Experts Are at a Loss on Investing

Los Angeles Times reports Harry M. Markowitz won the Nobel Prize in economics as the father of "modern portfolio theory," the idea that people shouldn't put all of their eggs in one basket, but should diversify their investments. However, when it came to his own retirement investments, Markowitz practiced only a rudimentary version of what he preached. He split most of his money down the middle, put half in a stock fund and the other half in a conservative, low-interest investment. "In retrospect, it would have been better to have been more in stocks when I was younger," the 77-year-old economist acknowledged.

That is true, but I feel sure he made a lot more on his investments than Social Security made.

At least Markowitz invested more wisely than some of his fellow Nobelists. Several of them concede that they have significant portions of their nest eggs in money market accounts, some of the lowest-returning investment vehicles available.

Not as low as T-Bills

"I know it's utterly stupid," confessed George A. Akerlof, a UC Berkeley professor and 2001 winner of the Nobel Prize in economics. As President Bush crisscrosses the country promoting his plan to overhaul Social Security, he argues that Americans are ready to trade in a portion of their traditional benefits for ownership and control over their own investment accounts. People have grown so comfortable with stocks and bonds, he asserts, that they can invest their way to more prosperous retirements by watching their quarterly statements, adjusting their portfolios and looking out for themselves. But a growing body of research shows that millions of Americans fail to get even the most elementary investment decisions right.

And with Bush's proposal they still might get it wrong, because it is a voluntary program, and they might foolishly decide not to go with it.

More than one-quarter of those eligible for employer-provided 401(k)s fail to sign up for them, according to the Federal Reserve. More than half of those who do sign up funnel their money either into overly conservative or overly aggressive investments, according to the Employee Benefit Research Institute, a Washington think tank sponsored by hundreds of companies. Even more disconcerting, new research suggests that most people don't behave anything like the economically savvy men and women that free-market advocates and economic theorists claim they are. They often shut down in the face of many choices. They sometimes even fail to go after free money.

In committing investment errors such as these, ordinary Americans turn out to be in good company. Even some winners of the Nobel Prize in economics admit to making similar mistakes, either by failing to pay attention to their own retirement arrangements or by making faulty decisions when they do. "I think very little about my retirement savings, because I know that thinking could make me poorer or more miserable or both," quipped 2002 Nobel Prize winner Daniel Kahneman of Princeton University. "I would rather spend my time enjoying my income than bothering about investments," said Clive W.J. Granger, an emeritus professor at UC San Diego and a 2003 Nobel Prize winner. White House officials dismiss such remarks as largely irrelevant to the Social Security debate. They describe the president's proposed investment accounts as voluntary and low-risk.

They are right

They suggest that those who oppose the accounts are taking a special swipe at low-income Americans, who otherwise would not have the money to invest on their own. "It's almost an insult to the ability of some Americans to take charge of their retirements," Bush spokesman Trent Duffy said. That Nobelists and other highly educated professionals get tripped up by retirement is hardly proof that people can't handle their own retirement investments. But it does suggest that few are terribly good at the job, and fewer have the time or inclination to get better quickly. And the president's accounts plan would require people to do a very good job at investing.

No it wouldn't. The choices would be very limited, but any of them would make as much if not more than T-Bills (I say as much, since T-Bills would be one choice). But even if they selected T-Bills, the money would be in their personal accounts, and the government would not be squandering it.

Under the proposal, Americans born in 1950 and after would be able to divert a portion of their Social Security payroll taxes into individual investment accounts. But in return for doing so, their traditional Social Security benefit would be reduced — by the amount diverted plus a 3% annual after-inflation charge on that amount.

I don't think that is correct. Certainly it would be reduced by the amount they invested, but I think the 3% after-inflation charge is not true.

With inflation now running about 3%, that means account holders might have to earn 6% a year just to break even. Anyone who followed Markowitz's approach — putting half of their balance in a low-interest investment — would almost certainly lose money by signing up for accounts. So would someone who followed Akerlof's approach — placing a substantial amount of it in money market accounts, which now pay about 2%. Markowitz, Akerlof, Kahneman and Granger are not the exceptions among the nation's most-educated elite or the general population in taking a cautious or hands-off approach to retirement investment.

Even if he is right about the 3% after-inflation charge, the money would be in their personal account, not being wasted by the government, with just a promise that taxes would be raised in the future to repay it.

In interviews and e-mails, five of the 11 Nobel winners in economics during this decade and a handful of others since 1990 said they failed to regularly manage their retirement savings. One even says he missed the mark in how he invested his prize winnings. Several had or have retirement funds parked in money market accounts or other low-interest investments that they say are probably too conservative. The same is true of an estimated 50% of Harvard's 15,000-member faculty and staff, who permit all of their retirement savings to be funneled into money market accounts, according to the university, by failing to specify how they want their funds invested.

Steve Bainbridge blogged the article misses the point that investing is really rather simple. You park your money in no-load passively-managed index funds, weighted as heavily to equities as your risk tolerance can take, and then you get on with the rest of life. So if personal accounts come down the pike, put your money in passively-managed no-load funds and forget about it. If the Democrats and their MSM allies like Gosselin manage to block personal accounts, put what little discretionary money Uncle Sam leaves you after taxes in passively-managed no-load funds and forget about it. In the long run, you'll come out ahead of the game with a lot less stress.