Quotulatiousness

January 12, 2018

Investing: Why You Should Diversify

Filed under: Economics — Tags: , — Nicholas @ 02:00

Marginal Revolution University
Published on 30 Aug 2016

So far, we’ve been telling you what not to do when investing. Here’s what you should do: diversify.

Don’t put all your eggs in one basket. Definitely, don’t put your investment money solely in your employer’s stock. That’s very loyal, but it’s a terrible strategy. Just think of Enron’s employees. They had huge chunks of their retirement funds in company stock. Upon Enron’s collapse, many employees who were once multimillionaires ended up with almost nothing.

As you can see, diversification is much safer. Diversification reduces risk by spreading your investment across different assets, doing so without reducing potential returns. Plus, modern financial markets make diversification easy. For example, our favorite investment instrument is the low-fee index fund. These funds mimic a large market basket of stocks, like the S&P 500. The sheer variety in the fund is what mitigates the risk. It’s diversification for the win.

A quick reminder, though. Choose an index fund with low fees. Fees may seem trivial, until you watch them eat away at your investment. Imagine this: take a hypothetical $10,000. Invest that in a fund with a 1% fee, and you’ll have roughly $57.5K after 25 years, assuming an average 8% return. Now, invest the same $10K, in a fund with a 0.2% fee.You’ll get roughly $70K over the same quarter-century.

Our point is — when it comes to investing, simple is best. So for example, if your employer offers a 401K, take the offer!

That being said, you might believe that the market is irrational. Anomalous, even.

No worries.

Next time, we’ll tackle behavioral finance to see if you can profit from anomalies, and irrationality.

January 4, 2018

Who Is More Rational? You or the Market?

Filed under: Business, Economics — Tags: , — Nicholas @ 04:00

Marginal Revolution University
Published on 6 Sep 2016

We mentioned before that it’s hard to beat the market. And you shouldn’t try. But what about market anomalies?

One anomaly is the Momentum Effect — where past stock performance predicts future performance, at least a bit. As an example, portfolios with past winners tend to outperform the market in the medium term. Why is that? The market sometimes under-responds to changes in information. Thus, some stocks can lag, even if rationally, they shouldn’t. This is why picking past winners can generate some profit, though the profit’s usually small.

There are also other anomalies, like the Monday Effect, where stocks fall more on Mondays. Or, there’s the January Effect, which says that stocks surge higher in that month. There’s been some evidence for these effects, but these anomalies don’t last.

Despite its flaws, the market is still more rational than you. Don’t forget, you’re probably like most individual traders. You may become overconfident. You may not calculate probabilities that well. And if the market crashes, you’re likely to act more emotionally than you should — just like everyone else.

But don’t just take our word for it — even Warren Buffett agrees! Don’t try to beat the market.

November 28, 2017

Evergreen headline – “FCC bureaucrats don’t know what they’re talking about”

Filed under: Government, Liberty, Media, USA — Tags: , , , , — Nicholas @ 03:00

Nick Gillespie on the heightening panic over the FCC’s reversal of the controversial Net Neutrality rules:

Current Federal Communications Commission (FCC) Chairman Ajit Pai memorably told Reason that “net neutrality” rules were “a solution that won’t work to a problem that doesn’t exist.”

Yet in 2015, despite a blessed lack of throttling of specific traffic streams, blocking of websites, and other feared behavior by internet service providers (ISPs) and mobile carriers, the FCC issued net neutrality rules that gave the federal government the right to punish business practices under Title II regulations designed for the old state-enabled Bell telephone monopoly.

Now that Pai, who became chairman earlier this year, has announced an FCC vote to repeal the Obama-era regulations, he is being pilloried by progressives, liberals, Democrats, and web giants ranging from Google to Netflix to Amazon to Facebook, often in the name of protecting an “open internet” that would let little companies and startups flourish like in the good old days before Google, Netflix, Amazon, and Facebook dominated everything. Even the Electronic Frontier Foundation (EFF), which back in 2009 called FCC attempts to claim jurisdiction over the internet a “Trojan Horse” for government control, is squarely against the repeal.

[…]

Yet the panic over the repeal of net neutrality is misguided for any number of reasons.

First and foremost, the repeal simply returns the internet back to pre-2015 rules where there were absolutely no systematic issues related to throttling and blocking of sites (and no, ISPs weren’t to blame for Netflix quality issues in 2013). As Pai stressed in an exclusive interview with Reason last week, one major impact of net neutrality regs was a historic decline in investment in internet infrastructure, which would ultimately make things worse for all users. Why bother building out more capacity if there’s a strong likelihood that the government will effectively nationalize your pipes? Despite fears, the fact is that in the run-up to government regulation, both the average speed and number of internet connections (especially mobile) continued to climb and the percentage of Americans without “advanced telecommunications capability” dropped from 20 percent to 10 percent between 2012 and 2014, according to the FCC (see table 7 in full report). Nobody likes paying for the internet or for cell service, but the fact is that services have been getting better and options have been growing for most people.

Second, as Reason contributor Thomas W. Hazlett, a former chief economist for the FCC, writes in The New York Daily News, even FCC bureaucrats don’t know what they’re talking about.

Hazlett notes that in a recent debate former FCC Chairman Tom Wheeler, who implemented the 2015 net neutrality rules after explicit lobbying by President Obama, said the rise of AOL to dominance during the late 1990s proved the need for the sort of government regulation he imposed. But “AOL’s foray only became possible when regulators in the 1980s peeled back ‘Title II’ mandates, the very regulations that Wheeler’s FCC imposed on broadband providers in 2015,” writes Hazlett. “AOL’s experiment started small and grew huge, discovering progressively better ways to serve consumers. Wheeler’s chosen example of innovation demonstrates how dangerous it is to impose one particular platform, freezing business models in place.”

November 25, 2017

Can You Beat the Market?

Filed under: Economics — Tags: , , — Nicholas @ 02:00

Marginal Revolution University
Published on 23 Aug 2016

On average, even professional money managers don’t beat the market. To show you why, here’s a scenario to consider:

Say we advise you to invest in companies serving the aging US population. Since the percentage of elderly will rise over the coming decades, it makes sense to invest now in products and services that the elderly might need. Sounds logical, right? Wrong.

See, the aging of the US population isn’t a secret. It’s public information. Now, say you acted on the information and did buy stock as we advised. The current price of that stock already reflects information known to the market. Thus, it’s hard to systematically outperform the market, given that everyone else tends to have the same information you do. This is also the main idea behind the efficient market hypothesis.

According to the efficient market hypothesis, the prices of traded assets already reflect all publicly available information.

With information available to buyers and sellers alike, no one has any sustainable advantage over anyone else. This is why even the pros tend not to beat the market. And that aside, even if news did pop up to change the price of an asset, it would be at random and would likely be reflected in the asset price almost immediately. So there’s no reliable way to forecast performance.

As proof of that, take the Challenger space shuttle crash of January 28, 1986. Within minutes of the crash, the news hit the Dow Jones wire service. The stock prices of the major contractors who helped build the shuttle fell immediately. Keep in mind: that was in the 80s. At today’s pace, new information can change stock prices within seconds. This is why stock tips often end up obsolete.

So to sum up — it’s hard to beat the market. You have to accept that.

Still, how should you invest? That’s what we’ll discuss in the next video.

November 9, 2017

How Expert Are Expert Stock Pickers?

Filed under: Economics — Tags: , , — Nicholas @ 02:00

Marginal Revolution University
Published on 16 Aug 2016

In this first video in our Personal Finance section of Macroeconomics — and also our new course on Money Skills — we’ll begin to lay out some smart rules for investing.

Today, we’ll tackle Rule 1 — ignore the expert stock pickers.

What’s the basis of that rule? Well, in his 1973 book, A Random Walk Down Wall Street, economist Burton Malkiel made a controversial claim. He claimed that a blindfolded monkey, throwing darts at the financial pages, could select a basket of stocks that would do just as well as a set chosen by the pros.

One of Malkiel’s later students, the journalist John Stossel, set out to test that claim. Stossel did throw darts at the financial pages. The darts landed on 30 companies. Turns out, Malkiel did have it right — the randomly-selected stocks did better than professionally-picked ones.

The point here is, random picking roughly gives you as good results, as trusting the pros. Consider — in most years from 1963-2008, the S&P 500 Index outperformed most of the managed mutual funds. And in a different study, researchers took the top 25% best-performing funds. Two years later, less than 4% of the original set remained in the top quarter. Five years later? Only 1% stuck around.

Basically — past performance doesn’t guarantee future results. Chance often tends to win out.

To show you what we mean, take a hypothetical set of 1000 experts making market predictions. Let those predictions be based on a coin toss. Experts who land heads will say the market will surge this year. Those who land tails say the opposite. At the end of the experiment’s first year, 500 of the 1000 experts will have been right, solely by chance. Now, say the remaining 500 toss again. At the end of the second year, 250 experts will have been right, again by chance. Continue with this logic, and by the end of the fifth year, roughly 32 of the 1000 will have been right, five years running.

Perhaps these 32 will be hailed as geniuses, but remember, they only came about through a coin toss.

So, what’s to conclude from this? Two things.

First, luck and chance matter. In some cases, it can be hard to differentiate luck from skill, as proven by the “genius” 32. Second, no need to spend big bucks on a money manager. After all, the studies prove that random picking often works just as well as professional management.

That said, what if you did have market information? What if you knew something about certain stocks, that made you think they’d do well? Could you beat the market then? That’s what we’ll answer in our next video, when we tackle the efficient market hypothesis. Stay tuned!

September 30, 2017

Office Hours: The Bond Market

Filed under: Economics — Tags: , — Nicholas @ 02:00

Marginal Revolution University
Published on 19 Jul 2016

In Intro to the Bond Market, you learned the basics about bonds and how they differ from stocks. But what if you’re investing and you’ve got a few possible companies to choose from? How would you evaluate which bond is likely to be the best investment for you?

Let’s look at an example from our bond market practice questions:

Suppose you’d like to invest in a company and you’ve narrowed your choice down to three firms: Company A is offering a zero-coupon bond with a face value of $1000 to be repaid in 1 year for $963. Company B has the same face value and maturity date but sells for $871. And company C also has the same face value and maturity but sells for $985. In which would you rather invest?

If some of the terms have you scratching your head, don’t worry! Go ahead and start this Office Hours video. Mary Clare Peate from the MRU team will cover the jargon and give you the tools you need to master the problem on your own.

September 20, 2017

Intro to the Bond Market

Filed under: Economics — Tags: , , — Nicholas @ 02:00

Published on 12 Jul 2016

Most borrowers borrow through banks. But established and reputable institutions can also borrow from a different intermediary: the bond market. That’s the topic of this video. We’ll discuss what a bond is, what it does, how it’s rated, and what those ratings ultimately mean.

First, though: what’s a bond? It’s essentially an IOU. A bond details who owes what, and when debt repayment will be made. Unlike stocks, bond ownership doesn’t mean owning part of a firm. It simply means being owed a specific sum, which will be paid back at a promised time. Some bonds also entitle holders to “coupon payments,” which are regular installments paid out on a schedule.

Now — what does a bond do? Like stocks, bonds help raise money. Companies and governments issue bonds to finance new ventures. The ROI from these ventures, can then be used to repay bond holders. Speaking of repayments, borrowing through the bond market may mean better terms than borrowing from banks. This is especially the case for highly-rated bonds.

But what determines a bond’s rating?

Bond ratings are issued by agencies like Standard and Poor’s. A rating reflects the default risk of the institution issuing a bond. “Default risk” is the risk that a bond issuer may be unable to make payments when they come due. The higher the issuer’s default risk, the lower the rating of a bond. A lower rating means lenders will demand higher interest before providing money. For lenders, higher ratings mean a safer investment. And for borrowers (the bond issuers), a higher rating means paying a lower interest on debt.

That said, there are other nuances to the bond market—things like the “crowding out” effect, as well as the effect of collateral on a bond’s interest rate. These are things we’ll leave you to discover in the video. Happy learning!

August 23, 2017

Intro to Stock Markets

Filed under: Business, Economics — Tags: , — Nicholas @ 04:00

Published on 5 Jul 2016

Today, we’ll examine a new kind of financial intermediary: stock markets.

As an individual, you participate in the stock market when you buy a company’s shares. This turns you into a part-owner, entitled to some of the company’s profits. Sometimes, profits are paid out directly via dividends. Other times, profits are reinvested for company growth. In this case, you benefit by seeing the value of your shares rise in tandem with this growth.

Still, the buying and selling of stock doesn’t actually create any new investment. Buying and selling only transfers ownership between stockholders. What actually creates investment is when a company offers stock to the public for the first time (known as an Initial Public Offering or IPO), which is when it issues new shares to raise money for key ventures.

This process of turning savings into investment is what makes the stock market an intermediary.

A key caveat, though — buying stock essentially means betting on a company. As with all gambles, sometimes it pays off, sometimes, it doesn’t. For you as a saver, this means some of your stocks will win, and others, not so much.

This volatility makes stock markets more risky than banks. Bank savers typically don’t have to worry about fluctuations in the value of their deposits.

As for the entrepreneurial side, the stock market is a key institution encouraging new businesses. For a founder, the payoff typically comes during the IPO. An IPO allows founders to sell some of their ownership (in a now more-valuable company) so they can diversify their own holdings.

Next time, we’ll look at the third kind of intermediary: bond markets.

July 15, 2017

Office Hours: The Solow Model: Investments vs. Ideas

Filed under: Economics — Tags: , , , — Nicholas @ 04:00

Published on 7 Jun 2016

Ideas are a major factor in economic growth. But so are saving and investing. If you were given the choice between living in an inventive (more ideas) or a thrifty (more savings) country, which would you choose?

The Solow model of economic growth, which we recently covered in Principles of Macroeconomics, can help you make the choice. In this Office Hours video, Mary Clare Peate will use our simplified version of the Solow model to show you an easy way to work out each country’s economic prospects, and then compare them to see where you’d rather be.

February 28, 2017

Outbreak of World War 1 – A Banker’s Perspective I THE GREAT WAR Special

Filed under: Economics, Europe, History, Military, WW1 — Tags: , , — Nicholas @ 05:00

Published on 27 Feb 2017

The classic narrative of the outbreak of World War 1 is that everyone saw it coming and was awaiting it with patriotic fervor. But studying the people that profited most from a war, the bankers, that idea is definitely challenged.

February 24, 2017

Well it is the twenty-first century after all…

Filed under: Business, Personal — Tags: , , — Nicholas @ 03:00

Hey guys! I just bought marijuana for the very first time!

A thousand shares of a legal marijuana grower called Aphria, Inc. I am so conflicted — I don’t know whether I should feel counter-cultural or conformist…

I sold my last remaining Blackberry shares to cover most of the cost of the purchase, which (given Blackberry’s shrinking technological niche) was a bit of a relief.

Legal notice: Nothing in the above post should be considered in any way to be professional financial investment advice.

December 12, 2016

Refuting Piketty’s call for revolution, again

Filed under: Economics — Tags: , , — Nicholas @ 02:00

Tim Worstall points out that Thomas Piketty has mis-diagnosed the “problem” of rising capital:

The report shows that there were 13 OECD countries in which assets in funded pensions represented more than 50% of GDP in 2015, up from 10 in the early 2000s. Over the same period, the number of OECD countries where assets in funded private pension arrangements represent more than 100% of GDP increased from 4 to 7 countries.

We’re living longer lives these days, we’re working for fewer decades of them and thus people are rationally saving for their expected golden years. Thus capital as a percentage of GDP rises – not to produce inheritances, but to produces incomes in retirement. And rises by potentially at least more than 100% of GDP.

We can’t see that this is a problem and we most certainly cannot see that this is an argument for greater taxation of capital. Quite the reverse in fact, people saving for their old age should be encouraged, not specifically taxed.

So much for the most recent French call for revolution then, eh?

November 24, 2016

QotD: Black hats and white hats

Filed under: Economics, Government, Politics, Quotations, USA — Tags: , , , , — Nicholas @ 01:00

When considering the major failures of recent American governance – the 2008-09 financial crisis, the catastrophe that is U.S. policy in the Mideast – the one thing that any honest-minded person must conclude is: Nobody meant for things to turn out this way. It is impossible to make precise predictions about the effects of government policy; that is the nature of systems characterized by high levels of complexity. It’s one thing to predict that it’ll be colder during the winter, but another thing to predict down to the millimeter how much snow will fall on a particular acre in rural Maine on the third Wednesday in February, which is really what we expect from our public policy.

Classic cowboy movies, in contrast, are not complex at all: The good guys wear white hats, the bad guys wear black hats, all hats remain firmly affixed to all heads at all times, and that’s that. You can pretty much always predict how an old Western is going to turn out.

But that isn’t how the real world works.

On Tuesday, I had a conversation about Elizabeth Warren and Wall Street, pointing out that the popular version of that story – Senator Warren vs. Wall Street – is so oversimplified as to be not merely useless but misleading. The reality is that there are people working on Wall Street who dislike Senator Warren – investors and bankers, mainly – and people who adore her – notably Wall Street lawyers, who are reliable donors to her campaign and to those of other Democrats. My naïve interlocutor said: “Hopefully, it’s the lawyers that fight against Wall Street,” as though there were such a thing, as though there weren’t nice progressive lawyers in Manhattan who jokingly refer to their yachts as the SS Dodd-Frank.

Spend any time writing about this sort of thing and you’ll hear angry and panicked denunciations of derivatives-trading from people who pretty clearly do not know what a derivative is, just as you’ll hear paeans to Glass-Steagall sung by people who don’t understand the difference between a commercial bank and an investment bank, who don’t know how Goldman-Sachs makes its money or what it is that Standard & Poor’s does.

But they’re quite sure they know who is wearing the black hats.

Kevin Williamson, “Black Hats and White Hats”, National Review, 2015-04-15.

September 15, 2015

Tyler Cowen’s primer on Chinese economics

Filed under: China, Economics — Tags: , — Nicholas @ 03:00

At Marginal Revolution Tyler Cowen pulls together the key economic points you need to know to understand what is happening in China’s economic downturn:

1. You can’t invest 45-50 percent of your GDP very well forever. It’s amazing how long China’s run has been, but it is over. The quality of their marginal investments is now low and that means their growth rate will be much lower too. The low hanging fruit is gone, at least for the time being. They might later on resurrect some new low-hanging fruit through institutional reform, we’ll see if they end up stuck in the middle income trap but right now they are at a sharp discontinuity.

2. There is no simple way to switch to a “consumption-driven” economy without the growth rate both falling and staying permanently lower. Structural reforms are absolutely called for, but in this context they represent a surrender to a lower rate of growth and thus they are especially difficult to pull off in a politically sustainable manner.

3. The Chinese have been growing at ten percent or nearly ten percent for about thirty-five years. More than a generation of Chinese is used to treating the risk premium as if they don’t have to worry about it. I shudder to think what economic and also political decisions have been made on that basis.

4. The Chinese economic response to the dwindling of their low-hanging fruit is sharp rather than smooth because there is a sudden revision of expectations, as people realize the risk premium isn’t zero after all. And seeing the others see that causes the new set of beliefs to spread pretty quickly. That is a very painful process for a macroeconomy, and it is not well captured by simple AD-AS analysis, although of course it has implications for both AD and AS.

5. I would not so quickly infer that the Chinese government is stupid when it comes to economics. It is true their actions do not correspond to what professional economists would recommend. But they are painted into a very unpleasant corner and have lots of interest groups to feed. Their observed response is possibly explained by some kind of public choice-constrained, nested game, internal conflict-driven seventh-best response. They were smart a few years ago, and they are still smart now. That doesn’t mean they will end up doing a good job.

6. Avoid mood affiliation! You can be a pessimist about the Chinese recession now without being a) a pessimist about China in the longer run, or b) a pessimist about Chinese political stability. Those are separate albeit related questions, and you are not forced to have the same mood response to all of them.

May 25, 2015

QotD: Deflation

Filed under: Economics, Quotations — Tags: , , , — Nicholas @ 01:00

Deflation occurs when there is not enough currency in circulation to meet the needs of the economy. Here again, the classical definition focuses on falling prices rather than an insufficient currency stock, but deflation is primarily a monetary phenomenon.

It is the economic version of anemia: too little blood is reaching the body. Each unit of the currency goes up in value relative to the goods and services available, but because the stock of currency isn’t growing fast enough, it starves the economy of investment capital. There isn’t enough money to build out existing business, to create new ones, or to hire new workers. (This is in part what happened during the Great Depression of the 1930’s.) Inventories shrink, but new goods aren’t being produced due to the lack of investment capital. Eventually the economy grinds to a halt as production withers away.

Specie currencies are more prone to deflation than fiat currencies for the simple reason that fiat currencies are not based on scarce (and thus valuable) resources like gold, silver, or what have you. There’s only so much gold and silver to go around, and sometimes the supply of bullion can be interrupted for long periods. (Sometimes this is even done deliberately by rival nations or speculators.) Also, because the value of gold and silver is set outside the control of government or authority issuing the currency, it limits the kinds of monetary policy the sovereign can conduct, especially during times of crisis.

Monty, “Inflation, Deflation, and Monetary Policy”, Ace of Spades HQ, 2014-07-11.

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