In praise of saving - NOT investing

[Chuckanut]

Then again, investing (appropriately) for decades and then rolling some or all of it into an SPIA is another way to "buy" a pension, too -- but at today's interest rates the cost of an income stream is way too high.

True. I have heard it recommended that people who want a SPIA should dollar cost average their money by purchasing a number of smaller annuities over a period of time, thus allowing for higher interest rates in the future. I am not recommending this, just passing it on. I do not own a SPIA.

 

[ziggy29]

True. I have heard it recommended that people who want a SPIA should dollar cost average their money by purchasing a number of smaller annuities over a period of time, thus allowing for higher interest rates in the future.

And also smaller amounts in multiple SPIAs is less likely to cause you to lose everything in case of defaults. If a state guarantee fund backs each annuity up to $100,000, for example, buying three $100,000 annuities instead of one $300,000 annuity could provide greater asset protection against failure of the insurer. In that sense it's similar to having multiple savings accounts or CDs with multiple institutions so you don't exceed FDIC limits with any one bank.

 

[clifp]

I know there are a lot of people who think this way... but it is not true...

You HAVE lost value... there is nobody who is willing to buy your stock or ETF at the price you paid... which makes it a loss.... it has not been 'realized' yet because you have not sold..... and there is a chance that the value will go back up and you might gain back all of your losses, but to say you haven't lost anything at that moment in time is wishful thinking...

No NO NO
Ben Graham in the Intelligent Investor explained that value of a stock is the sum of all of the future dividend payments of it. In the absence of a change in the financial condition of company the value remains relatively constant.

McDonalds MCD dropped roughly 1% today to from 100.55 to $99.58. It has roughly 1 billion shares outstanding which means that somebody who owns a share (not me) would own one one billonth of the company. Let say that McDonalds make $.25 net profit for every burger they sell. Rather than paying dividends McDonald decide to distribute profits to shareholder for every billion burgers, fries, shakes etc. they sell, the send the shareholder a check.

Now there may have been some news I missed, but I seriously doubt that McDonalds is going to sell 1% less burgers over the next 100 year or make 1% less profit today than they did yesterday. It is much more than likely I am going to get pretty much exactly the same number of checks and the same size from McDonald today as I did yesterday.

It is true that Mr Market is willing to pay me 1% less for those future checks today than yesterday but the dollar value of those checks is the same cause I still owe one billionth of McDonalds.

All assets have an intrinsic value which is separate from the price at given time. The price of my house has fluctuated a lot over the past 6 years up 50% from what I bought down 25% from the peak. However the intrinsic value of it as place to live with a very nice view in a warm climate hasn't changed much. "Price is what you pay, value is what you get." Now intrinsic value of things does change, especially for individual companies But great thing about Mr. Market is your never have to accept it price you can wait for another day.

 

[nun]

No NO NO

Now intrinsic value of things does change, especially for individual companies But great thing about Mr. Market is your never have to accept it price you can wait for another day.

Tell that to the people who bought ENRON.

The dividend point is well taken, that's why I own Wellesley, but most people will look at the price and if it's gone down they feel that they've lost money and from that flows some big errors they make when investing ie sell low and buy high.

Part of my praise for saving is that it gets away from the complications of investing. If I was to advise a beginner I'd start with Mr Micawber's injunction about spending; once that is done I'd encourage them to save until they have a years worth of spending in an easy access account; then save into a long term saving account or annuity with the goal of it generating 50% of income requirements at retirement and once that is going ok only then think about investing in index mutual funds.

As an example putting $8k a year for 30 years into something like TIAA-Traditional will produce $400k and that will buy $30k annual income annuity for a 65 year old man. Combine that with SS and you have the average income for most Americans covered, even before you touch your mutual fund investments.

 

[Texas Proud]

No NO NO
Ben Graham in the Intelligent Investor explained that value of a stock is the sum of all of the future dividend payments of it. In the absence of a change in the financial condition of company the value remains relatively constant.

McDonalds MCD dropped roughly 1% today to from 100.55 to $99.58. It has roughly 1 billion shares outstanding which means that somebody who owns a share (not me) would own one one billonth of the company. Let say that McDonalds make $.25 net profit for every burger they sell. Rather than paying dividends McDonald decide to distribute profits to shareholder for every billion burgers, fries, shakes etc. they sell, the send the shareholder a check.

Now there may have been some news I missed, but I seriously doubt that McDonalds is going to sell 1% less burgers over the next 100 year or make 1% less profit today than they did yesterday. It is much more than likely I am going to get pretty much exactly the same number of checks and the same size from McDonald today as I did yesterday.

It is true that Mr Market is willing to pay me 1% less for those future checks today than yesterday but the dollar value of those checks is the same cause I still owe one billionth of McDonalds.

All assets have an intrinsic value which is separate from the price at given time. The price of my house has fluctuated a lot over the past 6 years up 50% from what I bought down 25% from the peak. However the intrinsic value of it as place to live with a very nice view in a warm climate hasn't changed much. "Price is what you pay, value is what you get." Now intrinsic value of things does change, especially for individual companies But great thing about Mr. Market is your never have to accept it price you can wait for another day.

I think you are mixing up the intrinsic value with the what is someone willing to pay me today value. As you mentioned with your house... the amount someone was willing to pay fluctuated a lot... the value of it went up... someone was willing to lend you money on that increased value... when it went back down, nobody would lend you money...

The point I am trying to make is that saying you do not lose anything until you sell has kept people is horrible investments because they don't want to 'lose' that money.... and I say 'yes, you have LOST it, now what do you want to do going forward'.... and I have heard it many times from people (the most recent from the mother of my best friend who owned GM debt prior to BK)... I told her to sell as she had lost money... but she said 'I have not lost anything until I sell'.... well, the BK court made her sell.... at an even bigger loss than when I told her....

Now, you are correct that if you own 1 billionth of a company today and the stock price goes down, your ownership of the company does not change... but if the price of your company goes down 50% today.... you lost 50% in value... sure, tomorrow it might go right back up, but it might not... you have to make your decision of should I keep my money in this stock or move it to another.... what is my best option today... most of the time it is to leave it where it is...

But would you agree that Netflix has lost value this year IOW, the true value of the stock is lower... if so, then would someone who bought it at $300 per share have lost value even though he has not sold the stock I think the answer is yes, he has lost value... and I would be hard pressed to understand anybody who said no, he has not lost value... (the stock is selling at about $68 now)....

 

[Nemo2]

I say 'yes, you have LOST it, now what do you want to do going forward'....

+1

As far as I'm concerned this "You haven't lost it until you sell" is a totally invalid truism.

 

[bubba]

+1

As far as I'm concerned this "You haven't lost it until you sell" is a totally invalid truism.

Ditto

 

[NW-Bound]

Having owned a lot of individual stocks over the years, I have seen plenty of price fluctuations that I have become somewhat jaded. A 25% drop, not necessarily from my purchase price but even from a recent high, should be cause of concern for me. A drop of 50% would be very alarming, and often meant a permanent loss, and quite often an eventual total loss, meaning bankruptcy.

The above only applies to individual stocks, not one's entire portfolio. If the latter drops 25%, that should be enough to cause one's sleepless nights! Diversify, diversify, dummy...

The above said, I will admit that in the tech stock rout of 2000-2003, I "lost" as much as 40% from March 2000 top to March 2003 low. Well, I recovered, but I swore to myself, never again! In the drop from 2007 to 2009, I was doing a bit more aggressive preemptive selling, and fared a bit better. Top to bottom, I suffered a "loss" of less than 25% of total portfolio, which has been also recovered.

I don't blame people who could not stand the heat of the kitchen and stay out.

 

[nun]

I don't blame people who could not stand the heat of the kitchen and stay out.

Nothing wrong with the heat of the kitchen, as long as you've got a lounge chair and a tall one in an air conditioned room.

 

[clifp]

Now, you are correct that if you own 1 billionth of a company today and the stock price goes down, your ownership of the company does not change... but if the price of your company goes down 50% today.... you lost 50% in value... sure, tomorrow it might go right back up, but it might not... you have to make your decision of should I keep my money in this stock or move it to another.... what is my best option today... most of the time it is to leave it where it is...

But would you agree that Netflix has lost value this year IOW, the true value of the stock is lower... if so, then would someone who bought it at $300 per share have lost value even though he has not sold the stock I think the answer is yes, he has lost value... and I would be hard pressed to understand anybody who said no, he has not lost value... (the stock is selling at about $68 now)....

A couple of points. First I agree that refusing to recognize that value of an investment has changed has cause many people to lose a lot of money by holding on to loser. Netflix or Enron are prime examples of situation I AM NOT talking about. Enron books were cooked and once that fact was discovered the price rapidly approached the value. Netflix stock was clearly overvalue in $250+ price which is why I shorted it and made money. In addition this year management did a series of things that were stupid which reduced customer good will and the intrinsic value of the company. The combination of being over valued to start with and lower intrinsic value accounts for much of the reason that price Netflix is down 75% from its peak.

I don't believe in an efficient market over the short term. In particular I think price fluctuations are far more dramatic than actual changes in intrinsic value.

When the price of a stock declines in many cases (and probably most cases for an individual stock) it is because the value (as defined by the present value of the future dividend payments) declined. An easy to understand example is a heavily regulated utility in a slow growth area. It pays a 4% dividend that increases very slowly. If interest rates rise such that you can get 4% in 3 year CD or a TIP bond, the value of the dividend of the utility is much lower. After all the utilities nuclear power plant could melt down and you can kiss your dividend goodbye. The stock price should decline so that the utilities has a higher yield that 4%.

Where we disagree is when you say that if the price declines you HAVE lost value. In some cases yes, but not necessarily Value using Graham's definition. As somebody who depends primarily dividends to fund my retirement I don't worry about daily or even annual price fluctuations cause unless the current/future dividends of my stocks change I haven't lost anything. I'd be perfectly happy if they closed all stock markets for the next 5 years. Although I'd miss watching some of the cuties on CNBC and doing stock research . So if there wasn't stock market trading, what would the value of my stocks be? How would you know if it went up or down?

I'd argue that price is not equal to value is especially true in the case of broad based mutual funds/etf with high levels of volatility. Nothing fits this definition better than an Emerging Market Index fund like the OP was talking about. If we look at Vanguards (VWO), the returns were 2006 29% 2007 37% 2008 -53% 2009 +75% 2010 +19% 2011 -22%. VWO is $45 billion dollar fund which owns stock in 873 mostly big ($15 billion average market cap) in scores of different countries. Now the economic collapse of 2008 absolutely hurt the intrinsic value of most companies in a big way, but I am hard press to believe that changes were as dramatic as the price changes suggest. I don't know which is crazier the 53% drop in 2008, or the 75% gain in 2009. I am sure there is an Enron or three among the 873 companies, and no doubt a few scores of managers like Netflix's team but I am positive the true value of this fund doesn't change that dramatically every year.

I guess my main point is that stomaching the crazy price swings is a lot easier if people remember that what they really own when the buy a fund like this is ownership position in lots of good business, and rights to future profits. I realize that this is foreign concept to the public at large, but I do think forum members can actually help with the education process in situations like parties. Especially if your football team is out of the running....

 

[NW-Bound]

Nothing wrong with the heat of the kitchen, as long as you've got a lounge chair and a tall one in an air conditioned room.

Some people are happy to stay in the lounge chair and wait to be served whatever gets cooked up in the kitchen. Some others like to do the cooking themselves, and are willing to take the risk of getting eye brows singed .

Well, what's the end result? Is it "good eats"? Hard to tell. Some years, a perfectly seared steak. Some other years, burned rice.

 

[nun]

Some people are happy to stay in the lounge chair and wait to be served whatever gets cooked up in the kitchen. Some others like to do the cooking themselves, and are willing to take the risk of getting eye brows singed .

Why can't anyone see that I'm advocating a balance between the kitchen and the lounge chair. Having the lounge chair gives you somewhere safe to be if you burn something in the kitchen.

To stop the analogies for a second. Having a good foundation of savings that can produce some income actually lets me be a better investor. I hope that the CD ladder will be worth investing in sometime soon. I look longingly to the UK where you can still get a tax free, 5 year, savings account at 4.5% interest.

 

[steelyman]

Isn't this really just the usual asset allocation discussion? People talk/write all the time about their stock/bond/cash allocation, and each have their preferences. If yours is 0/0/100, then that's OK if it works for you.

 

[NW-Bound]

Why can't anyone see that I'm advocating a balance between the kitchen and the lounge chair. Having the lounge chair gives you somewhere safe to be if you burn something in the kitchen.

To stop the analogies for a second. Having a good foundation of savings that can produce some income actually lets me be a better investor. I hope that the CD ladder will be worth investing in sometime soon. I look longingly to the UK where you can still get a tax free, 5 year, savings account at 4.5% interest.

OK, I get you now. Talk about dashing in and out of the hellish kitchen

Well, among the "safe" things I have are the I-bond accounts, and having missed the really good deal around 2000, mine do not pay me that much, and that is even before taxes (deferred until when I withdraw). I also have money in other short-term interest-paying accounts.

I do try to play the "barbell" strategy, meaning instead of indexing to be in the middle, I would try to have part of my money safe, so that I can take more risk with the other half. Well, as I reported earlier, it has been a mixed result.

When I get bored with all this, will just put it all in Wellesley or Wellington...

 

[nun]

OK, I get you now. Talk about dashing in and out of the hellish kitchen

My point in starting all this was to bemoan the lack of emphasis that is place on saving today, rather than trash other investments. Mutual funds are almost exclusively pushed in 401ks, etc and the financial media doesn't talk about the utility of CD ladders or products like TIAA-Traditional which i think will lead to a disaster for the baby boomers are those that come after.

 

[brewer12345]

My point in starting all this was to bemoan the lack of emphasis that is place on saving today, rather than trash other investments. Mutual funds are almost exclusively pushed in 401ks, etc and the financial media doesn't talk about the utility of CD ladders or products like TIAA-Traditional which i think will lead to a disaster for the baby boomers are those that come after.

So it isn't saving if people don't buy your chosen investments? Now we are getting somewhere...

 

[ERD50]

So it isn't saving if people don't buy your chosen investments? Now we are getting somewhere...

Confused? Me too!

Or maybe it's perfectly clear?

-ERD50

 

[nun]

So it isn't saving if people don't buy your chosen investments? Now we are getting somewhere...

Exactly, at last someone understands

 

[Texas Proud]

A couple of points. First I agree that refusing to recognize that value of an investment has changed has cause many people to lose a lot of money by holding on to loser. Netflix or Enron are prime examples of situation I AM NOT talking about. Enron books were cooked and once that fact was discovered the price rapidly approached the value. Netflix stock was clearly overvalue in $250+ price which is why I shorted it and made money. In addition this year management did a series of things that were stupid which reduced customer good will and the intrinsic value of the company. The combination of being over valued to start with and lower intrinsic value accounts for much of the reason that price Netflix is down 75% from its peak.

But that is not what the average Joe thinks.... when you say 'I have not lost anything because I have not sold'.... the vast majority will think it applies to all situations... and when I have heard it from almost everybody it is relating to a bad stock pick they made....

Also, how do you know if the company you have invested is the next Enron or one of the other companies that crashed

I don't believe in an efficient market over the short term. In particular I think price fluctuations are far more dramatic than actual changes in intrinsic value.

When the price of a stock declines in many cases (and probably most cases for an individual stock) it is because the value (as defined by the present value of the future dividend payments) declined. An easy to understand example is a heavily regulated utility in a slow growth area. It pays a 4% dividend that increases very slowly. If interest rates rise such that you can get 4% in 3 year CD or a TIP bond, the value of the dividend of the utility is much lower. After all the utilities nuclear power plant could melt down and you can kiss your dividend goodbye. The stock price should decline so that the utilities has a higher yield that 4%.

I also do not believe in an efficient market. But what about the value of a stock that does not pay dividends What is that reason for the change in value.

Where we disagree is when you say that if the price declines you HAVE lost value. In some cases yes, but not necessarily Value using Graham's definition. As somebody who depends primarily dividends to fund my retirement I don't worry about daily or even annual price fluctuations cause unless the current/future dividends of my stocks change I haven't lost anything. I'd be perfectly happy if they closed all stock markets for the next 5 years. Although I'd miss watching some of the cuties on CNBC and doing stock research . So if there wasn't stock market trading, what would the value of my stocks be? How would you know if it went up or down?

Most companies are valued on the ability of them to earn profits going forward, not the dividends they pay. Again using real life example, there is GM, Citi (well, almost any bank), GE etc. etc.

I just took a look at GE... they paid a 31 cent dividend until Feb 2009. The next dividend was 10 cents. Did the value of GE go down by 2/3rd The stock had gone down from the $40s to $12 with the high dividend... then it went back up when the dividend was cut. I would say that GE price changed because people thought that they could not make the profit they had been making. But again, did someone 'lose value' under your definition if they had invested in GE even if they did not sell I would say yes... and even using your definition of PV of future dividends I would think you would say yes.... so the statement is false under this example... which IMO makes it false all the time...

I'd argue that price is not equal to value is especially true in the case of broad based mutual funds/etf with high levels of volatility. Nothing fits this definition better than an Emerging Market Index fund like the OP was talking about. If we look at Vanguards (VWO), the returns were 2006 29% 2007 37% 2008 -53% 2009 +75% 2010 +19% 2011 -22%. VWO is $45 billion dollar fund which owns stock in 873 mostly big ($15 billion average market cap) in scores of different countries. Now the economic collapse of 2008 absolutely hurt the intrinsic value of most companies in a big way, but I am hard press to believe that changes were as dramatic as the price changes suggest. I don't know which is crazier the 53% drop in 2008, or the 75% gain in 2009. I am sure there is an Enron or three among the 873 companies, and no doubt a few scores of managers like Netflix's team but I am positive the true value of this fund doesn't change that dramatically every year.

I would suggest that the value of the EM did change because people's risk tolerance changed.... I will agree that the swings are probably more than the true underlying value of the companies, but that is part of the market... the emotion of people...

I guess my main point is that stomaching the crazy price swings is a lot easier if people remember that what they really own when the buy a fund like this is ownership position in lots of good business, and rights to future profits. I realize that this is foreign concept to the public at large, but I do think forum members can actually help with the education process in situations like parties. Especially if your football team is out of the running....

I agree that the price swings can make a lot of people do things that they should not do... having an AA and investing in a broad range of mutual funds can help people ignore the ups and downs of the market.... but what I do not believe is making people try and feel good by making a statement that is not true... I tell them that you need to invest in the overall market and let your money work. I tell them what alternative investment do you have.... IOW, what is the best for you right now. Do not worry about the loss... it is done... let's look at today and tomorrow and make intelligent investments...

 

[ziggy29]

My point in starting all this was to bemoan the lack of emphasis that is place on saving today, rather than trash other investments.

I don't know. For many years I heard financial planners and personal finance gurus bemoaning the pitiful savings rate. Of course now, we're being told that we're saving *too much*, which is sending us into a recession.

You can't win with the so-called experts. For most people I think saving (in the more traditional preservation of capital sense) and investing in equities have a place -- "traditional savings" to provide a cushion and an emergency fund to get you through a certain amount of time, and investing for long-term future growth. Not everyone can save 40-50% of their after-tax income or more, which might be what it takes to have enough with the -1% to +1% real return of "traditional savings" to finance a 30+ year retirement.

 

[obgyn65]

Same for me. I have never been an investor. I am 100% in CDs, munis, cash or equivalent. Happy with my choices.

Well, here I am, coming into my final year before retiring and coming out of the closet as a self proclaimed saver.

 

[haha]

+1 I don't know how people can say they want to get out of 'risky' stocks after they run and understand those scenarios. Seems the 'riskiest' thing you can do is drop your equity allocation too low.

-ERD50

I wouldn't be retired if I hadn't invested, and invested fairly well.

Everyone is different.

Ha

 

[foxfirev5]

I wouldn't be retired if I hadn't invested, and invested fairly well.

Everyone is different.

Ha

I see quite bit of the savings vs investing debate. Many advisors are now touting an ultra conservative approach. I prefer to "dance with the one that brought ya".
Sticking to my 45/40/15 conservative allocation.