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.

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.

Book Takeaways – Atomic Habits

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This year I’m a part of a book club. Each month we read one book in the genre of self-improvement and meet to discuss our findings and takeaways. January’s book was Atomic Habits by James Clear. Along with the regular book club meeting, I’m going to highlight some key ideas and actionable items for you, my readers. Books may be the single best source of knowledge and wisdom available to humans. I love reading, and I love sharing ideas I’ve read so this exercise will tick a few boxes for me. Here goes. 

  1. Outcomes are a lagging measure of our habits, we get what we repeat. This is great news because it means we can work to change our habits and get different outcomes. 
  2. Goals are not correlated to results. Clear makes an impactful point that winners and losers have the same goals. Goals are helpful for providing direction but mostly worthless in obtaining a desired result. For that, we need systems/habits.
  3. Habits change identities. I consider this Clear’s most profound and important contribution to the discussion of habits. We fail to make lasting behavior changes routinely, regardless of our intention or passion, the size or specificity of our goals, or the breadth of our knowledge. Even when faced with an ultimatum, change or die, (ie, change your diet or your diabetes will kill you) people fail to change. The reason is that our actions are closely knit with our identities, and we fail to change who we are. The antidote is to start with a tiny action. Just do something good, however small. Each good action is undeniable proof that we have acted like (been) a different person, and that begins to mold our identities. The point of all this self-improvement effort is not to accomplish goals, it’s to become different people. I don’t need to lose 20 pounds, I need to become a healthy person. I don’t need to make $200k in five years, I need to become a valuable coach. The pounds and money are only byproducts.
  4. Make good actions easier and bad actions harder. In order to begin taking the small actions that will shape our identities, it’s helpful to set ourselves up for success. Humans drift toward the path of least resistance by default, so remove resistance from good actions and add resistance for bad actions. A few examples: 1) Set out your workout clothes before bed so it’s easy to wake up and get dressed for the gym. 2) Unplug the TV after each use so you have to plug it in if you want to watch something.
  5. An implementation intention is critical for habit building and behavior change in general. We tend to set goals and hope for some motivation to begin working on them. The problem is that motivation is scarce and inconsistent. An implementation intention solves that problem, it means we make a plan to implement our new habit by giving the habit a regular time and a regular place. In order to do something different, you must have a plan for it. If you intend to work out, choose a regular time (that fits into your schedule), and a regular location (whether it’s a space in your house or gym nearby). We make plans for all sorts of important things in our lives, habits call for the same attention.
  6. As a general rule, the more immediate pleasure you get from something, the more suspicious you should be of its long-term benefit. Not that we need to stop doing things that make us happy, just be aware that immediate pleasure and long-term benefits are almost never congruous.
  7. At some point, it comes down to who can handle the boredom of taking regular good action, day after day. You become healthy by eating good meals every day. You get strong by lifting the same weights over and over. You gain wealth by doing the same important function of your work time after time after time. Fall in love with the process, embrace the boredom.
  8. Success is not a goal to achieve, it’s a system of improvement, an endless process of refinement. It’s incredible what you can build if you just don’t stop.

Why don’t we use the gold standard anymore?

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Today we no longer use a gold-backed currency. Even when the dollar was backed by gold, the U.S. government would adjust the gold-to-dollar ratio with regularity, essentially muting any effect of the currency’s gold backing. So while officially abandoned in 1971, we’ve been off the gold standard for quite a while, since about 1914.

Beginning in and around the 19th century, developed nations almost universally adopted the gold standard. Uncoincidentally, the 2nd half of the 19th century is heralded as one of history’s great economic eras. But, in 1914, at the outset of WW1, developed nations involved in the fighting began moving away from the gold standard. They were faced with two options to finance war operations: 1) increase taxes, 2) leave the gold standard and print money. Option one would have been supremely unpopular, option two would accomplish the same thing as option one just without the national outrage. Taxes are one thing, people understand what’s happening, they’re giving up their money for a government to provide services that the collective majority generally agrees upon. Fiat money is different. Instead of imposing additional taxes, fiat money allows the government power to print money, devaluing the currency and causing citizens to end up with less money via inflation. Imposing taxes and printing money grant the same outcome for governments, they end up with more money, and it also creates the same outcome for citizens, they end up with less money. The issue is that citizens have a measure of control over taxation by voting, complaining, revolting, etc. They have very little control over printing money.

It’s impossible to prove, but nevertheless an interesting thought experiment: what if governments hadn’t abandoned the gold standard in 1914? In all likelihood the war would have endured for a fraction of the time it did in reality. Taxes would have been imposed (the only way for governments to fund the war), they would have been incredibly unpopular (because ordinary people didn’t care about petty monarchical conflicts between nations), governments would have run out of money to fund their war efforts, and the war would have ground to a halt, almost certainly sooner than four years, and more probably within one year. Again, it’s impossible to prove, but certainly possible.

Since 1914 little has changed, fiat (government-issued) money is the currency of the age. Taxation has steadily decreased over the last one hundred years while government spending has steadily increased by borrowing and printing notes. A return to the gold standard at this point is all but impossible. The fact is that gold, while a great purveyor of value, is impractical for day to day use. It’s heavy, it’s hard to divide into smaller bits, and it’s costly to keep secure. These are the reasons why gold was concentrated into central banks and traded via government promissory notes in the first place.

Unfortunately, every example in history involving the utilization of soft money (money that’s easily producible) has eventually resulted in large-scale economic collapse. That’s not to say it’s impossible for fiat money to succeed, the U.S. government, while far from perfect, has not inflated the currency to disastrous levels, and may not for a long time. But no human or human institution has been able to stave off the temptation to over-print currency indefinitely.

So that’s depressing, is there a solution? We know that hard money (money that’s scarce and/or hard to produce) is foundational to thriving economies. Gold is the best example we have of hard money, but it has inherent flaws that make it difficult to use in our modern world. An interesting development in the last decade is the inception and rise of crypto-currencies. I won’t pronounce Bitcoin the ultimate salve of modern economics, but it’s certainly worth keeping an eye on. Crypto-currencies offer many of the beneficial characteristics of gold (difficult or impossible to produce, widely accepted), and avoids many of gold’s pitfalls (it’s not heavy, not hard to divide, and inherently secure). The market will ultimately decide if some type of crypto-currency is any type of answer, for now, it’s a fascinating concept.