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The Michael Shermer Show

A series of conversations between Dr. Michael Shermer and leading scientists, philosophers, historians, scholars, writers and thinkers about the most important issues of our time.

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EPISODE # 184

Alexander Green on Money & Why It Matters

The Gone Fishin Portfolio (book cover)

In this special episode of the show Shermer and Green discuss one of the most important and yet poorly understood concepts in modern society: money and why it matters. In this episode, they discuss:

  • SEC Report on the financial literacy of Americans,
  • why money matters,
  • the origin of money,
  • how to make money,
  • how to make money work for you,
  • how the stock market works,
  • how stocks and bonds compare to real estate and other investments,
  • individual stocks vs. indexed funds and mutual funds,
  • why you should not try to “beat the market”,
  • millionaires next door: what are their secrets and what are their lives like?
  • how many millionaires earn their wealth vs. inherit it,
  • the survivor bias: business books only analyze the winners (Gates, Jobs, Bezos) and ignore the vast majority of failed business ventures,
  • the power of compound interest,
  • Can we count on Social Security to cover our needs in retirement?
  • the difference between a IRA, 401(k), and a Roth IRA,
  • hedge-fund managers and investment advisors: where are the customers’ yachts?
  • the relationship between risk and reward,
  • the relationship between saving and spending, or time discounting: value the future enough to invest in it now but don’t plan for the greatest 90th birthday party ever in case you can’t make it,
  • What’s wrong with free market capitalism?
  • money, happiness, meaningfulness, and
  • the role of luck and contingency in how lives turn out.

Alexander Green is the Chief Investment Strategist of The Oxford Club, with more than 35 years experience as an investment analyst, portfolio manager and financial writer. He writes a highly acclaimed financial newsletter, The Oxford Communiqué along with three VIP trading services: The Insider Alert, The Momentum Alert, and Oxford Microcap Trader. He edits the free daily investment research service Liberty Through Wealth. He has been featured on Oprah & Friends, CNBC, Fox News, and The O’Reilly Factor, and has been profiled in the Wall Street Journal, BusinessWeek, Forbes, Kiplinger’s Personal Finance, and many other publications. He is the author of three other financial books: The Secret of Shelter Island: Money and What Matters, Beyond Wealth: The Road Map to a Rich Life, and An Embarrassment of Riches: Tapping Into the World’s Greatest Legacy of Wealth. His book, The Gone Fishin’ Portfolio, outlines his battle-tested strategy that embraces the uncertainty of financial markets-and life in general, one that will yield market-beating portfolio returns in both good times and bad, and premised on the reality that nobody knows what the market is likely to do next.

Money Managers

You may hear about fund managers like Bill Miller, who in 2006 was declared by CNNMoney.com to be “The Greatest Money Manager of our Time” because he beat the S&P 500 stock index 15 years in a row. But as my science writer friend Leonard Mlodinow calculated in his book The Drunkard’s Walk: How Randomness Rules Our Lives, there are over 6,000 fund managers in the U.S., and so if you do a simple coin-flip calculation of the odds that someone in that cohort of 6,000 fund managers would beat the S&P 500 15 years in a row, it turns out to be .75, or 3 out of 4. As Len says, the CNNMoney headline should have read “Expected 15-Year Run Finally Occurs: Bill Miller Lucky Beneficiary.” And, wouldn’t you know it, in the two years after Miller’s 15-year streak, the story read: “the market handily pulverized him.”

Business Book Survivor Bias

Pomona College statistician Gary Smith analyzed two of the bestsellers in the genre. In the 2001 book Good to Great (which sold over four million copies), the author Jim Collins culled 11 companies out of 1,435 whose stock beat the market average over a 40-year time span, and then searched for shared characteristics among them that he believed accounted for their success.

Instead, says Smith, he should have started with a list of companies at the beginning of the test period. The next step would be to “use plausible criteria to select eleven companies predicted to do better than the rest. These criteria must be applied in an objective way, without peeking at how the companies did over the next forty years. It is not fair or meaningful to predict which companies will do well after looking at which companies did well! Those are not predictions, just history.” In fact, Smith notes, from 2001 through 2012, the stock of six of Collins’ 11 “great” companies did worse than the overall stock market. This implies that this system of post hoc analysis is fundamentally flawed.

Smith found a similar problem with the 1982 book In Search of Excellence (which sold over three million copies) in which Tom Peters and Robert Waterman identified eight common attributes of 43 “excellent” companies. Since then, says Smith, out of the 35 companies with publicly traded stocks, 20 did worse than the market average.

Only after the fact can we pick out the winners. Instead, you should pick stocks in companies with a solid track record—or, even better, invest in mutual funds tied to, for example, the S&P 500—and then, well, go fishing; that is, leave your investments alone. For example, Green calculates that if you invested $10,000 in 1990 in a mutual fund tied to the entire S&P 500 and then went fishing, 20 years later you would have $90,000, not counting dividend reinvestment, which would push you well over the $100,000 figure.

By contrast, if you tried to be actively involved in trading—buying and selling stocks and trying to anticipate what the market would do—you risk missing the biggest increases in that 20-year block. For example, if you miss just the 5 best days in that 20 years, your $90,000 account would plummet to $45,000. If you miss the 10 best days you’d end up with around $35,000. If you miss the best 25 days your $10,000 investment would only bring you only $19,000. And if you miss the best 50 days…you’d actually lose money.

Or take the decade from 2005 to 2015. Even with the Great Recession in the middle that wiped out so many people’s investments, if you had invested $10,000 in the S&P 500 with dividends reinvested you would still be left with $36,418. Astonishing. And, again, had you bought and sold stocks and missed the market’s 10 best days that decade, your $36,418 would have been halved to $18,358.

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