More of the Money We Earn Is Used to Buy Stocks Than Anything Else

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We spend lots of money on lots of different things over the course of our lives. Groceries. Transportation. Entertainment. Housing. Health insurance.

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But most of us end up devoting a larger portion of our earnings to the purchase of stocks than to anything else. Most aim to put aside something in the neighborhood of $1 million to finance a comfortable middle-class retirement. We don’t spend that much on housing or groceries. Stocks are an important purchase. Arguably the most important.

We Feel Unconfident When We Buy Stocks

However, most of us don’t feel confident that we know what we are doing when we buy stocks. I know this from personal experience. I am working on a book (Investing for Humans: How to Get What Works on Paper to Work in Real Life) on the far-reaching implications of Robert Shiller’s Nobel-prize-winning research findings. When I meet someone new and tell him or her what it is that I do with my time, I can count on them saying something to the effect of “Boy, that’s a book that I need to read!” The purpose of the response is to be politely supportive. But the way in which it is phrased and the frequency with which it is advanced indicates strongly a general sense of confusion about the subject of stock investing.

All big purchases make people a bit uneasy. People get nervous when they have to put money down on a house. And many of us feel at least a bit of discomfort when we need to purchase a car. But my experience has been that that discomfort diminishes over time. I felt far more at ease purchasing my second car than I did purchasing my first, and by the time I purchased my third, I felt knowledgeable enough to offer advice to others going through the experience.

Most of us purchase stocks many, many, many times. The common thing is to put something aside into a retirement account out of each paycheck. So by the time we are in our 30s we should be old hands at the stock-buying game. But few of us feel assured that we know all that we need to know in this area.

Waiting For The Next Crash

This is a public policy problem, in my assessment. Sooner or later we are going to experience another price crash. How investors react to it will affect the survival of our economic system and possibly even of our political system. In the wake of the 2008 crash, there were numerous big-name figures who were advising people not to panic. Panic is of course a bad thing. So I understand the impulse to reassure investors who have been shocked by a sudden loss of a large percentage of their accumulated life savings. But it seems to me a more important project to provide to investors the background knowledge of how markets work that they need to absorb so that they will not be inclined to panic in the first place.

The 2008 crash brought on feelings of panic because people were not expecting it. They should have been. By the time the crash arrived, prices had been at very high levels for a very long time. Sustained high price levels always bring on a price crash. There has never yet been an exception to this rule. So why the surprise?

The answer is that unsustainably high stock prices (irrational exuberance) hurt everyone in the long run but appear to be benefiting everyone in the short run. Investment advisers earn more money during bull markets than they do during times when prices remain at reasonable levels. Investment sites generate more traffic at such times. The economy takes off at such times (the trillions of dollars of irrational exuberance created during a bull market translates into one heck of a lot of temporary consumer demand). So there is all the reason in the world for most of us to suppress discussion of where irrational exuberance takes us in the long run.

The Dangers Of Irrational Exuberance

The way that I like to say it is that -- two-thirds of the risk of stock investing is attributable to the human inclination not to speak of the dangers of irrational exuberance until it is too late to do something about it. Stocks are perceived to be a risky asset class. But Shiller’s research points us to the way to make them far less risky than they have ever been in the past. If we all worked to keep irrational exuberance reined in (through effective market timing!), prices would never go so high as to bring on a price crash and the economic crisis that inevitably follows from one.

Our lack of confidence in our understanding of how the stock market works is not an accident. We don’t want to know. In one sense, we do. We know that it is important to know and we do not want to make mistakes with our retirement money. But knowledge of how the market works would make it much harder for us to fool ourselves to the extent we need to to keep a bull market going for long. So we comment ruefully about our lack of knowledge while suppressing any inclination to dig down deep and figure out what is really going on when trillions of dollars of wealth go “poof!” in a price crash.

Shiller merited the Nobel prize that he was awarded. His research promises (threatens?) to teach us all for the first time how stock investing works in the real world. We have moved only fitfully in the direction of enjoying the learning experience that he has made possible. But I believe that that will change in the days following the next price crash. I believe that at that time we are all going to learn a lot about this important subject in a short amount of time.

Stocks matter. We all devote a lot of the hours of our lives to earning the money we need to finance our old-age retirements. We should want to know what we are doing when we purchase stocks. To some extent, we already do. But Shiller’s insights are so far-reaching that we find it scary to give them in-depth consideration. Think of how far and how fast we will move ahead once we do. Oh, the places we will go!

Rob’s bio is here.