Monthly Archives: November 2012

Should the US Reform the Student Loan System?

Guest post by Contributing Editor, Matthew Amster-Burton, Mint.com.

Anyone who has read my previous columns about paying for college knows that I’m a student debt hawk. Student loans in their current form are dangerous: it’s too easy to borrow massive quantities; they can almost never be discharged in bankruptcy; and students and parents rarely understand what kind of quicksand they’re getting into.

At the same time, a “buy now, pay later” system makes sense. We have all sorts of public subsidies for college tuition, including the federal student loan program, because having an educated population benefits everyone. Continue reading

What Are the Core Asset Classes for Total Return Portfolios?

One of the most important questions for investors and advisors is identifying a set of asset classes that will be considered for inclusion in a portfolio.  Some people will decide that all they need or want is one broad stock market index fund and one bond fund.  Others will choose to include Real Estate Investment Trusts (REITs) and commodities.  There are well-thought-out arguments that inflation-protected government bonds (TIPS) are a major core asset class.  It is also quite common for investors or advisors to break stocks out into value vs. growth and small cap vs. large cap.  Continue reading

An Alternative Approach for Drawing Income from Your Portfolio

The question of how to safely generate income from a retirement portfolio is one of the most challenging in financial planning.  In the days when people had traditional pensions, their employers simply promised them a constant inflation-adjusted income for the duration of their retirements.  As we have moved away from traditional pensions and into self-directed savings plans such as 401(k)’s and IRA’s, investors and advisors must create their own customized income plans.  New research from Morningstar highlights what appears to be a better approach to creating a stable income stream from an investment portfolio. Continue reading

Sector Watch: Municipal Bonds

Municipal bonds are issued by states and municipalities and typically have tax advantages relative to other fixed income assets.  In general, income from muni bonds is tax exempt at the federal level and at the state level for investors living in the issuing state.  Municipal bonds have historically been favored by investors in high tax brackets who, of course, derive more benefit from the tax exemptions by virtue of being in the highest tax brackets. Continue reading

Game Theory, Behavioral Finance, and Investing: Part 5 of 5

In the first four parts of this article, I have discussed a number of well-known behavioral biases that cause investors to make decisions that are, to put it kindly, less than optimal.  In this final installment, I summarize how best to avoid these costly traps.

As these blog posts have been published over the past couple of weeks, the issues are much in evidence.  Apple (AAPL), long the darling of the market, has lost favor and Groupon (GRPN) seems to be following a relentless downward spiral.  Surely many investors in Groupon must be asking themselves how they could possibly have seen the company as a good bet.  Apple stock, which was trading at $700 in mid-September, is currently at $544, a decline of 22% in two months.  The news that has come out on Apple does not seem sufficient to justify such a broad shift in the market’s consensus as to the long-term value of Apple as a company.  And, of course, we have the poster child of behavioral bias: Facebook (FB).  How is it possible that the market’s consensus view of the share value of such a widely held company could be almost 50% below its first day closing price of $38?  As Warren Buffett is quoted as saying, in the short-term the market is a voting machine and in the long-term the market is a weighing machine.  When voting overwhelms weighing, investor psychology is dominating.

Continue reading

Do We Live in the Golden Age of Investing?

Guest post by Contributing Editor, Matthew Amster-Burton, Mint.com.

Do we live in the golden age of investing?

Moronic question, right? Of course we don’t. The S&P 500 sits at about the same level it did five years ago. Bond interest rates have never been lower, and the Fed says it’s planning to keep them that way through mid-2015.

Turn on any financial channel and you’ll find as many gloomy predictions as you care to sit through: debt-fueled implosion in Europe, the next flash crash, the shrinking dollar, a stagnant labor market, Great Depression 2.0 (or is it 3.0 by now?). Continue reading

Game Theory, Behavioral Finance, and Investing: Part 4 of 5

In earlier installments of this article, I have discussed some behavioral biases that tend to influence people to make bad investing decisions.  In this post, I explore several more of these biases.  The focus of this piece is on how we perceive ourselves and our ability to make independent decisions.  One of the key ideas within rational markets is that people gather public information and make informed decisions.  Without rational market participants, it is unlikely that markets themselves will converge to appropriate prices for traded assets (stocks, bonds, real estate, etc.).  Continue reading

Game Theory, Behavioral Finance, and Investing: Part 3 of 5

In this post, I continue the discussion of behavioral finance with examples of some of the key behavioral biases and where they can be seen in recent market behavior.  The specific focus of this post is those biases that drive investment fads and bubbles.

Recency Bias

It is almost invariably the risk that we ignore that really hurts us.  The market today is, for the most part, discounting inflation risk.  Historically, inflation has been a major threat, especially to bond investors.  Today, with yields at historic lows, the implied inflation expectations are exceedingly low.  The process by which the market comes up with rationales as to why a risk, that has historically done major damage, no longer matters is at the heart of every bubble.  We have had the housing bubble (in which investors became convinced that houses were an infinite source of capital appreciation), the Tech bubble (in which investors decided that valuations based on earnings were irrelevant) and now the government debt bubble (in which investors are implicitly assuming that inflation risk is no concern).  The bubbles get out of control largely because people assume that what has worked recently will continue to work. Continue reading