subscribe

chriskimmet / Chris

There are no people in chriskimmet’s collective.

Huffduffed (140)

  1. Everything You Always Wanted to Know About Money (But Were Afraid to Ask) - Freakonomics Freakonomics

    Q: You have $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much will you have in the account if you left the money to grow? A) More than $102. B) Exactly $102. C) Less than $102. D) I don’t know. (Photo: frankieleon / Flickr)

    Our latest Freakonomics Radio episode is called “Everything You Always Wanted to Know About Money (But Were Afraid to Ask).” (You can subscribe to the podcast at Apple Podcasts or elsewhere, get the RSS feed, or listen via the media player above.)

    The bad news: roughly 70 percent of Americans are financially illiterate. The good news: all the important stuff can fit on one index card. Here’s how to become your own financial superhero.

    Below is a transcript of the episode, modified for your reading pleasure. For more information on the people and ideas in the episode, see the links at the bottom of this post.

    •      *      *

    A bunch of years ago, I had just quit what I had thought was my dream career — trying to become a rock star. And now I was trying to figure out what came next. I was considering three options. No. 1 was to become a shrink. I really liked psychology — but, in the end, I decided I was too selfish to spend my days helping other people with their problems. No. 2 was to become a financial advisor; I really liked learning about saving and budgeting and investing — but, again, I was selfish; I didn’t want to devote all my energy to other people’s problems.

    No. 3 was to become a writer — and that’s what I did. But the other ideas didn’t just go away. There’s at least a little bit of psychology in just about every episode of Freakonomics Radio. As for the financial stuff — well, that’s something we all wrestle with that every day, isn’t it? Today on Freakonomics Radio, we’ll wrestle with it together. We will wrestle with the standard advice on how much to save:

    Harold POLLACK: “You have just told me to save 20 percent of my money. Fuck you!”

    We’ll wrestle with the fact that a financial windfall does not guarantee long-term success:

    Annamaria LUSARDI: We found that 15 percent declare bankruptcy.

    And: we’ll lay out a personal-finance road map that anyone can follow:

    John BOGLE: It’s pretty simple: avoid emotions and concentrate on the economics.

    •      *      *

    Annamaria Lusardi is an economist who teaches in the business school at George Washington University.

    LUSARDI: I was born and raised in Milan and moved to the U.S. about 25 years or so ago for my graduate studies.

    As you can tell, she still sounds a bit Milanese.

    LUSARDI: I have to say I cannot get rid of it. It’s inside me.

    When Lusardi first moved to the States, many things were unfamiliar. Our sports, for instance — especially American football.

    LUSARDI: I only became interested in football because everybody is watching football on Sunday. If I needed to talk to my friend, we had to talk about football first. When I met the football players, then I had to be able to talk football seriously.

    When she “met the football players”? What’s that all about? Well, a few years back, George Washington University started a special M.B.A. program called STAR — that stands for “special talent, access, and responsibility.” The program was designed for people who were already very successful.

    LUSARDI: They are often very wealthy and they have to manage many things — not just their wealth, but also their name, their reputations. it just so happened that most of the students were actually athletes and the majority of athletes were actually football players.

    These were professional football players.

    LUSARDI: Some of them were from the Baltimore Ravens, and I am a big Baltimore Ravens fan. They are, first of all, incredible students. They are my favorite students.

    Why were they her favorites? Lusardi found her athlete-students incredibly disciplined and, perhaps not surprisingly, good team players. She was also impressed with how charitable they were. And she was charmed by their sheer size. One day, she was talking about the financing options of buying a car. The example she’d always used in previous classes was a Toyota Corolla. But the football players all started giggling. One student raised his hand. “Professor Anna,” he said, “I do not fit into a Toyota Corolla!” Lusardi also realized these N.F.L. players were facing an unusual financial predicament.

    LUSARDI: These are people which are very talented, very competent, but they have no knowledge of how to manage this money. Often they come from background where nobody has taught them financial literacy.

    Financial literacy is, and has been for a couple decades, Annamaria Lusardi’s passion.

    LUSARDI: We make financial decisions every day. The financial decision that we make today are different than the decision that our parents made. Our parents didn’t have to worry about pensions, they didn’t face the type of mortgages we face now. Didn’t have probably all the credit cards and all this consumer credit at their fingertips. Also, they didn’t have student loans. But we see other trends as well. For example, financial markets around the world have become more complex.

    Many economists, for many years, have assumed that most people are financially literate.

    LUSARDI: We assume that people know about interest compounding and they know about risk and risk diversification, and they act accordingly.

    But how much do people really know about the most basic financial principles? That’s what Lusardi, in collaboration with the economist Olivia Mitchell, set out to learn. They came up with three survey questions.

    LUSARDI: This was actually driven by the fact that in the first survey we only had room for three.

    They piggybacked their financial literacy questions onto the 2004 Health and Retirement Study. Being limited to three questions turned out to be a blessing.

    LUSARDI: Because first of all these questions are very predictive, but also because there are only three, they were adopted in so many national surveys in the U.S. and then in as many as 15 other countries around the world, and more recently a variation of these questions have been added to a global survey. So now we know about financial literacy around the world.

    Okay, before we hear about the state of financial literacy around the world, let’s hear the questions. No. 1:

    LUSARDI: “Suppose you have $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?”

    The answers were multiple choice. A) More than $102. B) Exactly $102. C) Less than $102. Or, if you really want to play along, D) I don’t know.

    LUSARDI: And the correct answer is…

    The correct answer is: A), more than $102. Because 2 percent interest on $100 in a year is $2, so after year 1 you have $102 — and then over the remaining four years, the interest grows on that $102, and so on. And that’s why compound interest has been called “the eighth wonder of the world.”

    LUSARDI: Question 1 is about compound interest but really it’s about assessing numeracy.

    Okay, question No. 2:

    LUSARDI: Question 2 is about inflation: “Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After one year, how much would you be able to buy with the money in this account?”

    The answers: A) More than today. B) Exactly the same as today. C) Less than today. Or, D) I don’t know.

    LUSARDI: The answer is “less than today” because if inflation is 2 percent, prices go up 2 percent. But if you only earned 1 percent in your saving account, you basically can buy less.

    And: question No. 3:

    LUSARDI: Question three has to do about risk diversification: “Do you think the following statement is true or false: buying a single company stock usually provides a safer return than a stock mutual fund.” “True,” “false,” and of course you can say, “Do not know.”

    And the correct answer is … true! Buying a single stock is safer than buying a mutual fund. Just kidding! That’s false.

    LUSARDI: Because a single company is a lot riskier than a basket of stocks. Don’t put all of your eggs in one basket.

    Okay, how you’d do — did you get all three right? If so, that would put you in a distinct minority.

    LUSARDI: Americans are not financially literate.

    That’s right: Lusardi found that only around 30 percent of the respondents got all three questions right. The numbers are pretty similar around the world, even in other rich countries. In the U.S., financial literacy has some distinct demographic differences: “those facing most challenges,” Lusardi and Mitchell wrote, “are the young and the old, women, African-Americans, Hispanics, the least educated, and those living in rural areas.”

    LUSARDI: Financial literacy should not be taken for granted. Actually, if you ask me, we are at a crisis level.

    You might ask yourself: if financial literacy is so important; and if so many people are so bad at it — what are we doing wrong? One simple answer is that even well-educated people often don’t attain, as part of their formal education, much of a basic financial literacy. What about parents — aren’t they supposed to teach their kids the basics? Maybe. But money being what it is — a topic that makes a lot of people uncomfortable — you can see how a lot of parents, especially if they’re not financially literate, somehow never get around to teaching their kids.

    Some people argue that financial education isn’t the answer anyway. They say the main problem is that too many financial instruments are either too complicated or inherently exploitive. We got into this debate in an earlier episode of Freakonomics Radio; here’s the legal scholar Lauren Willis on why it’d be better to design more user-friendly financial instruments than to expect everyone to learn more about personal finance:

    Lauren WILLIS in a Freakonomics Radio episode: It’s like saying, “We should start teaching everybody to be their own doctor, teaching everyone to be their own mechanic.” Terribly inefficient to do that. Not only is it inefficient, but it has this culture of blaming the consumer. “You’re the one who didn’t figure this all out. You didn’t go to the classes or didn’t pay attention, or whatever.” And that’s not going to help in the long run.

    Annamaria Lusardi does not share that view. At George Washington, she founded a research center called the Global Financial Literacy Excellence Center. Its mission is pretty obvious. And part of that mission, it turned out, was to teach financial literacy to a bunch of pro football players. Whose circumstances, she points out, are quite atypical.

    LUSARDI: They are very young and they get all of the money that people earn in a lifetime early in life.

    That’s right: as Lusardi writes, “A career lasting six years (the median length) will provide an N.F.L. player with more earnings than an average college graduate will get in an entire lifetime, plus a modest pension.”

    LUSARDI: But they just couldn’t translate that sum of money, the lump sum they had, into the stream of money that they could support themselves throughout life.

    There are a lot of ways to blow a sudden fortune. Friends and family may come at you with their palms open. You’re approached by all sorts of advisers with all sorts of brilliant investment schemes. There are taxes to pay — upper-income-bracket taxes, by the way, which shrink your net income by a lot. And, of course, it’s a lot more exciting to spend money today than to save it for tomorrow. Lusardi, inspired by her current football students, decided to gather some data on older players.

    She and her colleagues looked at a cohort of N.F.L. players who’d been drafted in the late 1990s and early 2000’s, to assess their long-term financial outcomes.

    LUSARDI: We look at bankruptcy rather than other measures of financial distress because these are the things we can check and which there is data.

    And what’d they find?

    LUSARDI: We found that more or less twelve years into retirement, 15 percent declare bankruptcy.

    That’s right: 15 percent of these guys, who’d already earned a career’s worth of income, went bankrupt — a rate that’s similar or even higher than the overall population of men in their age group, even though the N.F.L. retirees had obviously earned a lot more money. Lusardi also found that the risk didn’t even decline for the players who earned the most.

    LUSARDI: To me, the experience of the N.F.L. is a good example of the effect of financial illiteracy.

    The N.F.L. bankruptcy data reinforced Lusardi’s earlier findings about financial illiteracy. So what’s to be done? Because it’s pretty obvious that many people have no idea how to handle their personal finances. Even people who you’d think should know — even exceedingly well-educated people, like this guy:

    POLLACK: I must say I had a very lackadaisical attitude about personal finance until I was about 40 years old.

    That’s Harold Pollack.

    POLLACK: I’m a professor of social service administration at the University of Chicago.

    Pollack works with University of Chicago institutions like the Crime Lab and the Center for Health Administration Studies.

    POLLACK: I have a doctorate in public policy, but I hadn’t really applied it to finance.

    But then something happened.

    POLLACK: My mother-in-law died suddenly and my brother-in-law Vincent had to move into our home. He’s intellectually disabled, and he was 340 pounds and had many related challenges.

    Pollack’s wife had to quit her job to take care of her brother, and Pollack began to worry about their financial health.

    POLLACK: One day we had to buy a Lazy Boy-type chair just because he was so big that our furniture didn’t work for him, and it was like $900 for this chair. And I just remember thinking, “I’m going to go through all my money.” I became obsessed with personal finance.

    He began looking at the literature on investing.

    POLLACK: One of the first things I learned was that the conversation among real experts was actually a lot simpler than the conversation that you would get if you watched financial TV or read brochures from financial-services firms.

    The people Pollack calls “real experts” — academics, typically, who’d done real, empirical studies — told a very different story than investment professionals.

    POLLACK: I started to joke around that the fundamental problem that the industry faced was that the best advice was available for free at the library.

    Pollack started writing about these ideas on a blog called The Reality-Based Community. For one piece, he was interviewing the financial journalist Helaine Olen about a book she’d written, called Pound Foolish: Exposing the Dark Side of the Personal Finance Industry.

    POLLACK: And I said to her, “Isn’t the industry’s fundamental problem that the best advice for most people would fit on an index card, and it’s available for free at the library?” We chuckled and the conversation moved on — except that I started getting emails from people and comments on my blog saying, “Hey, where’s the index card?”

    But there was no index card.

    POLLACK: I was speaking metaphorically so, of course, I was stuck. But I had planted a flag and I felt I had to honor that. So I just reached into my kitchen drawer and I pulled out my daughter’s 4×6 index card that she was using for school. And I scribbled down in maybe two minutes nine rules and I took a picture with my iPhone and I posted it on the web.

    Coming up on Freakonomics Radio: Harold Pollack’s index card catches fire on a variety of websites.

    POLLACK: Boing Boing, which I’d never heard of actually. Lifehacker, which I also had never heard of.

    Also: are credit card rewards programs as good as they seem?

    POLLACK: All the research suggests that that these rewards programs just make you spend more money.

    And: how closely should you watch your investments?

    BOGLE: Don’t peek!

    •      *      *

    As I mentioned earlier, before settling into my writing career, I thought about becoming either a psychologist or a financial adviser. What I didn’t mention is that the book I was working on before Freakonomics was a perfect hybrid of those two things — it was about the psychology of money. The working title was Money Makes Me Happy (Except When It Doesn’t). That book got put in a drawer once Freakonomics started happening. But I still think its animating sentiment is pretty solid. Basically: money is one of those rare topics — a bit like sex, and maybe religion — that people have strong feelings about, and yet have a hard time discussing.

    As a result, a lot of us stumble through life knowing we should know more than we do about personal finance but we’re too intimidated or embarrassed or something to do much about it. Harold Pollack, a public-policy scholar at the University of Chicago, tapped into this sentiment when he dashed off an index card with nine easy rules about personal finance. It got nearly half a million hits on Pollack’s blog; The Washington Post picked it up; also:

    POLLACK: Boing Boing, which I’d never heard of actually. Lifehacker, which I also had never heard of. A bunch of these websites that actually have big followings — that I’m too old to be in the target demographic — for really grabbed it.

    The card was translated into Romanian.

    POLLACK: Which is great. I hope that people in Romania find it useful. I’m not sure that they have 401(k)’s there. I suspect we’d have to modify it a little bit. It just started showing up all over the place. In fact, there was a guy who plagiarized it. I found a YouTube video, of some life coach who just wrote out his own card. It was word-for-word exactly what I wrote and he spoke it as if he had made it up.

    YOUTUBE CLIP: And that’s all the financial advice you’re ever going to need written on this index card.

    POLLACK: It was hilarious to listen to because he actually has a great voice, but he had completely stolen the idea. There was just something about it for a lot of people. All of us are facing this very intimidating task: “How do I save for retirement? Where to invest my money? How do I deal with all these questions about budgeting and when to buy a house and all that stuff.” “Oh, I just have to look at these nine rules on this card.”

    Pollack never pretended that he’d discovered some amazing new rules of financial behavior.

    POLLACK: When my colleagues at the business school saw this and they saw what these rules were, they were just like, “You’re kidding.”

    But that didn’t stop him from turning his index card into a book, co-authored with the journalist Helaine Olen. It’s called, yes, The Index Card: Why Personal Finance Doesn’t Have to Be Complicated.

    POLLACK: Of course, it’s ironic that I say, “Here’s this index card. That’s what you need.” Then people are saying, “Well, why is there a book?” In some sense, you could say all of religion comes down to the Ten Commandments, but a lot of us seem to need some commentary on those, need to know how to execute those. Or depending on your religious faith — I sometimes refer to the book as the Midrash to our index card for your Jewish listeners.

    And, for our non-Jewish listeners: a Midrash is rabbinic commentary or teaching on a biblical text — not quite a canonical passage, but revered nonetheless. That’s kind of what Pollack was going for with The Index Card book. Okay, so what’s in it? Let’s start with Rule No. 1:

    POLLACK: Rule No. 1: strive to save 10 to 20 percent of your income.

    Because — well, if you aren’t saving any money, then everything else is a lot harder.

    POLLACK: One of the great things is once you start to save this money it really reduces the stress in your life so amazingly fast. I must say that my original card said, “You should save 20 percent of your income.” That’s really hard. I got a bunch of emails that were essentially in the following form: “Dear Professor Pollack: I’m a 28-year-old single mom and I work as a cashier. You have just told me to save 20 percent of my money. Fuck you!”  

    My responses to all of those emails was, “You know what? You’re totally right. I totally see where you’re coming from. At this stage in your life, you cannot save 20 percent of your gross income.” When you’re at that stage, how can you manage your credit card debt? How can you save something? How can you start getting yourself on a good budget? You’re doing that, you’re doing really well. My original card was really good for middle class people like me. It wasn’t quite as good for people that were at different stages in their life.

    I was brought to some humility by the large audience that I inadvertently attracted.

    Rule No. 2:

    POLLACK: Rule No. 2: pay your credit card balance in full every month.

    How important is this one?

    POLLACK: This may be the most important single rule on the card for a lot of people. If you’re carrying a credit card balance, every dollar that you pay down on that, you’re getting a risk free, tax free return that’s usually more than 15 percent.

    Because that’s roughly how much you’re paying the credit card company for the privilege of using their money.

    POLLACK: Unless your name is Warren Buffett, you’re just not going to get that investment from anything else that you’re doing. Credit cards and other forms of high-interest loans are just a really serious trap for a lot of people.

    One problem is that credit card companies are savvy — and they can make you feel like you’re doing a great job just by paying off what they call the monthly minimum. You are doing a great job — for them. Because they’re collecting all that interest from you. Pollack warns us to beware of any deal that offers to help you smooth out your cash flow.

    POLLACK: If you belong to a gym and they say you can pay $500 upfront for the year or you can make 12 equal $50 payments.

    If you choose that payment plan, the cost of your membership is now $600. Therefore, whenever possible:

    POLLACK: You try to use cash as much as you can and you pay off your credit card. By the way, one of the things that I recommend to people is basically ignore your credit card reward program. All the research suggests that that these reward programs just make you spend more money.

    Rule No. 3?

    POLLACK: Rule No. 3: max out your 401(k) and other tax-advantaged savings accounts.

    A typical 401(k) is a retirement plan run by your employer. But there are a lot of options, including for self-employed people.

    POLLACK: There are several reasons why your 401(k) or your equivalent is just the foundation of your saving. First of all, very often your employer will kick in a matching contribution, and that is free money. You can also set up your 401(k) contributions to be automatic, so you never have to touch the money.

    There are other tax-advantaged savings vehicles.

    POLLACK: For example, there are two things that people can do to save money for their kids college that have tremendous tax advantages. One is called an E.S.A. and I won’t go into the details, but the second account is called the 529. The 529 actually allows you, if you have a little bit more money or you have a large family that wants to contribute, you can actually put in up to $14,000 a year.

    Pollack works hard to not bring politics into his financial advice but as soon as you get into tax-advantaged savings plans, you’re getting into politics. Because these tax breaks don’t just happen. Someone in Washington had to draw up a plan that was meant to reward some kind of behavior — in the case of 401(k)s and 529s, that’s saving for retirement and college, respectively. But the tax code is full of breaks — many of which, some people argue, tend to help well-off people become even better off. The home-mortgage interest deduction, for instance. So what are you supposed to do if you think the tax code is unfair? Well, unless you’ve got some friends on the House Ways and Means Committee or the Senate Finance Committee — they’re the people who write the tax code — maybe the best advice is to simply work hard to exploit the existing tax breaks. Sure, you can complain that “the tax code favors rich people.” Or you could say, “Hey, using the tax code to my advantage could help me become rich.” All right, moving on to:

    POLLACK: Rule No. 4: never buy or sell individual stocks.

    And …

    POLLACK: Rule No. 5: buy inexpensive, well-diversified index mutual funds and exchange-traded funds.

    We actually spent our previous episode going over this idea in some detail. Bottom line: most people who pick stocks for a living do a worse job than a monkey with a dart board — and they charge you a lot more than a monkey would. How much? Enough to fund their beautiful offices, and homes, and boats — even though, again, your investment returns will likely be worse than if you just bought, as Harold Pollack notes, some low-cost, diversified index funds.

    POLLACK: This is a completely easy one. There’s just a ton of literature that suggests that people chase after shiny objects and the stocks that we buy aren’t particularly well-chosen. The stocks that we sell, we’re often selling them at the wrong times. Why do you want to get into that?

    We also spoke last week with John Bogle, the founder of Vanguard, the world’s largest universe of low-cost index funds. Here’s how Bogle summarizes the appeal of what Pollack is preaching:

    BOGLE: You want to capitalize on the magic of compounding returns without succumbing to the tyranny of compounding costs.

    But that “tyranny of compounding costs” can be hard to resist — because the people who sell investment advice are really good at selling it. They make you believe they alone know the secrets to the investing universe. They do it in TV commercials like this one:

    FINANCE FIRM’S COMMERCIAL: We understand the challenges of a complex global economy …

    Pollack’s advice: do not heed the siren call of slick, fancy, expensive investment advisors. For what it’s worth, this has become quite standard advice; and it’s backed up by acres of research. That research also suggests that, for the average investor, diversification is a good idea. A few different types of stock-index funds — growth, value, international, etc. — and also some bond funds and maybe some other, less sexy investments.

    POLLACK: You want to have the right percentage of your investments in stocks and in the other classes that you invest in. If the stock market drops 20 percent you should be buying stocks after that not because you think the market’s now undervalued or anything like that but just because the percentage of your portfolio that is in stocks is now below where you want it to be.

    BOGLE: I like the idea of a little balance in your asset allocation.

    Jack Bogle again:

    BOGLE: For the youngest investors, when you first start obviously, you should be 100 percent in stocks. But as you build up a little assets maybe by the time you’re 25 or 30 you’re probably going to want to be 15-20 percent in bond funds, and 85 percent in stock funds. As you get older, you’re going to probably want more in bond funds and less in stock funds because the fear of loss is going to be greater when you have a very large amount of money.

    Obviously it can be really hard for the average person to take in and execute all this investment advice on their own. So you might consider hiring a financial advisor. But not just any financial advisor, Pollack says:

    POLLACK: Rule No. 6: make your financial advisor commit to the fiduciary standard.

    The fiduciary standard is a federal requirement designed to ensure that financial advisors don’t sell clients products that are better for the advisors than for the clients.

    POLLACK: It basically says: “All the advice that you’re giving me and all the products that you’re offering me are designed to maximize my own financial well-being. You’re not being paid by anybody except me. I understand in a transparent way your financial incentives.” If you don’t have the fiduciary standard, it’s a little bit like walking down to the Ford lot and saying, “Do you think I need a new car yet or do you think I should keep driving the old one for another couple of years?” There was a wonderful study done by some researchers at Harvard where they just sent out actors who had different kinds of retirement savings. They would go into storefront financial firms and they would just say, “Hey, here’s what we’re doing. Tell us if we should do something different.” Some of them had crazy investments that were all in the stock in their employer. Some of them had absolutely excellent investments that have been designed by financial professionals in low-cost index funds and things like that. The ones that had excellent investments, the majority of the financial advisers they talked to recommended that they actually not do that, that they do something that is essentially a more expensive imitation of that.

    This is not meant to besmirch the reputation of all financial advisors. It’s also worth noting that sometimes, it may be the advisors who try to keep their clients on the right track.

    Barry RITHOLTZ: We get paid a percentage of assets.

    Barry Ritholtz writes about investing but also runs an asset-management firm.

    RITHOLTZ: The more assets we gather and the better those assets perform, the more revenue the firm sees.

    Ritholtz has instituted a clever incentive to address his clients’ investing behavior.

    RITHOLTZ: If people maintain a portfolio for three years and don’t do anything foolish with it — and there’s a constant temptation to do something foolish — we will discount our fees an additional 15 percent as a good reward for good behavior. The thinking is, left to their own devices, after three years people get bored, especially in a market like we’ve seen over the past few years. So they start looking for a little fun, a little action, and, “Hey, maybe we should roll out of this long-term conservative portfolio and start dabbling in I.P.O.s and venture capital.” We want to discourage that behavior.

    All right, moving on — to the single-biggest expenditure most of us will ever think about.

    POLLACK: Rule No. 7: buy a home when you are financially ready.

    Okay, so let’s pull that apart — the “buying a home” piece and the “financially ready” piece.

    POLLACK: We should think of our home as something that we use and consume and something that helps us with our life, not as the major pillar of our wealth. We’ve been conditioned from birth to believe that you’re not a full adult until you own a home. You have to be careful about that.

    Your home is the most leveraged and undiversified investment you’re ever going make in your life. You don’t want to rush into buying a home and you want to buy a home in a very sensible way.

    “Sensible” meaning what?

    POLLACK: That means when you have a nice 20 percent down payment, which lets you get good terms on your loan. It means getting a vanilla-ice-cream-fixed-rate 15-year or 30-year loan, rather than to try to do something like an adjustable-rate mortgage. It means buying a home that you can afford and still have a strategic reserve if you move in and your hot water heater breaks or a raccoon eats its way through your roof or all the things that can happen to a home.

    Buying a home also represents what economists call a “commitment device” — it’s a way to lock yourself into a behavior you need some help getting locked into. In this case, your mortgage payment is a forced savings plan. Pollack sees the value in this thinking — but the lock, he says, can be fairly flimsy.

    POLLACK: A home is a good commitment device although it’s a less effective commitment device than it once was because of home-equity loans. Home-equity loans used to be called second mortgages. There was a certain stigma to getting them. They were not common. One of the challenges we discovered in the foreclosure crisis was there was a lot of people that were trying to dip into their home equity. When their value of their home dropped, boy, that could really blow up on you. If you’re going to use it as a commitment device you have to actually commit to it and not try to dip into your home equity in various ways. That’s, “buy a home when you’re financially ready.”

    Rule No. 8?

    POLLACK: Rule No. 8: insurance. Make sure you’re protected.

    Ah, insurance! So many types, so much pressure and fear. Honestly, that’s a topic for a whole other episode some day. Maybe we’ll get to that. But for now, here’s Pollack’s thumbnail take:

    POLLACK: The purpose of insurance is to make sure that you are protected if you have a life-changing event. You don’t need insurance for the $500 problem when somebody hits a baseball through your kitchen window. You do need insurance when the tree falls, there’s a $50,000 problem and your whole kitchen gets taken out. You need life insurance in case the people that depend on you need you after you die. You need liability insurance when you’re driving. You need to make sure that your life wouldn’t change if there was some adverse event. One of the things that we advise people in general is get the largest deductible that you can. You want the homeowner’s insurance with the $5,000 deductible if you can get it. First of all, it costs money for the insurer to honor all these smaller claims. You don’t want to be having to pay for that. But secondly, the people who get the high-deductible insurance are the people who know that they’re pretty unlikely to use their insurance. You’re putting yourself in an insurance pool that’s likely to be more favorable than the ones with the low deductibles. Insurance is important to guard against the big things, not the little things.

    Pollack’s next rule, he admits, is in a different category than the others. It is not actually about personal finance.

    POLLACK: Rule No. 9: do what you can to support the social safety net.

    Pollack has heard from a lot of people who don’t like Rule No. 9:

    POLLACK: They said, “You’re giving all this sensible investment advice and then you got all political on me.”

    But Pollack thought it was essential to include this, for a few reasons.

    POLLACK: One is there’s a lot of people who need help. Secondly, to the extent that my story is a part of our book, it would not be fully honest if I left off Rule No. 9. At the beginning of our conversation I talked about how my brother-in-law Vincent moved into our home and what a challenge that was because of his intellectual disability and his medical challenges. We would have absolutely gone bankrupt without his Social Security, Medicare, and Medicaid that prevented our family from losing everything taking care of him. We have to have each other’s backs. What the social safety net does, what social insurance does, is it is it allows us to protect each other against these risks that would just crush any one of us if we had to face it alone. It’s really important. As individuals we should we should do everything that we can to be prudent investors and to support ourselves and our families and to follow the rules that I’ve laid out. But you cannot guard against everything in life. I don’t particularly enjoy paying my taxes on April 15th, but I do feel that the American taxpayer had my back when I had a crisis. And you know I should be doing the same thing for other people.

    As you may recall, Harold Pollack’s index card had nine rules. But his and Helaine Olen’s book, called The Index Card, has 10.

    POLLACK: Rule No. 10: remember the index card.

    Okay, admittedly, this one is kind of meta.

    POLLACK: The idea here is we hope that this card is helpful. Take it out, put it on the refrigerator. It’s a reminder.

    A lot of recent social-science research suggests that reminders like this, nudges like this, are pretty effective. Also: one reason people often fail to make good decisions — financial or otherwise — is because those decisions are too complicated or intimidating. So: simplicity is a thing to strive for. And to value. Will a simplified choice always lead to optimal outcomes? Of course not. But will it generally produce a better outcome than either avoiding the problem or doing something really stupid? Yes, it will. Experience is also pretty valuable; I guess that goes without saying. So to conclude this primer on personal finance, maybe it makes sense to hear a bit more from the most experienced investor I know — Vanguard founder Jack Bogle.

    BOGLE: At almost 88 years old, I might be the most blessed man in the United States of America.

    Bogle’s longevity was not preordained.

    BOGLE In 1960, I had my first heart attack. I was only 31 years old, had it on a tennis court. I almost died. I had a disease that had never been discovered. It was finally discovered years later in France. But I was a mystery man and the doctors looked at me funny. When I got a pacemaker inserted, one doctor said to me, “You really probably don’t have that much time left. Why don’t you go up to the Cape and just walk out on the beaches every day. Take it easy, enjoy the remaining time on this earth.”

    Bogle did not follow that doctor’s advice. A few decades later, he did need a heart transplant.

    BOGLE: The transplant took place 21 years ago. I’ve broken a lot of records for anybody 65 years of age who gets a transplant. Not many 65-year-olds get 21 extra years.

    DUBNER: Let’s hear your quick advice for a primer on personal finances. Aside from investing in index funds— we know you’re going to advocate that. But it sounds like you’ve got a personal philosophy in terms of personal finance as well, yeah?

    BOGLE: It’s pretty simple: avoid emotions and concentrate on the economics. Invest for the long term and don’t trade. The ups and downs of the markets are unpredictable and foolish in the short term.

    DUBNER: You say that as someone who’s successful at avoiding emotions, but you have to know that most people aren’t whether we’re talking about investing or saving versus spending or politics or whatever. How did you either get to be the rational thinker that you are, or how do you advise people move in that direction? Because plainly it’s not so easy for most people.

    BOGLE: No. Let me be honest. It’s not easy for me. When we get one of these 50 percent declines, I’ve faced three of them in my career. It’s not fun. I get a knot in my stomach. A lifetime of experience, 65 years of experience in this field, has taught me that emotions are evil and therefore you really ought to fight to keep them out of the equation. Because the day you are most concerned is the day the market hits bottom and that’s the day you want to get out. Tthe day you will want to get in when the market it’s a new high. Well, believe me, buying in at the market’s new high and selling out at the market’s bottom is a very difficult way to make money.

    DUBNER: What about spending versus saving? How would you counsel someone to think about that?

    BOGLE: Well, every family is different. Given the unequal distribution of income, 20 percent of the families can’t possibly invest. They’re trying to stay alive, keep the wolf from the door, keep the children fed and housed and warm. When you get well up the scale of living, you’re able to afford more. People should pay themselves first out of every paycheck and have a contribution to a pension plan and just keep putting it away. Don’t even look at it. Don’t peek! When you open your envelope when you’re age 65 and are retired, be sure and you have a good cardiologist with you because you’re going to faint.

    DUBNER: Faint with happiness, not with shock.

    BOGLE: Faint with happiness, right. You won’t believe it!

    Believe it! And: if you still have questions about your personal finances, there’s good news: Harold Pollack will be answering your questions during a one-hour Facebook Live event we’re hosting, on Wednesday, August 9th, at 2 pm Eastern Time. You can post your questions on the Freakonomics Facebook page, or email them to radio@freakonomics.com with the subject line “Personal Finance.”

    Freakonomics Radio is produced by WNYC Studios and Dubner Productions. This episode was produced by Greg Rosalsky. Our staff also includes Alison Hockenberry, Stephanie Tam, Merritt Jacob, Eliza Lambert, Emma Morgenstern, Harry Huggins and Brian Gutierrez; we had help this week from Sam Bair. Most of the music in this episode was composed by Luis Guerra. You can subscribe to Freakonomics Radio on Apple Podcasts, Stitcher, or wherever you get your podcasts. You can also find us on Twitter, Facebook, or via e-mail at radio@freakonomics.com.

    Here’s where you can learn more about the people and ideas in this episode:

    SOURCES

    John Bogle, founder of The Vanguard Group.

    Annamaria Lusardi, chair of economics and accountancy at George Washington University.

    Harold Pollack, professor of social service administration at The University of Chicago.

    Barry Ritholtz, co-founder and C.I.O. of Ritholtz Wealth Management.

    RESOURCES

    “Bankruptcy Rates among N.F.L. Players with Short-Lived Income Spikes,” Kyle Carlson, Joshua Kim, Annamaria Lusardi, and Colin Camerer (May, 2015).

    “The Behavior of Individual Investors,” The Handbook of the Economics of Finance, Brad Barber and Terrance Odean (North Holland, 2013).

    “The Best Investing Advice has Always Been Too Boring for TV,” Harold Pollack, The Atlantic (January 7, 2016).

    “Efficient Capital Markets: A Review of Theory and Empirical Work,” Eugene Fama (May, 1970).

    “Financial Literacy and Retirement Prepared-ness: Evidence and Implications for Financial Education,” Annamaria Lusardi and Olivia Mitchell (January, 2007).

    The Index Card: Why Personal Finance Doesn’t Have to Be Complicated by Helaine Olen and Harold Pollack (Portfolio, 2017).

    “Luck Versus Skill in the Cross-Section of Mutual Fund Returns,” Eugene Fama and Kenneth French (October, 2010).

    “The Market for Financial Advice: An Audit Study,” Sendhil Mullainathan, Markus Nöth, and Antoinette Schoar (April, 2011).

    “Morningstar’s Active/Passive Barometer,” Ben Johnson, Thomas Boccellari, Alex Bryan, and Michael Rawson (June, 2015).

    Pound Foolish: Exposing the Dark Side of the Personal Finance Industry by Helaine Olen (Portfolio, 2013).

    “The Professor, the Student, and the Index Fund,” John Bogle, The Bogle eBlog (September 4, 2011).

    “A Random Walk Down Wall Street: The Time-Tested Strategies for Successful Investing,” Burton Malkiel (W. W. Norton & Company, 2016).

    EXTRA

    Global Financial Literacy Excellence Center.

    “What do Hand Washing and Financial Illiteracy have in Common?” Freakonomics Radio (January 20, 2012).

    http://freakonomics.com/podcast/everything-always-wanted-know-money-afraid-ask/

    —Huffduffed by chriskimmet

  2. The Stupidest Thing You Can Do With Your Money (Rebroadcast) - Freakonomics Freakonomics

    A study found that only the top 2 to 3 percent of active-fund managers had enough skill to cover their cost. (Photo: Visual Hunt)

    Our latest Freakonomics Radio episode is a rebroadcast of an episode from last year called “The Stupidest Thing You Can Do With Your Money.” (You can subscribe to the podcast at Apple Podcasts or elsewhere, get the RSS feed, or listen via the media player above.)

    It’s hard enough to save for a house, tuition, or retirement. So why are we willing to pay big fees for subpar investment returns? Enter the low-cost index fund. The revolution will not be monetized.

    Below is a transcript of the episode, modified for your reading pleasure. For more information on the people and ideas in the episode, see the links at the bottom of this post.

    •      *      *

    What would you say if I told you that everyday investors, people like you and me, are just throwing away billions and billions of dollars?

    Kenneth FRENCH: It’s not something that just started today. It’s been going on for the last 20 or 30 years.

    Is it some kind of a tax?

    Barry RITHOLTZ: It’s a tax on smart people who don’t realize their propensity for doing stupid things.

    Just how stupid is this stupid thing?

    Eugene FAMA: Basically, we were saying, “You’re charging people for stuff you can’t deliver.”

    But in recent years, there has been a backlash. Some would even say it’s become a revolution.

    John BOGLE: It’s definitely a revolution.

    RITHOLTZ: We are in the middle of the Copernican Revolution about the proper way to invest or at least the rational way to invest.

    Today on Freakonomics Radio: the revolution in low-cost index investing — also known as Wall Street’s worst nightmare.

    RITHOLTZ: There’s too much B.S. on Wall Street.

    •      *      *

    It’s hard to think of any other realm where empiricism — or at least what’s dressed up to look like empiricism — clashes so directly with delusion. I’m talking about investing; the stock markets, primarily. The alleged empiricism comes in the form of sales-pitch data:

    FRENCH: It’s easy to think — by seeing the ads and reading newspaper articles and stuff — that if you’re just clever enough, you’re going to win.

    The delusion comes in the form of how the stock markets actually work.

    FRENCH: We don’t understand the negative-sum nature of active investing. Whatever you win, I lose. Whatever I win, you lose, and we both paid to play that game.

    That’s Ken French.

    FRENCH: I am the Roth family distinguished professor of finance at the Tuck School of Business at Dartmouth.

    So the negative-sum nature of investing is one problem that’s often overlooked.

    FRENCH: And then the second problem we have [is] most people suffer from overconfidence, particularly in noisy environments where the feedback is weak. That describes the stock market. It’s incredibly noisy and it’s really easy to misinterpret what the return on your portfolio means.

    But wait a minute — we know how to interpret our portfolio returns, don’t we? Those big money-management firms and mutual fund firms and investment advisors, they’re so helpful in telling us how much our hard-earned money is growing. Right? Okay, it can be kinda hard to keep track of all the fees they’re deducting. But still — isn’t it amazing that the firm you chose — no matter which one you chose — just happens to be better than everybody else at picking the best stocks and funds?

    RITHOLTZ: There’s too much B.S. on Wall Street and being able to say, “Here’s what the data show” is really a useful skill.

    That’s Barry Ritholtz.

    RITHOLTZ: I run an asset-management firm called Ritholtz Wealth Management.

    DUBNER: All right. Explain how you, Barry Ritholtz, actually make money. Who is paying you to do what?

    RITHOLTZ: We get paid a percentage of assets. I haven’t looked at it this quarter but it’s somewhere under 1 percent, about .88 or .89. Somewhere in that range. The more assets we gather and the better those assets perform, the more revenue the firm sees.

    That’s a pretty typical setup. Many investors pay firms to manage their money — sometimes a percentage of assets, sometimes a flat fee. In return, you may get a variety of services — including advice about insurance or taxes. And, of course, investment advice: how best to save for a house, or your kids’ tuition, or retirement, whatever. Why pay someone for that advice? Because, let’s face it, investing can be confusing, and intimidating. All that terminology; all those options. So you hire someone to navigate that for you — and they, in turn, use their expertise to pick the very best investments for your needs. This is called active management. They actively select, let’s say, the best mutual funds for your needs. And you pay them for their expertise. You also pay those mutual funds, by the way — sometimes there’s what called a sales load when you buy it; and an expense ratio, a recurring fee the fund deducts from your account. So, between the mutual fund fees and the investment fees, that’s usually at least a couple percent off the top — and that’s whether your funds go up or down, by the way. So hopefully they go up. Hopefully the active management you’re paying for is at least covering the costs?

    FRENCH: What we actually found was the top 2 to 3 percent had enough skill to cover their costs. And the other 97 or 98 percent didn’t even have that.

    In 2010, Ken French and Eugene Fama published a study in The Journal of Finance called “Luck Versus Skill in the Cross-Section of Mutual Fund Returns.”

    FRENCH: So what Fama and I were doing in that paper is trying to figure out when a fund does really well, should we attribute that to a manager that is incredibly talented and really beating the market? Or are we just looking at the result of luck?

    That is, did their funds rise in value because of their stock-picking skill — or, perhaps, simply because the market was rising? And, again, the Fama-French finding:

    FRENCH: So the top 2 to 3 percent [have] enough skill to cover their costs. Everybody else: down below that.

    Ouch. It’s enough to make you think that maybe it’s not worth paying those investment experts for their expertise. If only there were some simple, cheap way to avoid all that active investing that often doesn’t pay off and just passively own, say, a small piece of the entire stock market. Well, as you may know, there is. They’re called index funds and E.T.F.s, for exchange-traded funds. They can be bought very cheap. And in recent years, a lot of people have been buying them.

    RITHOLTZ: When we look at the fund flows over the past few years, there is a massive outflow from active fund management.

    BOGLE: The number comes out to around a trillion and a half flowing into index funds and a half a trillion flowing out of active funds, which is a $2 trillion shift in investor preferences. It is definitely a revolution.

    That is John Bogle …

    BOGLE: … often called Jack, and I’m the founder of Vanguard and the founder of the world’s first index fund.

    How big a deal is Jack Bogle? Here’s what Barry Ritholtz thinks:

    RITHOLTZ: Jack Bogle is one of the unsung heroes of the American middle class. He has allowed people to invest over the long haul very inexpensively with excellent results in a way that they probably wouldn’t have been able to do without him and without Vanguard.

    Warren Buffett, the most famous investor in the world, had this to say recently: “If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle.”

    RITHOLTZ: Vanguard is clearly the leaders in low-cost indexing. They’re now $4 trillion, right? That’s an astonishing number.

    How astonishing? Four trillion dollars could buy you every major sports league in America; and Apple — the company, all of it; and put 8 million kids through college. And you’d still have a trillion left over. That’s how much money we have collectively given to Vanguard. Why? Because they were the first to offer an alternative to the old-school, expert-driven, high-fee investing model. Let’s get back to Jack Bogle.

    DUBNER: You said recently, “What’s clear is we’re in the middle of a revolution caused by indexing. It’s reshaping Wall Street, it’s reshaping the mutual fund industry.” Now, for the man who really can claim way more credit than anyone else for starting the revolution, does it seem like a revolution or more of an evolution? In other words, it’s been a long time coming.

    BOGLE: It is a revolution, still going on. It started in the last few years. It’s actually accelerated and I don’t think that acceleration can continue. But I do think the dominance of the index fund will continue simply because we’re in an industry where cost is everything and no one wants to compete on cost. Managers don’t want to compete on cost. They want to make money for themselves. It didn’t bother me that it took a long time. It takes time for people to understand, keep up. I did my best to help.

    One way Bogle helped was by setting up Vanguard as a cooperative. It’s owned by the fund’s shareholders; rather than distributing profits, it lowers its fees.

    DUBNER: As the founder of Vanguard, as the father of index-fund investing — how have you turned out financially? Are you worth billions and billions and billions?

    BOGLE: No, I’m not even worth a billion. They laugh at me. I’m not even worth $100 million. But I was never in this business to make a lot of money for myself. I’ve been nicely paid, particularly in the days when I was running the company, and I am not a spender. I buy a new sweater every once in awhile or a new shirt from L.L. Bean. My wife is the same way. We’re just not interested in things, toys. We’re very happy with our standard of living. We have a nice small house that we love. We have a wonderful family. At 88 years old, I might be the most blessed man in the United States of America.

    Bogle created Vanguard in 1975, when things weren’t going so well for him.

    BOGLE: It was a way for me to get back in the business, to get back at my old company, which I’d been fired from.

    The old company was Wellington Management, where Bogle had spent more than two decades. In 1970, had become CEO; in 1974, he was fired, for making what he admits was an “extremely unwise” merger decision. When he started Vanguard, it was just another traditional, actively-managed money firm — and that part of the business still exists — but Bogle had long questioned the wisdom of picking stocks.

    BOGLE: In Princeton University in 1951, when I was choosing a topic for my senior thesis, I chose the mutual fund industry. “The Economic Role of the Investment Company” was the title of my thesis. I examined the records of some funds — we didn’t have what we have today in records — but I looked at half a dozen funds anecdotally. I said in my thesis, this is a virtually a direct quote: “Mutual funds can make no claim to superiority over the market averages.” That’s the harbinger of the index fund.

    A harbinger, maybe, but Bogle spent his first couple decades in the business dancing the same dance as everyone else. Then, in 1974, the same year Bogle was fired from Wellington, The Journal of Portfolio Management published a paper by the economist Paul Samuelson called “Challenge to Judgment.”

    BOGLE: I was inspired by his article.

    Samuelson was a Nobel winner and an extremely influential thinker.

    BOGLE: I’m trying to think whether to say he was a thousand times smarter than I was or a hundred times, but it was something like that.

    Samuelson’s paper challenged the performance of active managers and suggested that, “at the least, some large foundation should set up an in-house portfolio that tracks the S&P 500 Index — if only for the purpose of setting up a naive model against which their in-house gunslingers can measure their prowess.” Bogle, who was in the midst of launching Vanguard, took it to heart. Others had been thinking through the idea, but Bogle, and Vanguard, were the first real players to take the plunge. The notion was brutally simple: most stock pickers think they are better than the market — and they aren’t; therefore, investors should just buy the whole market. And, since you’re not paying the big salaries, and all the other costs that go along with those stock pickers — the fund would be much cheaper to buy.

    DUBNER: When you founded it, it was treated as heresy, even laughable, by most people on Wall Street. Talk about what it was like to experience that reception.

    BOGLE: Well, I don’t cave in very easily. You may have sensed that. In a certain way, the more dissent I got the more confident I was that I was right. I’m that kind of contrarian person. People laughed. There was this great poster that said “Stamp Out Index Funds.” There’s Uncle Sam with a cancellation stamp all over it, all over the poster. “Index Funds are un-American.”

    DUBNER: They were considered “un-American”— that argument was what?

    BOGLE: The argument is, “In America, we don’t settle for average. We’re all above average.” But, of course, we’re not all above average. But basically, the poster was put out by a brokerage firm. The thing about the index fund — no sales loads, no portfolio turnover. You don’t buy and sell every day like these active managers do. It’s Wall Street’s nightmare and it still is! That kind of reception didn’t bother me. The fund was known as “Bogle’s Folly.” The original underwriting was supposed to be $150 million. This is the original underwriting of the index fund. The underwriters sheepishly, on the day the underwriting was completed, came in with $11 million instead of $150 million.

    DUBNER: Did you lose a little confidence then or no?

    BOGLE: No! They said, “Why don’t we just drop the whole thing?” It was probably the worst underwriting in the history of Wall Street. I said, “No, we’re not going to drop it. We have the world’s first index fund. That’s good enough for me.” We went ahead and started to run it. It took a long time for people to get the idea.

    But, increasingly, people are getting the idea. That rather than spending, let’s say, $10,000 to buy five different mutual funds, each made up of a basket of hand-selected stocks, you spend all $10,000 on one fund that simply tracks an entire stock index — the S&P 500, maybe. It’s going to be a lot cheaper than buying those separate, actively-managed funds — and, as the data have shown again and again — it will likely perform better as well. Over the past decade, according to The Wall Street Journal, “between 71 and 93 percent of U.S. stock mutual funds either closed or failed to beat their closest index funds.”

    BOGLE: If we go back to 1970, we find that there were approximately 400 funds in business and basically 330 or 340 have gone out of business. It turns out, in that period, there were two mutual funds who beat the market by more than 2 percent per year. Two! That’s half of 1 percent of all the funds that started in the business. Those are your odds.

    Those may be the odds, but the perception is different. Warren Buffett, a stock picker who does beat the market, is a national hero. In schools all across America, when kids are introduced to the concept of investing, they’re often encouraged to become little Buffetts — playing stock-market games where they pick individual stocks. Rather than being taught the sensible route of dollar-cost-averaging their way into low-fee index funds. It’s a bit like learning to drive on a Formula One circuit.

    FRENCH: The notion that we can all get rich by trading actively just doesn’t make any sense whatsoever.

    BOGLE: You have to understand one important thing about the market and that is for every buyer, there is a seller. And every seller, there is a buyer.

    FRENCH: Every time somebody wins, somebody loses even more.

    BOGLE: So when transactions take place, the only winner net is the man in the middle. The croupier in the gambling casino.

    FRENCH: You have to believe you really are superior to the other folks that you’re trading against.

    RITHOLTZ: I draw the parallel between being an outstanding market-beating manager, trader, whatever, with being an all-star in any professional sports league. It’s such a tiny percentage!

    FRENCH: If you don’t think that you’re really one of the best people out there doing this, you probably shouldn’t even start.

    RITHOLTZ: But every kid who ever picked up a baseball bat, a basketball, a football, dreams of winning the championship, hitting the bottom-of-the-ninth home run. The problem is if you invest based on those fantasies, the odds are strong that you’re going to be disappointed.

    BOGLE: This is actually simple wisdom.

    Simple, perhaps, but elusive. In part because the alternative — the gamble of picking stocks — is so seductive. Which may explain why it took so long for index funds to really catch on. The index fund is more predictable, and boring — which, as Jack Bogle sees things, is its virtue.

    BOGLE: It diversifies away the risk of individual investments. It diversifies away the risk of picking a hot manager and diversifies away the idea that you can pick market sectors like health care, technology, or wherever it might be.

    And then there’s the cost comparison. We’ll start with the typical mutual fund:

    BOGLE: They charge a lot for this service. We estimate the average expense ratio is almost 1 percent for an actively managed fund. Then these active funds, all of them have sales loads. The index funds do not. The active funds further turn over their portfolios at a very high rate and that’s costly. You add that all up and the cost of owning a mutual fund on average is 2 percent.

    And how does that compare to an index fund?

    BOGLE: You can buy an index fund of, an S&P 500 Index Fund, let’s say, for as little as 4 basis points, four one-hundredths of 1 percent. In a 7 percent market, you’re going to get 6.96 percent.

    That difference — 2 percent versus four one-hundredths of 1 percent — may not sound like a lot. But over time, those numbers are compounded by what Bogle calls the “relentless rules of arithmetic.”

    BOGLE: If the market return is 7 percent and the active manager gives you 5 after that 2 percent cost, and the index fund gives you 6.96 after that four basis point cost — you don’t appreciate it much in a year — but over 50 years, believe it or not, a dollar invested at 7 percent grows to around $32 and a dollar invested at five percent grows to about $10. Think what an investor thinks about when he looks at that number. He says, “Wait a minute! I put up 100 percent of the capital. I took 100 percent of the risk and I got 33 percent of the return.” Well, anybody that thinks that’s a good deal, I’ve got a bridge I want to sell them. Here’s the reality: this is the business, the mutual fund, actively-managed business, where you not only don’t get what you pay for, you get precisely what you do not pay for. Therefore, if you pay nothing, you get everything.

    Jack Bogle is plainly a cheerleader for the revolution he helped start. There are, to be sure, plenty of critiques of indexing, or at least shortcomings — we’ll get into those later. But the fact is that the revolution does seem to be happening. The question is …

    BOGLE: Why did it take so long? That’s what the question really ought to be.

     

    •      *      *

    On October 14 of 2013, the University of Chicago finance professor Eugene Fama began his day just like any other.

    FAMA: I was doing my exercises and preparing my class for that day — when they called.

    “They” being the Royal Swedish Academy of Sciences committee that awards the Nobel prize in economics.

    FAMA. Ten minutes later, there were reporters at the door. It was amazing.

    DUBNER: Wow. How did you like that?

    FAMA: I said, “Look, I have a class to go to. I can’t deal with you.” So I went and taught my class. They wanted to come into the class and I said, “These kids pay a fortune for these classes! Stay out there.”

    DUBNER: So you’re sometimes called “the father of finance” which—

    FAMA: I think it’s the grandfather at this point.

    DUBNER: Well, here’s the thing that seems strange to me: to a lot of people, given that it’s the 21st century and you’re not 500 years old, hasn’t finance been around for centuries?

    FAMA: Not as an academic discipline. If you go back to the late 50’s, there really was nothing called “academic finance.” Well, there was something being taught in business schools as finance, but it really had no strong research underpinnings. If you look back at that time, the people in finance weren’t economists. I don’t know how you’d characterize them.

    DUBNER: Accountants?

    FAMA: Yeah, they were professional people. Some of them had come over from accounting, but they weren’t strong in economics, so they didn’t think of questions in those terms. For example, if you took an investments course at that time, it was a course on picking stocks, basically. How do you analyze companies to pick stocks? Of course, they had no model of what determines prices, so there was really no way to answer that question in any rigorous way. But at that point we were developing lots of research that said, “This is basically very difficult to do, if not impossible, and it’s kind of pointless. We don’t really know anybody who can teach people how to pick stocks because we don’t know anybody who can pick stocks.”

    DUBNER: You’re famous for developing what we now know as the efficient market hypothesis. Explain it to a layperson.

    FAMA: It’s easy to explain. It’s a simple proposition. The proposition is that prices reflect all available information, which in simple terms means since prices reflect all available information, there’s no way to beat the market. Now, that’s an extreme statement of the hypothesis, and the difficult part is actually developing tests of it because you have to say something about what the market is trying to do in setting prices.

    Because it’s so hard to test, the efficient market hypothesis is not universally accepted. Some behavioral economists argue that the standard human cognitive errors create imperfect pricing that a shrewd investor can exploit. What’s Jack Bogle’s take?

    BOGLE: The markets are highly efficient — although, importantly, not perfectly efficient. Sometimes they’re very efficient and sometimes they’re not. It’s hard for we poor souls on Earth to know which is which

    RITHOLTZ: The basic concept of, “Can you beat the market?” — it’s more subtle than some people want to argue.

    Barry Ritholtz again:

    RITHOLTZ: It’s not black and white. It’s not that you can’t beat the market. You can and some people have and have for long periods of time. Look no further than Warren Buffett. The challenge is being able to select who’s going to be able to beat the market, for them to beat the market consistently year in year out, and then to do it in excess of costs, fees, taxes, commissions. That’s the brilliance of Eugene Fama, identifying that before anybody else saw it.

    Fama developed the idea in the late 1960’s.

    FAMA: The academic world grasped this stuff basically immediately. There was no resistance to it to it at all. It took a much longer time for it to penetrate into the applied community.

    DUBNER: And why was that?

    FAMA: That’s the $24 question. Well, an even higher price than that would be given the relevance of how long it’s taken for people to really wake up to the data and what it says about active investing.

    DUBNER: In retrospect, was the objection simply protectionist thinking by the financial services industry or was it something more than that?

    FAMA: The financial services industry had a lot to lose from this line of research because basically we were saying to them, “You’re charging people for stuff you can’t deliver.” So I was not a popular kid.

    DUBNER: Well, obviously the idea caught on. It’s often said that right now we’re in the midst of a “passive investment revolution.” Do you agree with that characterization? Is revolution too strong a word or no?

    FAMA: Well, when my co-author Ken French was president of the American Finance Association, in his presidential talk, he said that, “It basically took 50 years to go from zero percent passive to 20 percent passive. Then, in the next 10 years it’s gone up to like 30.” We’re still nowhere near taking over the world.

    DUBNER: When is active management a good thing? Or maybe put it another way, when is it worth it for me to pay my 1 or even 2 points for an active manager?

    FAMA: I would say I don’t know anybody for whom it’s worth it because I don’t think — I’ve analyzed more data than almost anybody, given that I’m so old. But the problem that people don’t understand is that active managers, almost by definition, have to be poorly diversified. Otherwise, they’re not really active. They have to make bets. What that means is there’s a huge dispersion of outcomes that are totally consistent with just chance. There’s no skill involved it. It’s just good luck or bad luck. You can’t tell the difference between the two based on returns alone. This is looking at the world before costs. When you look at the world after costs — which is what people eat; they have to pay the cost of the people charging them — well, then, the whole industry looks pretty bad.

    DUBNER: If you want to give yourself a bad chance versus the market and pay extra for it, that’s when you should get an active manager, basically?

    FAMA: Right. Be my guest.

    DUBNER: It sounds like college endowments. No offense. I don’t know how the University of Chicago runs its endowment. But the Ivy Leagues certainly …

    FAMA: Badly. I’m chuckling, [but] it’s not a laughable matter. But in the old days they used to invite me annually to go talk to the person who ran the endowment. It was clear he was totally not interested. Finally, I gave up and they gave up.

    RITHOLTZ: The joke is that Harvard is a $38 billion hedge fund with a small college attached to it.

    Barry Ritholtz manages money but he’s got a couple side gigs too.

    RITHOLTZ: I also am a columnist for Bloomberg View, and I host a weekly podcast called Masters in Business.

    In one column, he wrote, “If ever there was an argument for endowments to turn to passive indexing, Harvard is it.” This was shortly before the Harvard endowment shook up its management team after years of poor returns. I asked Ritholtz about it.

    DUBNER: Harvard’s annualized net returns for the past 10 years were less than 6 percent. In fact, when you look at the top-performing Ivy endowments, they were all around 8 percent for those 10 years. Again, sophisticated, expensive management with access to all kinds of information and investments. Just out of curiosity I went and looked at my boring own kids’ college savings fund, which is stashed in a pretty dull and very cheap 529 plan. There’s just a handful of choices, index funds. There’s one growth fund, one value fund, a couple of bond funds, and it costs pretty much nothing. And lo and behold, my ten-year annualized net return beat every single Ivy endowment. Those are the best and the brightest. Why on earth would anyone want to pay those fees for active management, whether you’re an individual investor like me or a huge endowment like Harvard?

    RITHOLTZ: Look, just because you’re at an endowment running billions of dollars associated with some of the most sophisticated investors, there’s no reason to think you’re not going to succumb to the same cognitive errors and psychological failings that every other human being does. There’s groupthink, there’s a refusal to admit that you were wrong. There is an even bigger embarrassment of saying, “I don’t know.” One of my favorite things to do is anytime I’m on TV and someone asks me a question, “Hey, where’s the Dow going to be a year from now?” I love to just say, “I don’t know.” They don’t know how to respond to it. When you’re in a room full of peers, when you’re in a room full of consultants, and everybody is pretending to be knowledgeable and sophisticated, there are all sorts of group dynamics that lead to — the technical term is “suboptimal decision making.”

    DUBNER: The financial services industry is obviously gigantic. A lot of people have a lot of relatively high-paying jobs for which they’re supposed to create value for people who are investing money. But the data show — forget about whether it’s Ivy League endowment data or across-the-board investment data — the data show that a lot of money that investors spend to get better returns is essentially wasted. First of all, would you agree with that statement?

    RITHOLTZ: Most of the money they spend is essentially wasted; not a lot. I would say the vast majority.

    DUBNER: All right. The argument would be that they’d be better off buying a few index funds for essentially pennies on the dollar compared to what they’re paying their investment professionals and that the financial services industry is kind of a tax on stupid people who think they’re being really smart. Do you see it that way?

    RITHOLTZ: It’s worse than that! It’s not a tax on stupid people who think they’re smart. It’s a tax on smart people who don’t realize their propensity for doing stupid things. Look at all the endowments. Look at look at how far behind the eight ball most of the state pension funds are. These aren’t dumb people. These are really smart, accomplished people. They, unfortunately, don’t want to admit they don’t know something, [and] are very put off by counter-intuitive information. It’s the Lake Wobegon syndrome: everybody wants to believe that they’re above average. “Sure it’s hard to beat the market, but I can.” What’s amazing is there are actually S&P 500 index funds that have a giant fee attached to it. I can’t explain how that works.

    DUBNER: And that’s a tax on stupid, no?

    RITHOLTZ: That is a tax on stupid, for sure.

    DUBNER: You’re literally paying whatever — double, triple, five times for exactly the same product?

    RITHOLTZ: That’s right. Triple. I want to tell you the Vanguard S&P 500 index fund is about 5 or 6 basis points. Schwab recently cut 1 to 2 or 3 basis points. There are S&P 500 funds with 50 and 75 and 100 basis points. It’s an insane — that is a tax on dumb.

    The Dartmouth finance professor Ken French has been closely watching the growing appetite for index funds.

    FRENCH: It’s not something that just started today. It’s been going on for the last 20 or 30 years. It does seem to have picked up speed.

    That said, French doesn’t quite see the passive-investing revolution as a revolution.

    FRENCH: I believe we are seeing a shift from active toward passive. That’s pretty clear, but I don’t think it’s quite as pronounced as most people argue.

    That’s because so much new money has been flowing into E.T.F.s.

    FRENCH: An E.T.F. is an exchange traded fund.

    Which may look a lot like a passive index fund …

    FRENCH: But what’s unique about E.T.F.s is you can trade them all day.

    And the volume of trading in E.T.F.s, French says, suggests that many traders are not truly passive.

    FRENCH: I think of passive as essentially a buy and hold. They buy it today and they hold it for years and years. We’re not seeing that in the E.T.F. marketplace. Some of the people are certainly doing that, but it appears a large fraction of them aren’t.

    That said, there’s plainly been an acceleration away from traditional active management. Why?

    FRENCH: I interpret that as one of the consequences of the financial crisis. Before the crisis, people had this view that Wall Street was our friend. After the crisis, there are a lot more cynical about fees that are being charged and services that are being provided by Wall Street.

    RITHOLTZ: At a certain point, the investing public turns around and says, “This is rigged. This is a tough gig. Why am I wasting my time picking stocks, paying commissions, paying high mutual fund costs? I could just index.”

    There are, of course, plenty of alternative views — especially from those who profit from old-school active investing. Still, you can imagine that if every investor in the world held pretty much the same investments — well, what would that lead to? A research note from the investing firm Sanford C. Bernstein argued that passive investing is, “worse than Marxism,” in that it threatens the legitimate give-and-take that is central to any market. Ken French again:

    FRENCH: One of the beautiful things that happens out there in the market is price discovery, and I would never argue all prices are right, but prices are pretty darn good. We learn an awful lot about how resources should be allocated from what the prices are in the financial markets. If nobody is doing price discovery, we lose a really valuable service. What I always say is, “If it’s somebody I don’t like, I’m more than happy to have them go out there and spend their money investing actively because as a group, they’re making the world better off.”

    For what it’s worth, Ken French, for all his skepticism about how modern investing works — he himself does some work with the huge investment firm Dimensional Fund Advisors. So does Eugene Fama. For all the noise about the passive revolution, it’s worth remembering that only about 30 percent of all mutual and exchange-traded funds are being passively managed. But it’s enough to concern plenty of people who worry about homogenization — especially when the federal government gets involved.

    SCARAMUCCI: My name’s Anthony Scaramucci. I’m the founder of SkyBridge Capital.

    When we spoke with Scaramucci, last year, he’d just sold SkyBridge Capital in anticipation of getting a job with the Trump administration. He eventually got that job as White House Communications Director, only to be fired after less than a week. When we spoke, I asked Scaramucci about the yet-to-be-instated fiduciary rule. That’s an Obama-era regulation that was pitched as ensuring that financial advisors act in their clients’ best interests.

    DUBNER: You called the fiduciary rule, “a case study in government overreach, a clear example of how faulty regulation can have severe unintended consequences.” You also promised to help President Trump repeal it. What are some of those unintended consequences of a rule to try to change the behavior of the people who are paid to manage other people’s retirement money?

    SCARAMUCCI: It’s really not changing their behavior. What it’s doing is it’s actually limiting the choices for the end user or the end investor. Because if you read the entire rule, which I’ve read, it’s a governmental decision to allocate capital into index funds and E.T.F. funds that the government is deeming those things as being more efficient. They’re more effective in terms of their lower cost analysis and, for the time being, the government is actually right. If you look at the last 5 or 10 years, those funds have performed better and charge less fees than, let’s say, a hedge fund or a private equity firm.

    But the problem with that analysis is that you’re not taking a 120-year, modern, economic historical analysis of business cycles and stock market trends. You’re really only looking at the last 10 years. The buffet table of investment opportunities for the average user — let’s say, my mom and dad, which I’m super concerned about — gets curtailed. I’m just going to sell you the things that the government wants me to sell you. What will end up happening is everybody will be overloaded in E.T.F.s, they’ll be overloaded in indexes. And when the market crashes — because they will have eliminated many of the financial advisers. You’ll lose 60 to 70,000 financial services jobs as a direct result of that rule. It’s a jobs killer.

    But what it also does is it fails to recognize the full economic value of a financial adviser. The economic value of a financial adviser is not just the return and the net return, net of the fees, but it’s also the psychological effect and the coaching that that financial adviser provides that family. The rule is bogus, Stephen, and the rule needs to be repealed. The people that really understand the rule know that. By the way, I love my clients, as most financial advisers do. I’m not trying to rip off my clients. I’m not trying to do something that’s dishonest. I’m just trying to increase, continually, their options in terms of what they can invest in.

    Think what you will of Scaramucci’s take on the overconcentration of investments in index funds. If the trend does continue, it’s hard to dispute, as he says, that a lot of financial-services jobs will be lost. I asked Barry Ritholtz about how his industry planned to protect — or reform — itself.

    DUBNER: As we’ve seen throughout history with any industry or institution that’s got leverage, that’s got money, that’s got a history itself, reform never comes from within. Nobody is going to say, “You know what? Our industry is really not providing value. We’re getting paid billions, trillions of dollars to manage this money and we’re actually doing a pretty crappy job. A monkey with a dart board would literally do better for just the price of monkey chow. So you know what? Let’s break up. Let’s send everybody home, say we’ve had a nice run. We’ve had these nice 100, 200, 300, 400 thousand dollar jobs just for shuffling other people’s money around poorly.” If the revolution really does come to pass and the world says, “You know what? The financial services industry as it’s currently configured — we only need about 5 percent of it.” What happens?

    RITHOLTZ: First, no self-respecting person in finance would work for those absurdly low figures you quoted. Let’s put that aside. Second, the financial markets go through this regular creative destruction every few years. Back in the early 70’s, commission prices were fixed. You couldn’t discount a commission if you wanted to. It was actually a legal regulation. Once that changed suddenly everybody predicted the end of the world of finance. “Oh my God, what’s going to happen? They’re going to start cutting prices!” That is what happened. You cut prices. More people were able to access the capital markets. It worked out really well.

    Every few years we go through one of these major innovations. Not too long ago, E.T.F.’s didn’t exist. We take for granted that for five bucks I could go out and buy an E.T.F. of every major index I want. That’s a shocking change that has also had significant impact. As we go through this process of these convulsions, the financial-services industry became too large. It became too outsized, it became too over-compensated. It was the tail that was wagging the dog. It used to be financial services companies operated in service to big corporations and small investors and everything in between, but eventually they started being a reason for their own existence.

    That’s now going through a change. Probably, before we lose 90 percent of people in finance or 95 percent, there’ll be something else that happens. It seems that every time there’s any major trends, whether it’s towards global investing or passive investing or day trading, it’ll last for a couple of years and then something new and shiny comes along and enough people are interested in it that a substantial portion of the previous trend participants will chase that. However, I will say that the evolution towards low-cost, towards indexing, and towards being aware of how your own behavior impacts your investing, is something that’s going to be here for the foreseeable future.

    All right, so we learned today that low-cost indexing seems to make a lot of sense, at least for a lot of people in a lot of situations. But what about all the other things you have to do to be a fiscally sane, and responsible, adult? Glad you asked! That’s what we’ll talk about on the next Freakonomics Radio. Because a lot of people — including a lot of otherwise really smart people — are totally clueless when it comes to their personal finances.

    Harold POLLACK: How do I save for retirement? How do I deal with all these questions about budgeting and when to buy a house and all that kind of stuff? Oh, I just have to look at these nine rules on this card.

    Everything you ever wanted to know about personal finance — and it fits on one index card. That’s next time, on Freakonomics Radio.

    Freakonomics Radio is produced by WNYC Studios and Dubner Productions. This episode was produced by Greg Rosalsky. Our staff also includes Alison Hockenberry, Stephanie Tam, Merritt Jacob, Harry Huggins and Brian Gutierrez; we also had help this week from Sam Bair. The music you hear throughout the episode was composed by Luis Guerra. You can subscribe to Freakonomics Radio on Apple Podcasts, Stitcher, or wherever you get your podcasts. You can also find us on Twitter, Facebook, or via e-mail at radio@freakonomics.com.

    Here’s where you can learn more about the people and ideas in this episode:

    SOURCES

    John Bogle, founder of The Vanguard Group.

    Eugene Fama, professor of finance at the University of Chicago.

    Kenneth French, professor of finance at Dartmouth College.

    Barry Ritholtz, co-founder and C.I.O. of Ritholtz Wealth Management.

    Anthony Scaramucci, White House Communications Director.

    RESOURCES

    “The Arithmetic of Active Management,” William Sharpe (January/February, 1991).

    “Challenge to Judgment,” Paul Samuelson (Fall, 1974).

    “Historical Timeline of Fiduciary Duty for Financial Advice,” Mark Schoeff Jr., Investment News (April 5, 2016).

    “Luck Versus Skill in the Cross-Section of Mutual Fund Returns,” Eugene Fama and Kenneth French (October, 2010).

    “Bernstein: Passive Investing is Worse for Society Than Marxism,” Luke Kawa, Bloomberg (August 23, 2016).

    “The Passivists,” The Wall Street Journal (October, 2016).

    “Whither Efficient Markets? Efficient Market Theory and Behavioral Finance,” Laurie Kaplan Singh (May 19, 2010).

    EXTRA

    “How Much is a Trillion Dollars? What a Trillion Can Buy,” FOX Business (April 30, 2015).

    http://freakonomics.com/podcast/stupidest-thing-can-money-rebroadcast/

    —Huffduffed by chriskimmet

  3. How I Built This with Guy Raz : NPR

    Guy Raz dives into the stories behind some of the world’s best known companies. How I Built This weaves a narrative journey about innovators, entrepreneurs and idealists—and the movements they built.

    https://www.npr.org/podcasts/510313/how-i-built-this

    —Huffduffed by chriskimmet

  4. Bullseye With Jesse Thorn: End of Year 2017 Comedy Special | Maximum Fun

    Show: 

    Bullseye

    New to Bullseye? Subscribe to our podcast in iTunes or with your favorite podcatcher to make sure you automatically get the newest episode every week.

    It’s that time of year again! The Bullseye team listened to hours of comedy from the past year and picked the absolute best for you to enjoy in one convenient episode. There was a lot of great stuff this year. Our list includes industry veterans, newcomers and lesser know talents you are going to love. This was no easy task — please let us know who else should have made the cut

    @Bullseye or on Facebook!

    Like what you hear? Click through to learn more information on these comedians. For your convenience links to buy their albums have also been provided below:

    Dana Gould - Mr Funny ManKate Willett - Glass GutterJosh Gondelman - Live at

    Max Fun Con EastRoy Wood, Jr. - Father FigureJackie Kashian - I Am Not The Hero Of This StoryShane Torres - Established 1981Myq Kaplan - No KiddingCameron Esposito & Rhea Butcher - Back to BackDave Anthony - Hot HeadDavid Gborie - Live at Max Fun Con

    WestJoel Kim Booster - Model MinorityChris Gethard - Career SuicideJanelle James -

    Black and MildSolomon Georgio - Homonegro SuperiorCristela Alonzo - Live at Max Fun Con East

    http://www.maximumfun.org/bullseye/bullseye-jesse-thorn-end-year-2017-comedy-special

    —Huffduffed by chriskimmet

  5. Episode 20 - Jetpackula written by Rob Schrab | Maximum Fun

    Show: 

    Dead Pilots Society

    Guests: 

    Patton Oswalt as Ben

    Guests: 

    Tony Hale as Jetpackula

    Guests: 

    Constance Wu as Megan/Receptionist

    Guests: 

    Rob Schrab as Dr. Veratu

    Guests: 

    Mel Rodriguez as Luis/Defenestrator/Trent

    Guests: 

    John Owen Lowe as Jonah

    Guests: 

    Sujata Day as Future Moo Cow/Susan/Della

    Guests: 

    Joel Spence as Farmer/Living Scarecrow/Vampresident Martin/Announcer

    In this episode, Andrew Reich and Ben Blacker interview Rob Schrab (The Sarah Silverman Program) regarding his dead pilot, Jetpackula. You’ll also listen to a live table read of Jetpackula, performed by some of today’s funniest comedic actors.

    For more Dead Pilot Society episodes, please subscribe to the podcast! Make sure to like us on Facebook, follow us on Instagram , on Twitter, and visit our website at deadpilotssociety.com

    http://maximumfun.org/dead-pilots-society/episode-20-jetpackula-written-rob-schrab

    —Huffduffed by chriskimmet

  6. Upgrade #165: The iPhone X Review - Relay FM

    This week is all about the iPhone X, which Jason reviewed and now has in his hands to answer Myke’s—and your—questions.

    https://www.relay.fm/upgrade/165

    —Huffduffed by chriskimmet

  7. 91- Wild Ones Live

    We have one cardinal rule on 99% Invisible: No cardinals. Meaning, we deal with the built world, not the natural world. So, when I read Jon Mooallem’s brilliant book, Wild Ones: A Sometimes Dismaying, Weirdly Reassuring Story About Looking at … Continue reading →

    http://feeds.99percentinvisible.org/~r/99percentinvisible/~3/bLF8wk5mIw8/

    —Huffduffed by chriskimmet

  8. BiggerPockets Podcast 080: Smart Rental Property Investing, Getting Your License, and Investing For Retirement with Jonna Weber

    Today we sit down with Jonna Weber, an investor agent who decided real estate was better for her retirement than stocks. Listen to her story now!

    https://www.biggerpockets.com/renewsblog/2014/07/24/smart-rental-property-investing-retirement-jonna-weber/

    —Huffduffed by chriskimmet

  9. Michael Kitces – The 4% Rule and Financial Planning for Early Retirement | Mad Fientist

    Retirement researcher and financial planner, Michael Kitces, joins me to discuss safe withdrawal rates and how to effectively plan for early retirement!

    http://www.madfientist.com/michael-kitces-interview/

    —Huffduffed by chriskimmet

  10. #FASuccess Ep 011: How Launching An Advisory Business Can Be Safer Than Working In One with Alan Moore

    Financial Advisor Success Podcast with Alan Moore of XYPN on how launching an advisory business can be safer than working in one,

    https://www.kitces.com/blog/alan-moore-xypn-podcast-launching-advisor-business-entrepreneur/

    download

    Tagged with podcast

    —Huffduffed by chriskimmet

Page 1 of 14Older