Stocks

Investing Is In Some Important Ways a Community Act Rather Than an Individual Act

Valuation-Informed Indexing #361

by Rob Bennett

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There’s a funny scene in an episode of Mad Men that reminds me of an unfortunate phenomenon that applies among the stock investors of today. Don Draper and his wife and two kids are enjoying a picnic at a public park. When it is time to get back in the car and drive home, they pick up the things they want to bring back home and then pull up the blanket on which they and the food had been sitting, causing papers and napkins and boxes and other trash to get tossed onto the grass. They all smile as they walk back to the car, not one of them showing any concern that they have spoiled the environment with an act that all those watching through today’s eyes view as careless and lazy and selfish.

FirmBee / Pixabay

People did things like that in the 1960s. Environmentalism wasn’t a thing. People smoked in elevators and people told racist jokes in public and people (both men and women) assumed that a woman whom they had never met was more interested in finding a husband than in career advancement. Our ideas of how to interact with others in the community change over time. Things that at one time we think of as personal matters (“it’s my trash, I’ll do what I want with it”) come to be perceived as matters of community concern.

I think that we are going to see that change in perception take place in regard to our views on stock investing sometime over the next decade.

Robert Shiller talks briefly about this possibility in his book Irrational Exuberance. People who saved less than they needed to because they were misled by the exaggerated statements of their portfolio values that appeared during bull markets “may find that their savings are inadequate, that the real value of the portfolio has fallen far short of the increased cost of a college education. The children may have to take out substantial student loans and get unrewarding part-time jobs to pay for their college education. Or they may decide to choose a shorter career route, foregoing the dream of a career in medicine, law or other professions. They may decide not to go to college at all. Others, a little older, may find that their careers or ambitions are thwarted.”

Investing sites deal with issues like retirement planning and asset allocation and risk management. What’s this talk about unrewarding part-time jobs and shorter career routes and unfulfilled ambitions? That stuff doesn’t belong in discussions of stock investing. Does it?

It’s Shiller who is pointing out these issues because it is Shiller who showed up how the old understanding of how stock investing works is terribly flawed. If the market really were efficient, investing would just be a process by which people take money they have saved, give it to businesses seeking capital to finance their endeavors, and enjoy the return obtained from doing so. But the market isn’t efficient, according to the last 36 years of peer-reviewed research in this field. Market prices are not determined through rational acts in which individual investors seek to pursue their self-interests effectively. Shiller showed that stock investing is largely an emotional endeavor, that the prices that we collectively set for stocks at times of high valuations are fantasy prices.

That changes everything. Fantasy thinking always ends in tears. So anything we do to encourage the fantasies that send stock prices temporarily to the moon hurt people. If the market were efficient, we could say that the stock prices that applied on the day after a 50 percent price drop are legitimate; after all, they are the product of a rational price-setting process. If Shiller is right that valuations affect long-term returns (that is, that gains not earned through productivity never last), then any action that encourages overvaluation is an action making effective financial planning impossible and thereby hurting human beings.

Economic crises don’t need to happen any more than polluted environments need to happen. Polluted environments happen when we become collectively careless about the disposal of our trash. Economic crises happen when we become collectively careless about the prices of our portfolios. As a nation we have become much more environmentally aware as we have come to realize that we will all suffer if we continue to think only about the effect that careless disposal of trash has on ourselves -- we need to care about the community to solve this problem. The same is true of stock investing. Overvaluation is a community problem. When we cheer on unjustified price increases, we are not only hurting ourselves, we are hurting a large community of people that needs to be able to engage in effective financial planning to enjoy life to the fullest extent possible.

Many retirements will fail in days to come because the high valuations of recent years will be followed by long time-periods in which returns are lower than they are ordinarily. When I jump up and down celebrating my cleverness in getting something for nothing by investing in stocks during times when prices are going up by 20 percent or 30 percent per year rather than by the 6.5 percent justified by the economic realities, I am hurting others. My celebrations cause others to gain confidence in the phony, temporary prices. My temporary financial gains even make others whose prudence caused them to refrain from participation in the irresponsibility of a runway bull to experience envy and perhaps to agree to join the dangerous partying themselves.

Getting stock investing right is important not just because it helps us all to achieve financial freedom earlier in life (although it certainly does that). Getting it right permits our economic system to work the magic it is intended to work, to distribute just rewards for hard, creative work and entrepreneurial projects. When the stock price is right, lots of things in our society go right for lots of people. When the stock price is wrong, the lies we tell ourselves to cause it to go wrong hurt us all in a multitude of ways.

Rob’s bio is here.