Reader Benjamin sent me this query, and I thought I’d be so bold as to hazard an answer, and anticipate that others will have valuable perspective to contribute:
I read NC on a regular basis, and would like to see some macro advice for your younger readers, like myself. If I’m parsing commentary correctly, I may be graduating (2011, 2012) at the tail end of a big depression. Could you spare a few paragraphs of prediction or caution for younger readers at some point this week? Most of your commentary tends to favor an older and more savvy investing body but I venture that a look at a bigger picture targeted at my demographic would be fun to write (and hey, at least I’d read it avidly). Topics to consider: buying in at the housing market’s bottom; alternate routes to building equity (’cause now I’m leery of the housing market as a vehicle); and traps that unsavvy investors like recent college grads might fall into.
You didn’t ask for advice on the career front, but unless you have a trust or are likely to inherit a substantial amount, your ability to support an investment strategy will depend on the level and stability of your income. I think the biggest change your cohort faces, and one mine is confronting with considerable pain, is lack of not merely job security but of obvious career paths. There are some exceptions; white collar careers such as medicine, law, and accounting that have managed to restrict entry via professionalization (education, licensing, ongoing requirements to maintain one’s standing) are ones where you have a good shot at using the same fundamental skill set for your entire career. But for many in those fields, the earnings potential is not what it used to be.
McKinsey requisitioned a study from Yankelovitch around 2000. It said that the average college graduate would have 13 jobs before he retired. A more recent study (can’t recall the source) claimed it would be 11 jobs by age 38. The latter doesn’t sound credible, but it’s may be reasonable to assume the level might have risen from the 2000 estimate.
So the cliche about developing a portfolio of skills, sadly, is good advice. One thing I now recognize in retrospect is high flier career paths are a double edged sword. While they offer a certain level of credibility (“oh you did/worked for so and so?”),The problem is that people early in their careers look at the upside, and often fail to consider what their options are if they are not as successful as they hope to be or discover they really don’t like the work all that much.
if you continue on these tracks beyond a certain level, you often wind up with very narrow skills (for instance, what happens to people who structured CDOs? The dot com bust similarly saw a lot of people having to find work in fields new to them). Some who go this route nevertheless are able to move from one “track’ to another (some investment bankers have become CFOs at large companies, for instance; law firm partners can be hired by their clients as general counsel), but moves like that include an element of luck and good personal chemistry.
That is a long winded way of saying most people underestimate employment risk. So most people (yours truly included when I was young) do not put away enough money to carry them between jobs. For someone in their twenties, six months of expenses; that amount has to go up as you get old, both because it takes longer for more seasoned people to find work and older people tend to develop higher fixed cost levels, This disaster money should be invested VERY conservatively.
The above probably doesn’t strike you as novel, but I’d be remiss in not saying it.
In planning, it is also important to know yourself, both in terms of possible career choices and investing, You are less likely to do well at something if you don’t have an affinity for it. Again, that no doubt seems pedestrian, but people can do an amazing job of talking themselves into career and investment choices that don’t suit them because they are swayed by what people around them are doing. For instance, I had convinced myself at the start of my career that making money was what motivated me, but that was because it was the right answer in interviews for the sort of job I had set my sights on. After gong down other paths based on acting out of surface motives, I got a better understanding of what really did and didn’t work for me, and it was very different than what I had believed.
The more you can do to get an understanding of your own MO – can you tolerate frequent, intense intraday pressure? How much autonomy do you need? How good at and tolerant of politics are you? Are you good at functioning in chaotic environments or do you like structure? Most people spent a lot of time thinking about their skills and strengths, when understanding what sort of environment they prefer is often given short shritf.
To your immediate question: it is well nigh impossible to give advice on how to think about investing in 2010 or 2011, beyond some genearlizatoins. By then, it should be clearer what the trajectory for the US and world economy is. That will make it easier to think about who winners and losers might be.
By then, the idea of “house as investment” might have been wrung out of the American psyche. Your home is first and foremost where you live. Real estate is always local, You may see opportunities that are attractive, but be very strict on looking at the after tax cost of ownership versus rental, Robert Shiller determined that the real returns to residential real estate were 0.4%. The first apartment I bought was cheaper after taxes than renting, and that was in Manhattan.
The other question is how much do you like investing? You can be a reader of this blog and actually not like investing, I write this blog and I hate investing (despite doing well via a risk-avoidant strategy, which BTW in this case does not mean a high allocation to cash, although that is tempting). The markets are too irrational and volatile for my taste (and Benoit Mandelbrot, the French mathematician, has shown that markets are far riskier than standard theories lead us to believe. His and similar work is acknowledged in theory and ignored in practice). And how much risk can you take, really? Standard recommendations are for young people to invest heavily in stocks, and reduce their allocation as they get older, But in a bad bear market, stocks can fall 50% (if memory serves me right, the S&P fell 47% peak to trough in the dot com bust). Can you take that?
Diversification by asset class is important, but a lot of things are touted as asset classes by clever fund managers, In a crisis all correlations move to one. Commodities are considered to be a good addition to a model portfolio because they have positive skewness (although they are also hugely volatile, and those markets are far smaller than securities markets, so new cash inflows can have a big impact), Income averaging is a good idea. Vanguard funds are a very good idea. Fees will eat away at what seem to be promising investment returns.
The big argument for holding stocks as opposed to investment funds is if you are investing in a taxable account. Mutual funds trade with sufficient frequency that they are tax inefficient. If you hold stocks, you can do better after tax, but you have to be prepared to leave them alone for years.
Ben Grahman’s little book, The Intelligent Investor, is very much worth reading. It gives some commonsensical guidelines (you’d need to update them for the existence of index funds) but the most important is either spend very little time on investing, do a few simple things with your money or make it your second job. Anything in the middle is worse, for you will overtrade and reduce your returns.