What’s so wrong with socialism?

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As a concept, socialism is appealing. It’s idyllic, it seems to diminish unfairness, promote the less-fortunate, favor equality, all good things. So what’s the problem?

The true problem with socialism is an economic one. It’s about simple math.

Socialism seeks to operate an economy, or society on the whole, by rules and regulations set by a small group of people in power.

Conservatives mainly criticize socialism as a system that misplaces incentives. While humans do operate by incentive, and socialism does skew incentives, this is not the most helpful critique. Socialistic regimes have imposed different forms of incentives throughout history, like fear of torture and death, to coerce their people into desired action.

There is also a basic problem with the idea that a few people should hold so much power over many. Regardless of the purity of a person, power generally corrupts. But, like the incentive criticism, this is not the most basic problem of socialism. The truth is, even under the most compassionate, just, caring leadership in the history of the world, socialism would still be doomed to fail.

The problem of socialism is, at its most basic, a problem of pricing. A truly free market is an incredibly efficient way to set prices and wages. Whenever there is too much of a good, demand (prices) goes down, and businesses and people react by creating less of that good. Whenever there is a shortage of a good, demand (prices) goes up, and businesses and people create more of that good. In a free market, this happens quickly, automatically, and constantly. Communication stems from millions of data points (decisions, knowledge, people) occurring every second of every day accurately determining what people want and delivering those goods.

When a government or ruling body steps in to set prices or fix wages (the standard operating procedure of socialism) instead of letting the market make a determination based on supply and demand, that body is bound to fail. Any group of people, regardless of their level of training, IQ, ambition, morality, etc. can never have a complete understanding of the millions of data points, decisions, and knowledge swirling within the market every second. A few people simply can’t know as much as the several billion people on earth collectively know.

Because of this, a set price or a fixed wage will necessarily result in waste (too much of a good) or lack (too little of a good). This state of mispricing, given enough time, will result in the collapse of society.

An example of wage-fixing can be seen in modern-day minimum wage policies. Minimum wage is an attempt to promote justice and protect the less fortunate from evil greedy companies; an understandable inclination, but unfortunately a worthless solution. In a free market, wages increase naturally (with bumps along the way) as demand for labor increases. In socialism, wage-fixing makes it difficult or impossible for some businesses to hire employees at a price they can afford, even if potential employees would be glad to work for such wages. At worst this creates an insane situation where businesses aren’t allowed to hire people who want to be hired, at best the market is inhibited and incentives are skewed (business may be more likely to hire contract employees or part-time employees to avoid additional costs required by regulation). A much more effective way to thwart greedy capitalists is to give the market space to create better jobs.

Socialism, as economic practice, will always necessarily fail. No group of people can ever possess the collective information of the entire market, and so they will never be able to accurately allocate resources and set prices.

The Savings Quandry

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We live in a fiat currency world. ‘Fiat’ simply means government-backed. The paper that dollars are written on is pretty close to worthless, but the U.S. government guarantees its value and other countries do the same for their own fiat currencies. The U.S. dollar is worth something, more than most other fiat currencies, because it’s backed by the most powerful government in the world. There are a few implications of this:

  1. In the past, humanity has utilized a multitude of different items or elements or commodities as money, ranging from cattle to gold, beads to shells, and anything in between. Very few of history’s currency still exist as anything resembling money for one main reason, they could be produced. The most important characteristic of money, or of anything valuable, is its rarity, the difficulty (or preferably the impossibility) of creating more of it. In order for money to hold value, it can’t be producible, there must be a limited supply. If it’s producible, there’s a massive incentive for people to produce it, and when people produce more of something, that thing loses value. This has happened countless times throughout history. Some Native American tribes used Wampum beads (gleaned from shells and clams) as money and used them to trade with European settlers. European settlers, with superior technology, were able to mass-produce the beads causing a massive devaluation. Wampum beads were inflated (or devalued, they mean the same thing) to the point that they became worthless, leaving the Native American tribes using them destitute. A similar issue is presented when we try to use commodities as money (silver, coffee, copper, etc.). Commodities are valuable (many us would be lost without our morning coffee and we’d have a hard time building skyscrapers without steel), but when demand for a commodity increases, so does the production of that commodity, so its value decreases. Money doesn’t need to have intrinsic value, it doesn’t have to be useful for anything else, it simply needs to be able to reasonably hold value through scarcity.
  2. Since we use fiat currency, the government controls the dollar and consequently has the ability to produce more of it. When they do, inflation happens. The government likes inflation. Since the U.S. officially and fully entered the fiat currency game in 1971, the U.S. dollar has been inflated (devalued) by around 3.86% per year, on average. The government introduces more money into the economy through various convoluted debt instruments and stimulus packages, decreasing the value of existing dollars. The belief is that a certain amount of inflation is good for an economy because it promotes spending and borrowing, the opposites of saving. It’s definitely not helpful for saving. If you left $100k in your savings account in an average year, at 3.86% inflation you would lose almost $4k. If the money is in a savings account, maybe the bank would offer you a tiny bit of interest to offset some of the loss. If you’re lucky you might get 1%, but you would still lose $3k. In one year! Leave your money alone in a bank account or under your mattress for any amount of time and you’re out a significant portion of your savings.

So the question remains, how do we save money?

Thankfully, there’s an answer. The solution to the devaluation of our dollars is investing. Specifically, investing in companies through the stock market. All that talk about long-term investing, diversification, portfolios, the stock market, etc., that stuff all has merit. The best way to overcome inflation in our day and age is to invest money in companies, and let it grow. The stock market is the great hedge against inflation. Market returns, over time, always outpace inflation. It doesn’t happen every year, when the market is down it can definitely be worse than inflation, but if you give it time, the market will always win, and by a large margin.

Unfortunately, as things are presently constituted, saving money is not incentivized. Fiat money and inflation encourage borrowing and spending. But, saving is more important now than ever (who’s in line for a pension when they retire?), and the stock market offers an incredible store of value, one that increases exponentially over time. Don’t skimp on your investments.

How to Invest in Uncertain Times (part 1)

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The market has been rocked. In the last two weeks (March 3-16, 2020), the S&P 500 has lost over 22% of its value. It’s the fastest 20% descent we’ve ever seen, and no one knows exactly where the bottom will be (or if we’ve already hit it). The market has moved in percentage multiples, both up and down, every day last week, an incredible level of volatility. The leading cause, which still feels surreal, is the propagating Covid-19 virus which has led to mass closings and increasing restrictions. Suffice it to say, it’s been a crazy couple of weeks.

In many ways, we’re in uncharted territory, which means we’ve got questions, like how are we supposed to respond to all of this? What’s the right thing to do when we’re confused about what’s happening? To add some clarity, I’ll offer up a few investing principles throughout this week.

 

Market timing doesn’t work.

  • No one knows what the market will do tomorrow. Many make predictions, but no one really knows. Don’t try to guess where the bottom is, or when we’ll hit it, or when to pull money out of the market, or when to put the money back in. The market is efficient.
  • Let’s say you really want to get out of the market because you don’t believe we’ve hit the bottom yet and you’re not interested in sticking around to find out. In order to successfully time the market you have to get two bets right: you have to get out of the market before it hits the bottom, and you have to get back in at or very near the bottom. The odds are not favorable.
  • A market study conducted at the University of Michigan measured returns from 1963 through 2004 (a period of 42 years). They found that 96% of the positive returns over that period came from 0.85% of trading days (90 out of 10,573 total trading days).
  • Another study done by A. Stotz Investment Research observed a 10 year period, from November 2005 through October 2015. After running the data through several simulations, they concluded that if you missed the 10 best market days over the specified 10 year period, you would stand to lose, on average, 66% of the gains you would have captured by staying in the market.
  • When the market moves up, it moves up quickly. Whenever your money is on the sidelines, you risk missing some of the best days the market has to offer. So stay invested, don’t panic, and anticipate the rebound.

Context is Decisive

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Context is the air we breathe, the water we swim in. It’s our outlook, our worldview, how things occur to us, what we believe is true. It’s influenced by experiences, what we’ve been taught, things we’ve done and seen. Context is rooted in the past, much of it originates from childhood, from formative years. For that reason context is super sticky, it has a lot of staying power, it’s hard to change. And as people get older, they become less and less inclined to change their minds, or even to listen to different ideas.

Context is correlated with action; or, our actions naturally flow from our context. Context is similar to identity in this way. If you identify as an overweight person, you’ll take actions that are consistent with that identity. You’ll eat a lot of unhealthy food and you’ll spend a lot of time on couches. You’d have an incredibly difficult time losing weight, assuming you even wanted to try. If you identify as a healthy person, on the other hand, you’ll watch what you eat and make the gym a regular part of your routine. It’s baked into who you believe you are.

Context is partly what you believe about yourself, but it’s also what you believe about the world. If you believe people are generally nasty and selfish, you’ll have a hard time caring about a stranger. You won’t even want to meet a stranger. If you believe money is scarce (which the vast majority of us do), you’ll feel a measure of helplessness about your long-term earning prospects. The process of money-making feels like a grind, not the motivating ‘work hard’ grind, the boring, fruitless, hopeless grind. On the flip side, if you believe money is abundant, you’ll be inspired to work hard, be valuable, find ways to help people, and most likely accumulate more money.

Since context is sticky we often feel stuck in them, even if we realize they exist. We fall into ruts, or routines, or habits, that stem from our context and then we don’t change. It’s like our contexts are hardwired into our brains, like we’re in the Matrix, unable to detach from the machine. But, we’re not entirely powerless in relation to our contexts.

We can control our inputs, what we’re reading, watching, and interacting with. Good books can have a profound impact on how we think. Take time to interact with and evaluate other ideas and arguments and contexts. The world is way bigger than our limited experiences.

We can take a step back and evaluate them. If you can understand your context, and even some of the background that helped mold it, you can begin to see how it could be different.

We can also control what we say. Context is intricately tied to language. Words are how we organize and process what we see and experience, we speak and listen and think with words. And we can use different words, like ‘scarce’ instead of ‘abundant’, or ‘get to’ instead of ‘have to,’ or say ‘thank-you’ more often. Those are subtle changes, but sometimes what we need is a perspective that leans a different way.

So context is decisive, but it can also be changed. I would start with a good book.

It’s a Rough Day in the Market

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As I write this on March 9, 2020, market indexes across the board are down, some by as much as 9%. Coronavirus has made the market skittish enough over the last few weeks, to compound things Saudi Arabia announced massive cuts to the price of oil this morning, which actually seems kind of great (lower gas prices!), but markets have not reacted kindly. The response feels like panic. It’s certainly a bad day in the market, but I want to provide a little bit of context for all of this.

 

Here’s what you should know:

  • Unless you know the future or have inside information (unlikely, and illegal to trade on), you should be a long term investor. Short term market moves are pure gambles, and most often end up hurting investors. Don’t move money based on fear, which is all we hear in the news, especially on days like today.
  • Despite what pundits may be saying, no one knows what the market will do tomorrow. No one knows where the bottom of a downturn is, no one knows how long it will last or how quickly the market will come back. Don’t panic with your money, especially when the market is down.
  • Bad market days have happened before. On Black Monday (October 19, 1987) the Dow Jones Industrial Average dropped 22.61%, in one day! In order to crack the top 20 bad market days the Dow would have to lose 7%, but even if that does happen, we’ve seen the market bounce back from far worse.
  • The market bounces back quickly. When the S&P 500 loses 10% or more it recoups all losses within an average of about 4 months. The worst thing you can do is move money when the market is down and miss the bounce-back.
  • A limited number of great days in the market account for most of the great returns. A 20 year period between 1998 and 2018 included 5,040 trading days. If you missed the 30 best market days out of the total 5,040, you would have ended up with a slightly negative return over the 20 year period, $10,000 would have turned into less than $9,000. We don’t know when those great days will come (though we know they often follow bad days) but we definitely don’t want to miss them by being out of the market.
  • Markets move, but the general trajectory is up. If you’re invested for the long haul and you understand your risk tolerance, bad market days are no problem. They don’t even have to be stressful.

 

Here’s what you should do (or not do):

  • Don’t panic. This is not the first time we’ve had a bad day in the market and it won’t be the last. The worst thing you can do is move your money out of the market. In fact, bad days in the market are a great time to invest more.
  • Make sure you understand how and why you’re invested the way you are. The market will sustain losses, but an un-diversified portfolio stands to lose a lot more. On the flip side, a well-diversified portfolio can put your mind at ease.
  • Make sure your diversified portfolio has a systematic way of rebalancing. When the market is moving, a system for rebalancing will ensure that parts of the portfolio that are doing well are sold, and the parts that are down are bought. It’s an automatic ‘buy-high-sell-low’ feature.
  • Work with an investor coach. When things look bad, all the news and information surrounding you will only confirm your worst fears. An investor coach will keep you disciplined, make sure the accounts are rebalanced, and will ultimately guide you through turbulent markets to a successful outcome.