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DOW 5000


Risk is about potential loss.


The following are Jason's comments in response to yesterday's "Minyan Mailbag: Who's Really Managing Your Money":

I disagree with John about his "Dow 5000" statement. I don't think "the system" is rigged, and I don't think most people should be fully managing their own money.

Perhaps we should go back to the old days. Like when the largest (alleged) stock manipulator of all-time was appointed the first commissioner of the SEC.

Or how about when stock pools were an accepted phenomenon, manipulating stocks at will to the detriment of just about everybody else.

Or how about when corporate criminals would rape their companies for millions, and never have to face more than a slap on the wrist as opposed to facing the very real prospect of living the rest of their lives behind bars.

Or how about when details of corporate investigations would be going on for weeks or months before the average joe-schmoe even had a clue, as opposed to now when even the slightest hint of impropriety gets reported by 24-hour news channels and countless websites and blogs, all within minutes.

There are financial criminals now, those who want to your money and will attempt every maneuver to steal it from you. There always will be. But we live in a time now of unprecedented transparency, unlike anything ever before seen in history.

The vast majority of people simply don't care about investments, and probably shouldn't bother. Does anyone honestly think that someone who works from 7 to 6, then comes home dog-tired to his wife and three kids, really has the time and inclination to guess about the effects of rising interest rates on consumer discretionary spending? I sure don't.

Maybe everyone should just buy gold bars and bury them in their backyard. That's real wealth, right? I guess it doesn't matter that anyone who's ever done that during just about any time throughout history has been on the losing end to the idiots who just bought stocks.

You take a risk by investing in paper assets, or letting others manage those assets for you. Just be aware that you face other risks, which in my opinion are far greater, by NOT doing so.

I must take each of Jason's points and comment:

I did not say that the system was "rigged." This implies that people have no choice, which they do. I would add though that advertising, like those commercials where the family broker drives the kids around in the car, strongly implies that people outside of the industry do not have the acumen to understand their own finances.

"Perhaps we should go back to the old days" implies that there is no choice, that we either have our current system of institutions or else go back to a system of corruption. The fact that people are more aware that there are financial criminals and that we prosecute them more readily (which really may or may not be true for it is difficult to compare today with then) is a non-sequitur. I have no idea what this has to do with anything. And I was not criticizing the system per se, but a nuance that has been created inside of it.

I agree that the vast majority of people are either too intimidated, confused, persuaded, or even too lazy, to become involved with their finances but I would not say that they don't care. They care very much if something goes wrong. And I strongly disagree that they shouldn't bother. I would not be writing for MV if I felt that they should not bother. I think almost all people if they take the time, could understand that rising interest rates will curtail consumer spending most of the time.

I understand that you don't agree that people should have some exposure to gold, but please respect my opinion that I do. I never said people should put all their net-worth in gold bars--only perhaps something like 10%. And the statement that implies that no one ever made any money in gold is false: as in stocks or any investment, returns depend totally on the time frame measured, where it is bought and sold. I bought gold a few years back at $230 per ounce and I can sell it today (and have sold some) at $450 an ounce.

The last statement, "you take risk by investing in paper assets, or letting others manage those assets for you...face other risks by not doing so", I agree with. But again, this is a non-sequitur and has nothing to do with what I said.

While speaking at NKU, a young woman spoke up and described a bad investment. It was a typical story of a financial advisor talking her into putting too much of a lump sum into one investment that went very wrong. The advisor no longer even returns her calls. This advisor is NOT a criminal. A criminal tries to take your money. The advisor would like nothing more than to make his client money; the advisor would make more fees, get more referrals and not feel guilty or take grief from the client.

The problem is that the advisor does not have the same risk assessment of the situation that the woman does (even though both may not realize it at first, until there is a loss). Risk is about potential loss. The advisor, while not wanting to lose the money for the client, is not subject to the same consequences of loss that the client is. This is not an overt decision: the advisor may think that he has the client's best interest at heart and maybe he does, but other factors like needing to make the sale and the fact that the advisor has other clients to fall back on subtly and unconsciously changes the advisor's assessment of risk. The advisor may even be depending on others in his firm to assess the risk, so it is twice removed.

Quite simply, the advisor has a subtle tendency to under-estimate the risk (or the consequences of that risk) of investment relative to the client. This is the "other people's money phenomenon."

When all these subtle differences are added up, risk in general is intermediated: The risk premium is lower than it would be if the ultimate bearer of risk really understood the potential for loss. If the risk premium is artificially low, then asset prices are artificially high. Thus my comment about DOW 5000.

This does not mean I think the DOW is going to 5000, although it is possible, just as it is possible that it could go to 15,000. My point is that I believe that the largest driver of asset prices is the risk premium people attach to various assets and that risk premium is artificially low due to OPM phenomenon.

There are many good financial advisors, mutual funds, hedge funds, banks, etc., but there are also many bad ones. This mailbag was in response to my comment yesterday (there were several like it):

I've often discussed this topic with my brother, a financial advisor who focuses on helping people with their overall strategy, usually meeting with his clients once or twice a year to review their options. Much of his business deals with people's 401K and mutual fund choices and his observation is similar to John's: Most of his clients had little or no idea what they were actually holding or what the risks were. Things like the "stable value fund," which the original writer mentioned are common -- masquerading as money market funds but with much higher risks and fees.

My brother in no way advocates that these people actively and directly manage their own investments. He does properly advocate that they should know what they are holding and what the risks are. He is also a strong advocate of then alerting the plan manager (usually somebody in HR with no real investment experience) as to the problems and the alternatives. At least one local law firm has changed its plan after two of his clients complained about the abysmal, overpriced and underperforming choices they were offered.

Minyan Michael Gat

The general public needs to understand more about finance, about the world economy (which is changing rapidly and has many implications) as the ultimate bearer of risk. There is a need for financial advice, but the bearer of risk should have the last say (and it could be as simple as the asset allocation decision).

And that means education. That means Minyanville.

No positions in stocks mentioned.

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