Where From Here, Financial Origami (Book Review)

One could hardly wish for a hotter stock market this year. See section III below for rates of return on investment through the first nine months of the year. The Total Stock Market Index fund is up more than 21% for 9 months. This month, as this is being written, the average client account has posted gains of 3.9% for the month. The Federal Reserve will apparently continue to stimulate the economy by purchasing more bonds every month, no “taper” of their efforts is in sight, though the current speculation is that the Fed might begin reducing their bond purchases sometime next spring, not stopping the stimulative bond purchases, just decreasing the amount of such purchases.

Stock Markets:

One of the Barron’s magazine websites reports that the S&P 500 average of large US stocks was, at the end of last week, selling for 19.3 times earnings. That is, if you wish to purchase $1 of earning power of the average large US corporation (as measured by earnings reported for the most recent year period) you would have to pay about $19.30 for its stock. We would rather pay less, but often in the last five years when this price/earnings (“P/E”) ratio was significantly less, the financial and economic news was so bad that we would hesitate before investing more of our money in the stock market. This is the way investing is, when the news is good other investors have already bid up the price of what we wish to purchase and vice versa. Jeremy Siegel, my principal stock “guru”, a Wharton School finance professor and author of Stocks for the Long Run, my favorite investment book, says that the average P/E ratio for the market is about 19. At 19 times earnings stocks are reasonably priced. So, I conclude, that it is all right for a long-term investor (and urge each of you to be a long-term investor) to add more money into the stock market. Please note that the stock market is subject to significant fluctuations, negative as well as positive. We much appreciate the fine increases in value so far this year; we enjoy positive fluctuations.

We are stressed by negative fluctuations, we tend toward panic (e.g. “This is my retirement, what if this trend continues?”). Being a long-term investor is not without stress, but stress is reduced by remembering that if we need money from our investments, and the stock market has declined in value, we can sell bonds for several years to obtain the funds we need, most of us have five years of probable withdrawals invested in bonds for this purpose.

If negative stock market fluctuations were stress-free, more people and institutions would invest a higher percentage of their money in stocks, and stock would, as a result, not be as good an investment buy. So, no free lunch, but stock continues to be the better, long-term investment. We should be prepared for the possibility that any $1.00 we invest in the stock market today or tomorrow might be worth 80 cents the next day, the fluctuations can be rapid and breathtakingly large. This should not deter us, but should require that our investments contain a mix of stock, bonds, and money market balances. We invest in stock because it has such a superior long-term, after-inflation, historical rate of return, not because it is stress-free.

Bond Markets:

As this is written, the Vanguard Total Bond Market Index fund is down more than 2% for the year. Bonds have been a great long-term investment over the last 30 plus years, a period that began with very high, double digit, inflation and high interest rates, and now is characterized by record low interest rates and lower than average inflation. Short-term bond rates of interest payment on bonds are below the rate of inflation (a negative, real, after-inflation rate of return). The prospects for bonds are not very good as there is a high probability that interest rates will increase sometime in the future (and when interest rates increase, the value of the bonds which we already own goes down).

Yet we should continue to own some bonds within our investments, for two principal reasons: first, as mentioned above, for those of us withdrawing from our investments to finance our life, bonds help protect us from negative fluctuations in the stock market (while still providing some interest income). Second, when those bad days of large, negative fluctuations in the stock market come, bonds help us sleep nights as they do not fluctuate as much in value as does stock. In fact, when stock goes down in value, bonds may increase in value. This makes bonds a good counterweight to stock, a good diversification.

Money Market Funds:

These funds are now paying only 0.1% 0.2% interest per year. They appear to be a bad investment, but are a store of value, the value of which is expected to be stable until we spend them. We need to invest in money market funds if we have upcoming cash needs.

Stability of Government:

Few of us are happy with Congress and the Executive branches of government right now. They did not solve the impasse on Federal government spending, taxation, or the national debt; the can was just kicked down the road one more time. Political uncertainty just adds to our worries, and political uncertainty tends to increase the extent of financial market fluctuations in value.

When things are not going well for our government, when the branches have a hard time agreeing and conducting business, it is harder to be an investor, but just as necessary and, potentially, just as rewarding. I look forward to opportunities to assist you as you negotiate future financial markets. Please do not hesitate to give me a call or send me an email if you have questions. I am grateful that several individuals and families have, this year, chosen me to begin to assist them with their investments. I welcome others. When you hear others complain about stock markets, bonds, or government, please help them connect with me. Many of you, similarly, acted on a referral. Thank you.