The Stakes Keep Getting Higher in the World’s Biggest Casino
As you probably know, the stock market broke another record recently when the Dow Jones Industrial average hit 22,000 for the first time ever.1 Naturally, all the Wall Street cheerleaders celebrated and gushed about the market’s “strength.” At the same time, Donald Trump claimed credit for the milestone—even though the market has been on an emotion-fueled upward trajectory for more than eight years. While it’s true his election has added more emotional fuel to the rally, it’s also true that corporate earnings and economic recovery overall have continued to lag far behind the overinflated market.
In theory, to justify record-high market prices, you should have a booming economy, not just the promise of one; but with GDP growth still barely at two percent and the Fed still unsuccessful in its attempts to manufacture inflation, we’re just not there. Basically, this stock market is levitating without fundamental support. It’s like the floating woman in the magician’s trick where the magician runs a hoop around the woman’s body to show there’s nothing suspending her from above or her supporting her from below. Sure, it looks impressive, but as an audience, we know it’s just an illusion. The question for everyday investors is: how much of your life savings do you want to have invested in an illusion?
I believe the stock market is always a gamble compared to other investment options, and an overvalued market not supported by economic fundamentals is simply a gamble in which the stakes are especially high. As I discussed in last month’s newsletter, the difference between gambling and true investing is a question of control. I illustrated this with the FanDuel analogy: If you bet on the New England Patriots to win, you may think you and team owner Robert Kraft have a lot in common because you’re both “invested” in a Pats victory. But, only Robert Kraft is truly invested because he owns the team and has some level of control over whether they win or lose. You have no such control. It’s the same as the difference between majority shareholders who own enough stock to have controlling interest in a company and everyday investors who are minority stockholders with no control; the former group is investing while the latter group is just gambling.
The Pricing Paradox
The value of control and how a lack of it works against everyday investors becomes even more evident when you consider the following paradox:
Say you have a business and decide to sell it. If the business is worth $1M, you should be able to sell 49 percent of it for $490K or 51 percent of it for $510K. But, that’s not how works. In truth, you’d be lucky to get about $350K for the 49 percent, but you could ask for about $650K for the 51 percent.
Why can you ask almost twice as much for that additional two percent? The answer is control. The 51 percent gives the buyer controlling interest, so as a seller on the open market, you must discount minority interest, but you can demand a premium for controlling interest.
Why is it then that when one publicly traded company makes a tender offer to buy majority shares of another, they typically come in with an offer that is only 5 to 10 percent over the current price per share—as opposed to almost double the price? There are only two possible answers for this question. Either the board of directors of the selling company is accepting too little from the buyer, or we, the average investors, are overpaying for that company every day when we buy its minority shares. Somehow, I don’t think any board of directors is going to be that “charitable.” I think the real answer is that the discount for minority shares is not priced into the market, which means that, by definition, everyday investors are always overpaying for stocks on the open market.
The distinction between investing and gambling is one of the main things I strive to teach as a financial educator—along with the fact that there are options beyond the stock market that do offer a level of control and therefore are legitimate investments. When you purchase an individual bond, for example, it comes with a contract providing two guarantees you don’t get with a bond fund (which is technically defined as the stock of a company that owns bonds). Those guarantees are income generated at a fixed interest rate for the life of the bond and the return of your principal if you hold the bond to maturity. That’s a true investment because the contract gives you the power to hold the bond issuer accountable. Most options in the fixed-income realm are contract based and therefore qualify as true investments.
Two Slot Machines
Here’s another analogy that I welcome you to share with friends or family if you’re concerned they might be gambling too much with their retirement savings without realizing it. Explain that when buying a stock, you must do three things right in order for the purchase to pay off, all of which involve some guesswork: you have to buy the stock correctly, it has to go up in value, and you have to sell it correctly. By comparison, when you buy an individual bond or bond-like instrument, you only have to do that first thing: buy it correctly. If you do that (ideally with the help of an advisor who specializes in such instruments), your investment will pay off, and you have a contract saying so. It may not pay off to the same extent that your stock might if you do all three things right, but you run far less risk of losing money.
Once you’ve explained all that, ask your friends this question: If you went to a casino and saw one slot machine that paid a big jackpot if you hit triple 7s but nothing if you didn’t, and you saw another machine that paid a smaller jackpot for triple 7s, but also paid you something no matterwhat you hit, which machine would you play? Most people instantly see the sense in choosing the second machine, which represents contractual, income-based investment strategies. But, even for people who choose the big-jackpot-or-nothing option, which represents the stock market, a follow-up question usually changes their mind: what if the money you were gambling with was your life savings? Unfortunately, that’s just what a lot of everyday investors are still unwittingly doing in what I call the World’s Biggest Casino (a.k.a. the stock market), even as the stakes climb higher.
1. “Dow hits 22K for first time; Tesla earnings on tap,” Yahoo Finance, Last modified August 2, 2017, https://finance.yahoo.com/news/dow-hits-22k-first-time-tesla-earnings-tap-2-192304709.html
* Investment Advisory Services offered through Sound Income Strategies, LLC, an SEC Registered Investment Advisory Firm. Wright Financial Group, LLC and Sound Income Strategies are not associated entities.
How to find out if you’re affected by the Equifax hack
You may have never used Equifax yourself — or even heard of it — but the credit reporting agency could still have a treasure trove of your personal information.
Equifax said Thursday that 143 million people could be affected by a recent data breach in which cybercriminals stole information including names, Social Security numbers, birth dates, addresses, and the numbers of some driver’s licenses.
Additionally, credit card numbers for about 209,000 people were exposed, as was “personal identifying information” on roughly 182,000 customers involved in credit report disputes.
Equifax is one of three nationwide credit-reporting companies that track and rate the financial history of U.S. consumers. It gets its data — without you even knowing — from credit card companies, banks, retailers, and lenders.
Equifax will not be contacting everyone who was affected, but will send direct mail notices to those whose credit card numbers or dispute records were accessed.
The Retirement Income Doctor Show
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From everyone here at Wright Financial Group, LLC, we hope you are enjoying the summertime and remember to appreciate the journey!