For Soros, the opposite was the case: His fund stayed at the Internet party too long in 2000.

Recently, though, both octogenarians have been dabbling in this sector — but in decidedly different ways.

SEC filings released on Thursday indicate that while Buffett is looking to the past for time-tested but overlooked plays on this sector, Soros seems only to be interested in future trends.

Buffett and ‘Old Tech’

Buffett is taking the old school approach. Quite literally. His tech sector holdings — indeed, his entire portfolio — looks as if it was straight out of the early or mid 1990s.

For instance, one of his biggest tech holdings, which recent SEC filings indicate he’s been adding to, is the century-old IBM INTERNATIONAL BUSINESS MACHINES CORP. IBM 0.1743% .

This technology service provider — which has run into difficulties in the crowded cloud computing space lately — has seen its revenue growth decline for several quarters while its stock has been under fire.

IBM Chart

IBM data by YCharts

No doubt, Buffett clearly sees IBM as a value, as the stock trades at a price/earnings ratio of around 9, which is about half what the broad market currently trades at. In his most recent letter to Berkshire shareholders, Buffett described IBM as one of his “Big Four” holdings, along with American Express, Coca-Cola, and Wells Fargo.

Beyond IBM, Buffett prefers lower-priced but slower growing internet backbone companies to fast-growing but pricey content providers. This is part of a tech investing trend that MONEY contributing writer Carla Fried recently addressed.

Other stocks he recently purchased or positions that he has been adding to include the Internet infrastructure company Verisign VERISIGN INC. VRSN 0.2846% and internet service providers Verizon VERIZON COMMUNICATIONS INC. VZ 0.0398% and Charter Communications CHARTER COMMUNICATIONS INC. CHTR 1.0274% .

Soros’ ‘New Tech” Bets

By contrast, Soros seems to be trying to ride current and future trends — albeit with highly profitable names.

In the second quarter, Soros added to his stake in the social media giant Facebook FACEBOOK INC. FB 0.2038% . Last month, Facebook shares hit a record high after the company reported robust profits. Plus, Facebook has proven to Wall Street that it can conquer the mobile advertising market, as nearly two-thirds of its revenues now come from mobile ads.

Facebook isn’t the only mobile bet Soros is making. He has also been recently adding to his stake in Apple APPLE INC. AAPL 0.1376% , which along with Google dominates the mobile computing space. New data from IDC showed that Apple’s iOS operating system held about a 12% market share among phones shipped in the second quarter — even though demand for iPhones has fallen as consumers await the arrival of the new iPhone 6, which will be introduced in September.

For the moment, Soros’ bets on these new tech names seem to be in the lead.

AAPL Chart

AAPL data by YCharts

But over the long-term, would you bet on Team Soros or Team Buffett?

MONEY retirement planning

3 Easy Moves That Can Boost Your Nest Egg By 60%

201412_RET_NESTEGG
Brad Wilson—Getty Images

These relatively painless investing tweaks can put you on the path to a secure retirement, even if you just do one or two of them.

Think you’ve got to come up with a big score or magnificent coup to boost the size of your nest egg and dramatically improve your retirement prospects? You don’t. A few simple tweaks can often make the difference between scraping by and living large after you retire.

In fact, you can put yourself on the path to a much more enjoyable and secure retirement with just three relatively easy moves: saving a little more, paring investment expenses and delaying retirement a bit. Here’s an example.

Let’s say you’re 30 years old, earn $45,000 a year, get annual raises of 2% and contribute 10% of your pay to a 401(k) or similar plan. And let’s further assume that your retirement savings earn a 7% annual return before expenses, for a net return of 5.5% after investment fees of 1.5% a year. Based on that scenario, by age 65 you would have a nest egg valued at just under $600,000.

Not bad, and certainly more than what most people age 65 have accumulated today. But you can put yourself in a much better position at retirement time if you make the three adjustments I mentioned.

First, let’s see how much saving more can help. If you increase your savings rate from 10% a year to 12%, that move alone would boost the age-65 value of your nest egg from just under $600,000 to nearly $715,000. That’s a gain of roughly $115,000, or almost 20%, right there.

Next up: investment fees. With the multitude of index funds, ETFs and other low-cost choices that are around these days, paring annual investment expenses is eminently doable. So, for the sake of this example, let’s assume you cut annual fees by just 0.5% a year from 1.5% to 1%, for an after-expense return of 6% instead of 5.5%. That reduction in expenses alone would add another 10% or so to the age-65 401(k) balance, pushing it from a little under $715,000 to nearly $790,000.

Now for the third move: delaying retirement a few years. This single adjustment has a two-barreled effect on your nest egg. Postponing gives you a chance to throw more savings into your retirement accounts and it gives the money in those accounts more time to grow before you start drawing on it. Waiting three more years to exit the workforce in the scenario above would bump the age-65 value of your nest egg from just under $790,000 to just over $975,000, just short of seven-figure territory.

By the way, postponing your job-exit date can also improve your retirement outlook in another way: Each year between the ages of 62 and 70 that you delay claiming benefits, the size of your Social Security check increases roughly 7% to 8%, and that’s before annual adjustments for inflation. To see how different claiming ages might affect your Social Security benefit (and your spouse’s, if you’re married), check out the calculators in RealDealRetirement’s Retirement Toolbox.

In short, making these three moves combined would have boosted the value of your nest egg in this scenario from a little less than $600,000 to almost $1 million, an increase of some 60%. That’s pretty impressive.

Of course, you may not be able to replicate these results exactly. If you’re getting a late start in your savings regimen, increasing your savings rate may not translate to as sizeable an increase in your eventual balance. Similarly, if you do most of your saving through a 401(k) plan that doesn’t include low-cost index funds and such–although most plans do these days—you may not be able to cut investment expenses as much as you’d like. Even if you’re able to pare expenses, there’s no guarantee that each percentage point reduction will mean a percentage-point increase in return, although there’s plenty of evidence that funds with lower costs do generally perform better.

And while many people may want to work a few extra years to fatten retirement accounts, health problems or company downsizing efforts may not allow you the choice of staying on the job a few extra years.

Still, the point is that these three moves, individually or combined, can likely improve your retirement outlook at least to some extent. And they’re much more effective at enhancing your retirement prospects than the move that many mistakenly gravitate to: investing more aggressively, which is a tactic that can backfire and leave you worse off.

So re-assess your retirement planning to see which of these moves makes the most sense for you. If doing just one gives you the boost you need to assure a secure retirement, fine. But if just one won’t do it, try to do two, or all three. Come retirement time, you’ll be glad you made these tweaks.

Walter Updegrave is the editor of RealDealRetirement.com. He previously wrote the Ask the Expert column for MONEY and CNNMoney. You can reach him at walter@realdealretirement.com.

MORE FROM REAL DEAL RETIREMENT:

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5 Tips For Charting Your Retirement Lifestyle

Courage: And 3 Other Qualities You Need To Better Plan For Retirement

MONEY stocks

How Watching TV Can Make You Poorer

Jim Cramer on the "500th Episode" of /CNBC'S "MAD MONEY."
Jim Cramer on the "500th Episode" of CNBC'S "MAD MONEY." Giovanni Rufino—© CNBC

Financial TV is entertainment, not enlightenment, say two TV pundits in a new book. Here's the real story about market gurus.

You cannot listen to the steady barrage of confident yet conflicting opinion on financial TV programs today without wondering which, if any of them, are getting it right. It’s been this way since the incomparable Louis Rukeyser launched the weekly PBS program Wall Street Week in 1970.

The pioneering cable station Financial News Network, which CNBC later bought, upped the ante in 1981 with daily money programming. That set the foundation for three decades of growth in the market for folks who could talk convincingly about the direction of stocks. This period made stars of analysts who often got it wrong—from Joe Granville and Robert Prechter in the 1980s to Henry Blodget and Jim Cramer in more recent times.

Yet as the voices of market gurus have grown louder and more numerous, the advice hasn’t got any better. The poor individual investor—stripped of his pension guarantees and wanting little more than to manage his 401(k) in a sound manner—has been left dizzy from the noise. This, at least, is the basic premise of Clash of the Financial Pundits, a book by financial commentators that takes aim at financial commentators.

The authors are former CNBC personality Jeff Macke and current contributor Joshua M. Brown, co-founder of Ritholtz Wealth Management. They write mostly in the voice of Macke, who during the depths of the financial crisis grew disillusioned with his role on Fast Money and disappeared—though not before an epic on-camera meltdown that can only be described as must-see TV. In some ways, this book reads like a cathartic undertaking meant to exorcise Macke’s demons. He is now host of the financial show Breakout, which appears on Yahoo Finance. I wonder if he realizes that by dredging up the memory of his public implosion five years ago more people will see it on YouTube than saw it live.

Clash is a stroll down memory lane for anyone that has been around the financial markets a while. It recounts bubbles past, starting with the South Sea Co. in the early 1700s when Sir Isaac Newton lost a fortune. The authors recount the rise and fall of “Calamity Joe” Granville, the spectacularly wrong Harry S. Dent, and the absurd Dow 36,000 prediction from journalist James K. Glassman and economist Kevin A. Hassett. Other names that pop up along the way include Ben Stein, Jim Rogers, Carl Icahn, James Altucher, Martin Zweig and more.

Brown and Macke give credit where it is due: Zweig’s real-time call of the 1987 crash on Wall Street Week, Cramer’s October 2008 sell-it-all message delivered on The Today Show, Blodget’s almost comical prediction in 1998 that Amazon.com would hit $400, which it did in just two months. But the whole point is to also note their miscalls and downfalls. Blodget, for example, was banned from the industry for life in 2002 after privately advising certain investors to sell stocks that he was publicly bullish on. Cramer took a beating on Jon Stewart’s Daily Show for being bullish on the soon-to-collapse Bear Stearns.

Being right and wrong is all part of the forecasting business, the authors point out, which is why it’s foolish to invest solely on one pundit’s view at any given moment. “At a certain point, the folly of forecasting becomes obvious,” the authors write. “It is at the dawning of this realization that we begin to grow as investors.”

As a young financial writer at USA Today, I watched the market for market punditry explode in the 1980s and 1990s. I was the first mainstream reporter to cover the annual “10 Surprises” list that helped elevate Morgan Stanley’s Byron Wien. Brown and Macke note that Wien’s innovation, which other forecasters soon picked up on, was a clever way to make a predication that could easily be dismissed if it did not come true. After all, who could be surprised if a surprise didn’t happen?

I worked next to Dan Dorfman, possibly journalism’s first $1 million investing columnist. In the 1980s, Dorfman wrote three times a week for USA Today and was on TV at least that often. His comments routinely moved stock prices and inspired other writers to try their hand at the market-moving game: Gene Marcial at Business Week, John Crudele at the New York Post, Herb Greenberg at the San Francisco Chronicle, to name three.

But Dorfman, who is not mentioned in Clash, had all but cornered this market. Ultimately, he got spread too thin and just couldn’t sustain the pressure to keep moving stocks. He was thought to be tied to a stock promoter and lost his job in 1996 when he refused to disclose his sources to his editor. (Full disclosure: Dorfman was working for Money magazine at the time.) At one point, venerable Coca-Cola responded to a Dorfman report with this statement: “Dan Dorfman does not have a clue.”

I’ve had my own brushes with TV punditry and seen firsthand how bookers, under pressure to get a warm body on camera, often don’t understand the topic to be discussed. They just want someone out there who will have an opinion and be entertaining. Once a booker asked me to go on air and talk about CEO pay. I had spent a week researching the subject and written a column about it. I was ready. On air, the host introduced the topic as Wall Street pay—which is a very different subject. I had almost nothing to contribute and was never invited back.

Macke and Brown explore this theme throughout and conclude that a successful pundit’s key attribute is the willingness to speak confidently on any topic, whether or not they understand it. Writing about Granville, whose “early warning” calls moved the market in the 1980s, they note that what he “had lacked in breadth and depth, he made up for with sheer personality and moxie. He had figured out the secret to all punditry, market or otherwise: certitude.”

The question underlying all of this is simple: Should you believe any financial forecaster and adjust your investments accordingly? The authors say no. They cite a 2005 study that looked at 27,000 forecasts by hundreds of experts over 15 years and concluded, “The experts’ forecasts were no more accurate than those of dart-throwing chimpanzees.”

That doesn’t mean expert opinion has no value. But the value is in the experts’ rationale and supporting arguments and how those jibe with your own considered view—not in blind loyalty to their advice. Key questions to ask include:

  • Who are the experts and what do they get for having an opinion?
  • Is their time frame the same as yours?
  • How many investment ideas do they generate each day or week? Is that realistic?
  • Why am I watching in the first place? Entertainment—or genuine need for this kind of information?

I didn’t expect to like this book. Pundits pontificating on the art of pontification feels light. Besides, even the pros know you should buy an index fund and head to the beach. The daily clatter is for traders and possibly ordinary people who just want to be entertained and try to understand how the market works.

But, like the punditry the authors explore, the material in Clash is entertaining. The book is built around engaging Q&A sessions and includes historical perspective that makes it useful in a big-picture kind of way. If you didn’t already know that the vast majority of talking heads are experts in name only, Clash will beat you over the head with examples until you are enlightened. As Cramer says in this book: “In the end it is just TV.”

More on how to invest:

 

MONEY Investing

Do You Really Need Stocks When Investing For Retirement?

Senior man on rollercoaster
Joe McBride—Getty Images

You may want to skip the thrills and chills of equities. But if you stick with bonds, be ready to do serious saving to reach your goals.

Even when stocks are doing well—and they’ve been on an incredible run the past five years with 17% annualized gains—there’s always a looming threat that the bottom could fall out of the market as it did when stock values plummeted more than 50% from the market’s high in 2007 to its trough in 2009. So it’s understandable, especially now when doubts abound about the longevity of this bull market, that you might ask yourself: Should I just skip stocks altogether when investing for retirement?

But if you’re inclined to give stocks a pass—or even just considering that option—you should be aware of the drawbacks of that choice. And, yes, there are substantial drawbacks.

Despite their gut-wrenching volatility—or, more accurately, because of it—stocks tend to generate higher returns than other financial assets like bonds, CDs and Treasury bills by a wide margin over the long term. That superior performance isn’t guaranteed, but it’s been pretty persistent over the last 100 years or longer.

Those higher long-term gains give you a practical advantage when it comes to saving for retirement. For a given amount of savings, you are likely to end up with a much larger nest egg by investing in stocks than had you shunned them. Another way to look at it is that by investing in stocks you can build a large nest egg without having to devote as much of your current income to savings.

Just how much of an advantage can stocks bestow? Here’s an example based on some scenarios I ran using T. Rowe Price’s Retirement Income Calculator, which you can find in Real Deal Retirement’s Retirement Toolbox.

Let’s assume you’re 30, earn $40,000 a year and are just beginning to save for retirement. The calculator assumes you’ll want to retire on 75% of your salary, so the target retirement income you’re shooting for is $30,000 (This is in today’s dollars; the calculator takes into account that your income will be much higher 35 years from now.)

First, let’s see how much you would have to save if you invest in, say, a mix of 70% stocks and 30% bonds, certainly nothing too racy for a 30-year-old with 35 years until retirement. To have at least a 70% chance of retiring on 75% of your pre-retirement salary at age 65 from a combination of Social Security payments and draws from your nest egg, you would have to set aside roughly 15% of your salary each year. (Or, if you have an employer generous enough to match, say, 6% of your salary, you’d have to kick in only 9% to reach 15%.)

You could improve that 70% probability by saving more or homing in on low-cost investment options, but let’s stick with the scenario above as a baseline for comparison.

So how would you fare if you decide to skip stocks altogether and invest solely in bonds? Well, if you stick with a 15% savings rate, your chances of being able to generate 75% of your pre-retirement income would drop to less than 20%. Not very comforting. You can boost the odds in your favor by saving more. But to get your chances of generating 75% of pre-retirement income back up to the 70% level, you would have to save almost 25% of your income each year. That’s a standard most people would have trouble meeting.

And the percentage of salary you would have to save would be even higher if you decide to hunker down in cash equivalents like money funds and CDs: just under 30%, or almost a third of your income.

Even if you had the iron will and perseverance to meet such lofty savings targets, diverting so much income from current spending to saving could seriously diminish the standard of living you and your family could enjoy during your career.

Just to be clear, I’m not suggesting anyone should just load up on stocks willy-nilly. That would be foolish, especially as you near or enter retirement, when a stock-market meltdown could derail your retirement plans. Indeed, in another column, I specifically warn against relying too much on outsize returns (whether from stocks or any other investment) to build a nest egg. Smart investing can’t replace diligent saving.

The point, though, is that stocks should be part of your investing strategy prior to and even during retirement. The percentage of your savings that you devote to equities can vary depending on such factors as your age, how upset get when the market goes into a steep funk and how much you’re willing to entertain the possibility of not having enough money to retire comfortably or running short of dough during retirement. Some of the links in my Retirement Toolbox section can help you settle on a stocks-bonds mix that makes sense for you.

But if after considering the pros and cons, you decide stocks just aren’t for you, fine. You’d just better be prepared to save your you-know-what off during your career, and keep especially close tabs on withdrawals from your nest egg after you retire.

Walter Updegrave is the editor of RealDealRetirement.com. He previously wrote the Ask the Expert column for MONEY and CNNMoney. You can reach him at walter@realdealretirement.com.

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Why Workers and Retirees Missed the Roaring Bull Market

Glass half Empty
Jupiterimages—Getty Images

Investor optimism dips, especially among retirees, a new survey finds. Maybe it's because 1 in 10 investors haven't noticed the huge gains in the market.

Quick, how much did the stock market gain last year? Tough question, right? Okay, let’s try a multiple choice: Based on the S&P 500 index, did the market rise 10%, 20%, or 30%? Evidently, that’s a tough question too because the vast majority of investors haven’t a clue.

Only 11% of adults with at least $10,000 in savings and investments got it right in a Wells Fargo/Gallup poll. This stands in stark contrast to the 67% that rate themselves somewhat or highly knowledgeable about investing and underscores the extent to which so many people simply don’t know what they don’t know.

For the record, the S&P 500 rose 30% in 2013—you received a total return of 32% if you reinvested dividends. This is the 13th biggest gain in a calendar year since 1926. Forget about getting the percentage right. Anyone paying attention should at least know that last year was a huge winner. Yet only 64% of investors even knew the market was up. Of those who did, 57% thought the gain was just 10% while 27% thought the gain was 20%. About 1% was looking through rose-colored glasses and thought the market rose 40% or more.

The poll also found that retirees were feeling much less optimistic in the second quarter. The Wells Fargo/Gallup Investor and Retirement Optimism index declined modestly overall but the portion looking only at retirees plunged 41%. This too seems incongruous. Second-quarter GDP surged 4%, one of the sharpest quarterly gains since the Great Recession.

One reason for this gloom is that about half of both retirees and workers are worried they will outlive their money, the poll found. Sadly, this may be a self-fulfilling prophecy. Playing it safe and earning 1% in a money market account won’t amount to much over time. Meanwhile, those who stayed true to a diversified portfolio of stocks through the downturn are doing better than ever. They were present for that 32% market gain—even if they have no idea how great last year was for them.

As a whole, the findings suggest that many people remain fixated on the past. The recession was a harrowing and humbling experience. But it is over. Real estate prices have turned up and the job picture is better. The stock market has more than doubled from the bottom. Yet when asked what they would do with a $10,000 gift, 56% in the poll said they would hold it as cash or stash it in an ultra-safe bank CD—not invest for growth. At this rate, expect more declines in optimism, especially as retirees stuck in cash see further declines in income.

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Use This Trick to Beat Your Friends at Fantasy Football

Minnesota Vikings running back Adrian Peterson
Jeff Hanisch/USA Today Sports—Reuters

The start of the football season is close and fantasy football drafts have begun. Here's why thinking like a long-term investor can ruin your season.

Last November, one National Football League running back had a particularly good day.

Strong, agile, and quick, this player absolutely tore apart the Atlanta Falcons defense on Nov. 17 to the tune of 163 rushing yards and three touchdowns. Fantasy football owners fortunate to have him on their rosters were awarded almost 35 points from his performance alone—more than a third of the total usually needed to win a whole game.

So who was this guy? Future Hall of Famer Adrian Peterson? The Philadelphia Eagles buoyant halfback LeSean McCoy? Jim Brown? No, no, and of course not. He was an undrafted second-year player out of Western Kentucky named Bobby Rainey. Who, you ask? Exactly. On that same day Peterson himself, perhaps the greatest running back since Jim Brown, ran for 100 fewer yards than Rainey and never touched the end zone en route to a pedestrian 8.5 fantasy points.

It’s hard not to look for a lesson in this episode. And for someone like me, immersed in the investing world, the inclination is to draw a parallel to value investing, the discipline made famous by Warren Buffett. Value investing involves looking for companies that the market does not fully appreciate in hopes that, over time, they will outperform expectations and send the stocks soaring.

But as the fantasy football season gets under way, with millions of fans around the country drafting players over the next few weeks, I’m here to tell you that a Buffett-like approach to fantasy football probably won’t lead to glory.

Why not? Well, to start, value-focused buy-and-hold investing is all about ignoring short-term market fluctuations and sticking with your investment philosophy over the long-haul. Coca-Cola THE COCA COLA CO. KO 0.565% has a bad quarter? Johnson & Johnson JOHNSON & JOHNSON JNJ 0.3536% delivered poor earnings-per-share growth? No matter. Value investors often see these rough patches as buying opportunities. And one of the foundational principles of value investing is that no investor can consistently predict exactly when to buy this stock or trade that one. When investors do engage in this perilous behavior, they generally end up losing money.

That ethos, however, falls flat when it comes to fantasy football. For one thing, there is no long-term in fantasy football. The season only lasts 17 weeks, which means you have only 17 chances to maximize your total scoring output. While one or two days of poor returns won’t hurt your portfolio, one or two weeks of fantasy football failure could ruin your season. Most leagues have around 10 teams, and, in order to make the playoffs, you’ll usually need seven wins. So if one of your players isn’t performing well, or hasn’t reached his full potential, you don’t have the time to wait.

In other words, don’t be scared to grab onto a hot player until he cools off. For instance, take another look at Peterson and Rainey. Going into the 2013 season, ESPN ranked Peterson the top fantasy football player to draft. Bobby Rainey is not Adrian Peterson. For his career, Rainey only has 566 rushing yards. Peterson has 10,115.

Nevertheless, Rainey was the superior running back over the last seven weeks of the 2013 NFL season. Using the NFL.com scoring system, Rainey earned 79.3 points from week 11 to 17, while Peterson (due in part to injury) only scored 54.8. Even if you take out Rainey’s career day against the Falcons, the two running backs scored pretty much the same number of points.

This isn’t an isolated example, either. Two weeks earlier, Nick Foles, who began the season as the Philadelphia Eagles second-string quarterback, threw for seven touchdowns and garnered 45.2 points for his fantasy owners. Foles would go on to accumulate a total of almost 260 points for the season (more than superstars Tom Brady, Ben Rothlisberger, and Matt Ryan) despite starting in only 11 of 16 games.

In fact, last season, 15 different players scored the most points in a given week (Peyton Manning and Drew Brees each did it twice). Of those 15 players, not one was listed in the top five on ESPN’s pre-season best fantasy football players list. Brady never scored the most points in any one week, for example, but Bears back-up quarterback Josh McCown did, in week 14.

In short, buying the football equivalent of Coca-Cola shares (one of Buffett’s most beloved and long-held stocks) and hanging on through thick and thin can be a losing game.

I learned this lesson the hard way, having drafted Buffalo Bill running back C.J. Spiller with my first pick last season. Ranked the 7th best player by ESPN going into last season, Spiller scored 3.5, 11.7, 3, and 7.7 over the first four weeks. Unwilling to give up on such a high pick, however, I kept him in my starting lineup for most of the season. I ended up in the bottom of my league and learned a valuable lesson in sunk cost theory.

Of course finding seven weeks of Rainey, or spotting the next Foles off the waiver wire, is difficult. Some up-and-comers are just flashes in the pan and will deliver worse returns than your first-round pick. But when this season’s Foles takes off, don’t be surprised. If you play fantasy football you must learn to embrace the shooting star—and if that star burns out, find another.

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