I am a boring investor (and proud of it)

At a conference in Austin, Texas a few weeks ago, one attendee commented that since I teach investments I must be a pretty good investor. I told him that I was actually a pretty boring investor. I confess, I don’t do anything fancy. I don’t try to time the market, I don’t sell short, and I don’t use options or futures contracts. This is not to say that I never have or never will again, I just tend to focus on asset allocation and the long term using primarily low cost exchange traded funds and no-load mutual funds (mostly index funds). Students have sometimes seemed disappointed that I didn’t have war stories to tell of outsmarting the markets and making a killing. You may think I am an aberration. Surely others who teach this stuff are glued to their computers looking for “mispriced” assets on which to pounce. Actually, as this article from Vanguard Investments reveals, I am the norm.      

Practice what you teach? Finance profs tend to keep it simple

You hear it all the time: Don’t try to beat the market. Buy and hold. Long-term investing trumps market-timing. It’s sound advice – at least according to many of the nation’s finance professors.

A recent academic survey found that most U.S. college finance professors consider themselves "passive" investors—that is, they tend to favor mutual funds over individual securities and resist trying to outperform the market through frequent trading.

Finance professors "study financial markets, but they also invest in the markets," said Colby Wright, assistant professor at Central Michigan University, who conducted the study with James S. Doran, Ph.D., of Florida State University. "Considering how knowledgeable they should be on the subject—and considering they are entrusted to teach others how to invest—we thought it would be interesting to find out what they do with their own money."

A tilt toward mutual funds

Of the 642 academics who responded to the survey, 67% identified themselves as passive investors, with most investing primarily in mutual funds.

"I think finance professors tend to be more risk-averse than the typical investor," said Dr. Doran. "They've done their homework, they've read the research, and they've taken to heart the philosophy that over the long run it's hard to do better than a broad-market index fund."

Gus Saulter, Vanguard’s chief investment officer, agreed with Dr. Doran’s assessment.

“It may seem counterintuitive that finance professors embrace long-term investing through mutual funds,” he said. “However, they typically have a sophisticated understanding about investing and a respect for the difficulty of beating the market. It's not surprising that a sophisticated investor would go with the odds and settle for market-like returns provided by index funds."

Their academic expertise notwithstanding, many respondents had never bought a futures contract, traded on margin, or purchased an exchange-traded fund. Likewise, a sizable minority had never traded an individual stock.

Beating the market: Do as I say, not as I do?

Nearly half the respondents agreed that stock markets are "efficient"—in other words, that it's practically impossible to outperform Wall Street over the long run because, at least in theory, all relevant information about every security is already "priced in" by the market before trading even begins.

Interestingly, however, a portion of those who believe beating the market is a fool's errand also confessed to ignoring this wisdom; almost a quarter acknowledged trying to beat the market with their own investments.

"That's a pattern we see all the time," said Mr. Sauter. "Whether you're an expert or not, it's human nature to imagine that you have some unique insight into the market, something that's eluded everyone else."

Dr. Doran concurs. "It comes down to confidence," he said. "Whether they're academics or professional investors, people who try to beat the market do so based on their confidence that they know something most other people don't—that they're privy to insights that the rest of us lack."

"That's a rare gift," he added, noting that—particularly when it comes to saving for retirement—most people do better to "keep it simple."

What Santa brought the Mad Max kids

Ho Ho Ho MERRY CHRISTMAS!

So what does Santa bring the kids of a guy who cares only about maximizing benefits and minimizing costs? No, not a lump of coal (although the kids aren't so sure). Here it is and it is excellent.  In fact, my personal finance students will be reading it next semester. In this tiny paperback, Jesse Mecham does an outstanding job of presenting the case for a budget – no matter how little or how much you have. And his personal story will ring familiar for many who take the time (very little time, actually) to read this little gem.  

http://www.amazon.com/You-Need-Budget-Jesse-Mecham/dp/146353437X/ref=sr_1_2?ie=UTF8&qid=1387663291&sr=8-2&keywords=ynab 

If you like your job, you can keep your job. Period! 

Okay, maybe that was a cheap shot at a president who is an easy target these days. He didn’t quite say that everybody could keep their jobs if the minimum wage was increased, but he was in error when he stated that there is no strong evidence that minimum wages cause unemployment among unskilled workers.  

The controversy over adverse effects of minimum wages center on two things:  1) Where the minimum wage is relative to the market clearing wage, and 2) Whether we are talking short-term or long-term effects.  

I always enjoyed asking my students why McDonalds would recruit new employees at $7.00 per hour when the minimum wage was only $5.15. This would usually stop them in their tracks. Was McDonalds just being nice? Well, there may be a lot of nice people at McDonalds but they weren’t paying 36% more than the legal minimum to be altruistic. McDonalds was paying more because they have to compete for workers with Wendy’s, Burger King, Pizza Hut, and a zillion other establishments and the competition had bid up the market wage well past the $5.15 minimum.   

So, if burger flippers (as a former burger flipper, I use this term with great affection) were already making more than the minimum, why bother raising it if you are only going to increase it to what burger flippers are making (or will soon be making) anyway? This is where economics gives way to politics. Raising the minimum wage in this instance was merely a symbolic gesture from politicians wanting to take credit for increasing wages with no (or little) downside risk. Again, if all you are doing is raising the minimum wage to the market wage, what’s the point? If they had any guts -- and if politicians really believed that simply raising the minimum wage would help unskilled workers increase their standards of living – wouldn’t they raise it to $20 or $100? I suspect that even the most economically illiterate politician knows that a minimum wage that much higher than the market clearing level is going to cause problems. 

In Europe, politicians have not been so timid, however. But if you learn anything in economics it is that because we live in a world of scarce resources, there are always tradeoffs and opportunity costs. The tradeoff here is higher unemployment, and in places like France, Spain, and Belgium, unemployment is typically much higher than it is in the U.S. and high minimum wages are cited as a contributing factor. 

As for long-term versus short-term effects, the market for unskilled labor tends to be relatively supply and demand inelastic in the short-term. This means that if even if the minimum wage is placed above the market rate, there won’t be much of an impact on employment. However, over time, elasticity increases as employers figure ways to respond to the higher labor costs which causes the quantity of labor demanded to decrease. Also, over time, some who were otherwise engaged at the lower wages (students, homemakers) will alter their schedules and enter the job market at the higher wages. This will increase the quantity of labor supplied.  

Lower quantity demanded + higher quantity supplied = greater unemployment.  

Bottom line, we would expect studies where minimum wage increases remained at or below equilibrium, or only measure short-term effects, to conclude that minimum wage has no significant impact on employment. Similarly, we would expect studies where minimum wage is increased above the equilibrium and cover longer periods to conclude that there are adverse effects. Of course, a good politician will only recognize the studies that support his or her ideology, hence President Obama’s statement that there is no evidence that the minimum wage causes unemployment (See  MIT Press https://mitpress.mit.edu/books/minimum-wages and NBER http://www.nber.org/papers/w18681.pdf  for evidence to the contrary) 

So would the proposed $10.10 minimum diminish employment opportunities for unskilled workers? Maybe not in the short-term but if it proves to be substantially higher than equilibrium (and it appears to me that this is the case), we can expect problems down the road.    

If it were as simple as passing a law, how about raising the minimum wage to $1,000 per hour and we will all be driving Rolls Royces and living in beach front mansions J 

For more about the minimum wage see: http://www.thebigquestions.com/2013/02/18/thoughts-on-the-minimum-wage/

For current minimum wage demographics, see the video below: 

 

 

Government and Efficiency

The old joke goes something like this:

What are the three most outrageous statements?

1) The check is in the mail,
2) I’ll respect you in the morning,
3) I’m from the government. I’m here to help. 

The inefficiency and waste of government has been talked about and joked about for ages but exactly what do we mean when we talk about government inefficiency? There is no better example than the Obama administration’s attempt to develop a health insurance website. The cost: $400,000,000. Yes, that’s 400 million dollars for a website that barely functions and has serious security problems. Why so much? Because the government is not subject to competition. It does not have to worry about going out of business if they produce an inferior product. And since they do not have to deal with competitive pressures, governments tend to be lax about productivity and cost controls.  

On the other hand, here is a private health insurance website that works just fine:  

www.ehealthinsurance.com  

Speaking of ehealthinsurance, they are cited in the following Wall Street Journal article that explains why insurance policies sold by the Affordable Care Act’s exchanges are more expensive and offer fewer choices:     

http://online.wsj.com/news/articles/SB10001424052702303460004579192081764514664#printMode

MM

Addendum: Bloomberg Government now estimates the cost of the ACA to be $1,000,000,000 (that's one BILLION dollars!!!)

The True Impact of the Affordable Care Act

The sticker shock of the Affordable Care Act is shaking the nation (along with the revelation that President Obama deceived the American people to get it passed -- and him reelected) but the biggest cost of the ACA is actually decades away. In the short-term, little change will be noticed. It is over the long-haul that we will see the true impact -- and it will be huge. Economist Brian Wesbury explains below: 

The economics of insurance and why the new health care law will break the bank

The economic function of insurance is to transfer risk that we cannot afford to retain. It is a very simple concept. Young parents, for example, may be totally confident that “as long as I am around” their kids will have all the opportunities life has to offer. The whole thing falls apart, however, if a parent dies before an estate can be built. To avoid such a devastating outcome, prudence dictates that this risk be transferred to a life insurance company. With life insurance, an estate would be provided in the event of a parent’s premature death. When the kids grow up and an estate is built, life insurance is typically no longer needed.

Again, there is nothing complicated about insurance. Since the concept of transferring the risk of a catastrophic event is so intuitive, it is puzzling how the purpose of insurance has become so misunderstood by so many. The insurance industry can take much of the credit for this confusion. They have done a masterful job of convincing us that we should transfer virtually all of life’s risks to them. The most outrageous example is their marketing of life insurance on kids. First, let me state that if I lost any of my kids, I doubt I would ever fully recover. My life would be dimmed forever -- but I would never have life insurance on them!

Why? Because kids are not financial assets. Quite to the contrary, my kids are three of the biggest cash suckeruppers this world ever saw. I would be much better off financially if I didn’t have them. Why would anyone insure a liability? Clearly, the premiums would be better used if they were invested in a fund on which the family could draw to pay final expenses (if that were to ever be necessary). If the balance of the fund turned out to be inadequate, the remainder could be borrowed and the money saved (and this sounds so cold) from not having the kid around anymore would quickly pay off any loans that may be needed. Flying in the face of sound economic reasoning, insurance companies have still managed to convince many parents that having life insurance on their kids is not only necessary, but a measure of their love for them.

We have also lost sight of the purpose and function of health insurance -- and in a big way. The economics is no different from other types of insurance. Yet, much like life insurance for kids, things have gone haywire.

There are many events that are fairly predictable and can easily be budgeted for. With great certainty we can assume that we will, on occasion, have to see a doctor for head colds, sore throat, minor injuries, etc. We may from time to time need to buy some medicine to speed our cure and make ourselves more comfortable. But, does the risk that we may catch cold really need to be transferred to an insurance company? Insurance companies are highly skilled at estimating probability and risk and they will not sell policies that cover these events unless the premiums are high enough to provide them a profit. Comprehensive policies cover these high frequency/low severity losses, and as a result, premiums must be higher to cover the additional administrative expenses. Insurance companies love to sell policies that cover such predictable events and agents are paid higher commissions for selling them.

However, it is more cost effective for the insured to retain the risk for these high frequency/low severity losses through the use of higher deductibles. This way, the cost of covering the administrative expenses can be reduced since the insurance is now focused on low frequency/high severity losses which also require less frequent administrative red tape. However, insurance companies (and now politicians) have been masters at convincing us that these high frequency/low severity situations are too risky for us to bear. Thus we see comprehensive policies sold where high deductible policies would be more efficient. (I do wonder when we will see haircut insurance. Wouldn’t it be nice to just give the beautician our insurance card whenever we get a trim? How about rain insurance? If we find ourselves stranded away from our car without an umbrella, all we would have to do is call a hotline and an umbrella would be delivered to us. We could forever eliminate the risk of getting wet!)

For those who are highly risk averse or have trouble managing their finances, perhaps big expensive coverage is a good idea. For those of us who are already expending a great deal of resources in health maintenance, the last thing we want to do is to pay to transfer risks that we have already worked hard to minimize. There are many, like myself and my family, who take health seriously enough to do everything possible to take care of themselves through proper eating, exercise, and by avoiding harmful substances like alcohol, tobacco, and illicit drugs. These prevention measures, however, are not without cost. Health club fees, food supplements, fitness equipment and maintenance (bicycles, running shoes, etc.) really add up. Good physical fitness is a major investment in time and money. With a comprehensive policy, we are effectively paying twice: once to transfer the full risk to the insurance company, and then again to minimize that very same risk we just paid to transfer.

It is therefore unfortunate that under the Affordable Care Act (aka Obama Care) many high deductible policies will not be allowed. Yes, our politicians in their infinite wisdom are ignoring economic reality and forcing us to purchase more insurance than we need. This is like a hungry man being forced to buy a whole herd of cattle just to get a Big Mac. He really needs the food but having to buy the whole Ponderosa is a serious financial burden. Of course, big, expensive comprehensive policies should be available for those who want them but they should not be the law of the land. Yes, everybody needs health insurance. The risk of catastrophic illness or injury is too great to self-insure. On the other hand, the risk of getting a head cold and needing some antibiotics is quite manageable and does not need to be transferred to an insurance company.

So why does the Affordable Care Act (aka Obama Care) require more insurance than is needed? Because this is more about redistributing income than it is about health care.

The ACA is built around the hope that by forcing the young and healthy to buy insurance, those funds can be used to pay for the health care of the sick and elderly and those with pre-existing conditions. The trick is to get the young to buy in. Unfortunately, because they will be forced to purchase more than they need, many will find it too expensive (except for those who are well connected politically, of course.  Young White House staffers, for example, have been exempted because it has been determined that it will cost too much).

Financial Analyst Dan Caplinger explains further in the video below: 

If twenty and thirty somethings opt out, where will the money come from to support the system? More taxes and more debt with the resulting drag on economic growth and standard of living. This is when the Affordable Care Act becomes even more unaffordable. (For more about the ACA's not-so-pretty fiscal picture, see: realclearmarketsobamacarefinancialunraveling)

With the new system breaking the bank and so many remaining uninsured, we will begin hearing arguments for a Canadian style single payer system – with all its accompanying shortages and backlogs. (This would have to be disconcerting for Canadians who have always had the U.S. as an outlet when wait-times have become too long. For example, Cleveland is now Canada's unofficial hip replacement center and the government of British Columbia had to contract with Seattle hospitals when the back log became too great. Where would Canadians go if the U.S. implemented the same system?)    

Canada's Frazier Institute tracks wait-times for health care. See: 

http://www.fraserinstitute.org/research-news/news/display.aspx?id=16488

More about the ACA in future posts.  

MM

How selling my truck made the world a better place

I sold my truck yesterday. My beloved Ford F-150, the top selling vehicle for as long as I can remember. But all good things come to an end (the up side is that all bad things also come to an end) and it was time to allocate those resources elsewhere. 

What is amazing is how merely making a simple trade improved the lives of the two people involved. As we completed the transaction at a local bank (where the buyer purchased a Cashier’s Check and I signed over the title) we were all smiles. Why? I was selling the truck for more than my reservation price, thus I was enjoying some newly created Producer Surplus and (at least judging by the smiles) my buyer was getting the truck he wanted for less than his reservation price and he was enjoying his newly created Consumer Surplus.

Our trade did not increase the number of trucks in the world. But by reallocating existing resources in a more efficient way, Economic Surplus was created and two lives improved. 

Trade truly does make the world a better place.  

MM