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Neil Irwin at the New York Times points out that all asset classes around the world are expensive compared to their historical prices. If that’s the case, is there any investment class available that has the potential to provide great returns over the long-term?

Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that is relatively low returns for investors…

But frustrating as the situation can be for investors hoping for better returns, the bigger question for the global economy is what happens next. How long will this low-return environment last?

The personal finance world operates on the assumption that the last century or so, minus the last decade, is a good reference for stock market expectations going forward. And depending on who you ask, that’s a return of 10 percent, 8 percent, or 6 percent. Regardless of the number, you’d have to go far outside of the mainstream to hear advice for the average investor that is something other than, “Invest mostly in a broad stock market index fund and don’t touch it for the best chance at getting historical returns.”

And this is the same assumption I’m living with. It’s why my investments are mostly in stock market index funds, though I’ve added some bond funds because it made sense to temper the risk of stocks and take advantage of tax advantages. But if my investments don’t end up appreciating over the next several decades, where will I be? Not so much better off than I am today, and if inflation erodes the value of my money (stored in these assets) faster than the values appreciate, then I’ll be worse off.

But what are the alternatives? Not investing my portfolio, keeping my money in cash form, there’s no doubt inflation will erode the value. At least invested, I have a fighting chance.

While the average investor is said to be better off investing in broad index funds, professional investment managers dealing with corporate cash look for undervalued opportunities. Not only are they not finding anything undervalued, but everything is overvalued. A company wants to reinvest in itself by building factories or property, for example, but it won’t if everything is overpriced, and they expect the company won’t get a good return on that investment.

If these professional investors with millions or billions of dollars to invest can’t come up with any good options, how is the average investor supposed to succeed?

Change your expectations.

There’s nothing magical about the 8 percent long-term annual return on the stock market. Most investors don’t see that return, anyway, because their behavior gets in the way. Even if the next hundred years was as promising for corporate performance as the last hundred years — the century in which the United States became a global economic power, the winner of the second World War, and the standard-bearer for the world (in its own mind, anyway), most Americans wouldn’t see the same kind of personal performance that financial planners advertise.

The kind of growth the United States saw in the twentieth century just doesn’t seem sustainable. Thinking globally, there still seems to be a lot of potential. But the economy in the United States has just become too expensive for the growth to happen here. I think that’s well understood, and people are looking internationally for growth opportunities, but this seems to be the point — it’s too expensive everywhere.

So maybe we just have to assume that long-term growth will be around 4 percent annually over the long term. No one wants to take this assumption because it causes problems with just about every financial planning model out there. Your “safe withdrawal rate” of 4 percent will fail, and inflation is a bigger risk.

The good news is that just doing something has to be better than doing nothing. If you invest 10 percent of your income into a stock market index fund for the long term over the next couple decades, it may only return an annual 2 percent, 4 percent, or maybe 6 percent. Well, there’s still the possibility of returns being higher. But even if they’re not, you’ll still be better off than those who have done nothing at all.

Start really thinking about the future.

The most promising way to make a future is to make it yourself. What are the biggest problems human existence will be facing in the next century? How can these problems be addressed? Apparently, there are enough people who believe that the availability of potable water is one of the problems humanity will face in the future. Scientists, including kids taking on middle school science experiments, are coming up with more efficient methods for cleaning water. It currently takes a lot of energy to turn ocean water into drinking water, and in areas of the world that don’t receive much rain, potable water is needed. This could lead to the growth of an industry in the next hundred years.

As the will for government spending continues to disappear, people will have to look to corporations to lead the way without government support. We may not get much from NASA in the next era, but private companies led by people who see some potential will pave the way for technological investment. The Internet is a product of twentieth century government funding, but that’s something that would never exist if the impetus was under today’s political climate. The next Internet, and by that I mean a world-changing technology, is going to be an opportunity that comes about only if the market deems it potentially profitable. And to take this further, the best opportunities will not be available to everyday investors; venture capitalists stand to gain from much of the potential economic growth of the next century.

We hear about the latest billion-dollar sale of technology companies, but most of these are backed — and therefore owned — by venture capitalists. So the smart kid who dropped out of college because he had a germ of an idea but pitched his business to venture capitalists will certainly see some financial benefit when he eventually exists the business, but it’s those who provided the capital who stand to win the bulk of the financial rewards.

So as much as I dislike the idea that average investors can now participate in angel investing through syndicates (because this is generally risky and sophisticated, and most investors don’t have enough wealth to manage risk and aren’t very sophisticated), this type of investing may be the only opportunity to see growth in the next decade. Angel investors take on risks, and usually they mitigate risk by diversifying across a large number of start-up businesses. These start-up companies may never see a time in which their stock is offered to the general public — or if they do, it will be after the initial investors take advantage of the early, most profitable period of growth.

Thinking about the needs of the future could give you insight not so much into where to invest, but where to spend your time. Or your life’s work. This may be more personally profitable than trying to invest 10% of your income into a certain industry or asset class.

Unfortunately, we have no way of predicting the future. Even the best minds have trouble coming up with what an industry will look like ten years from now. The automobile has lasted a hundred years. It’s probably a good bet that automobiles will be around for at least a few more decades. But after that, what will they look like? How will they be operated?

Google is betting on driverless cars. Tesla thinks the future is in purely electric vehicles. The traditional manufacturers and companies involved with the oil industry are the slowest to move. Will cars fly, like in Back to the Future? Probably not in 2015, but what about 2080? Someone is going to be right, and lots of people are going to be wrong. Those who are right will be the investors who experience the growth that is remembered — those who are wrong will be forgotten about and not included in historical accounts of a market. (That’s survivorship bias.)

Of course, there’s always a chance that no amount of planning will make a difference. Doomsday scenarios exist, even if they’re unlikely. Nature may change our ways of life in ways that we haven’t sufficiently planned for. But you can’t assume things that seem impossible. The best we can do is plan with the only understanding we have of the world today.

This may not solve the problem. Chances are good that people have already thought about what you see for the future, and that’s why professional investors can’t find any good, potentially profitable opportunities today. But if you take your ideas and start building something of your own, you’re creating your own value. Even if you don’t give birth to a new industry (kudos if you do!) you’ll be building value for yourself over the long-term, probably far better than an investment in any particular asset class will do for you.

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The issue of healthcare is one that keeps people in jobs far longer than they’d like. I’ve seen up close how someone with chronic health issues must deal with these choices, and in certain situations, the choices can be difficult.

Medicare coverage doesn’t begin until age 65, so where does that leave someone who stops working prior to that birthday? The issue of being able to afford health insurance on one’s own, even with the potential for subsidies through Obamacare if one’s income is low enough, can prevent people from leaving bad working environments. If you’re a working professional in your sixties but not a top executive, your chances of being able to quit one job and start fresh in another are quickly diminishing. Companies can’t discriminate against employees or potential employees based on age, but if you’re perceived as being close to retirement, you’re going to have a hard time getting hired in a new job.

Nurse and Patient via FlickrUnless you’ve been planning for decades to retire early by saving as much of your excess cash as possible to pay for potential medical expenses, it doesn’t take a intensive analysis to determine you’d be better off if you continue to work, even in a bad environment, until Medicare is an available option.

Not everyone has this choice. According to a recent survey by Fidelity, retirees left the workforce at age 62 on average, many not because they were dissatisfied with their work environment, but because health issues or physical limitations prevented them from continuing at their job.

There are ways to reduce health care costs on your own, like choosing a lower-cost high-deductible health plan. That could save money in premium payments, but this would only work for retirees who don’t expect to have many health issues before age 65. Through my own observations of people close to me, the likelihood of being close to retirement age without any health issues is low, even among people who have been living healthy lifestyles throughout their lives as adults. The body and mind age, entropy increases, and there’s little science can do about it today.

A common motivation message in today’s world is that it’s possible not only to retire early, but to retire extremely early. In general, and especially for the middle class, extremely early retirement is a myth foisted on the public. Retiring at or before the age of 30 — or even 35 — is not going to be possible without earning a lot of money quickly, saving almost all of it, and living a lifestyle that most middle class Americans would not be interested in.

And even then, many of the loudest early retirement proponents cheat: for instance, one might forget to mention one has a spouse who is not retired, whose income is covering day-to-day expenses, and whose job is covering health insurance and medical care for the family. That’s great, but it’s hard to call a household retired without changing the definition of retirement.

If you do retire in your thirties or even forties, you have at least a couple of decades before you’d be able to qualify for Medicare. Fidelity’s respose to the survey mentioned above included research that shows that someone who retires at age 62 rather than 65 can count on spending an extra $17,000 a year for health care before Medicare begins; imagine extending out that expense several decades in addition to the effect of rising health care costs and inflation by the time Millennials reach age 65.

So how can you retire today and manage paying for the increasing costs of health care?

1. Cheat, like many others. I’m not saying cheat the healthcare system, I’m saying cheat about how you consider yourself retired. Today, people “retire from the rat race” and open up their own businesses. The idea of being an entrepreneur is the farthest thing from being retired as possible because starting your own business requires much more work than clocking in at a corporate job in a cubicle every day. And you have more bosses than ever before — in the form of clients.

Nevertheless, people want to call this retirement, and who am I to argue with the shifting nature of the English language? So become a successful business owner (as if the decision to do so and the ability to succeed go hand-in-hand — they don’t) and let your business’s profits cover your healthcare expenses.

2. Cheat, like some more others. As I mentioned, you can call yourself retired if your spouse still works and his or her company covers most of the costs of your family’s healthcare. People actually do this. As long as your spouse doesn’t mind your being a freeloader, why not dump the responsibility of paying for living expenses on your better half?

Now, maybe you have saved up money over time and have invested a lot of that for the future. But wouldn’t you rather have the profits from your investments reinvested for the future while having today’s work-income pay for today’s expenses?

3. Save up for a long time. I wish I had known right from the beginning the realities of living expenses — many of which I have still yet to experience because I am still relatively young and healthy. I started my career out of college with a salary so low and basic expenses so high that savings was impossible. I don’t regrey my career choices but maybe I would have compromised differently, earlier than I did, with my living situations.

It’s easy to judge with the benefit of hindsight.

If retiring before age 65 is a goal for anybody, they must start planning today for the cost of healthcare without Medicare. And like any government program, you never know what the future holds. Medicare might not exist in its current form in 30 years. There’s a possibility a national healthcare system will be expanded, but there’s also a possibility that it will be more difficult to qualify for Medicare if it exists.

So contribute the maximum possible (whether bounded by mandated maximum investments or the confines of your net income) to your 401(k) and take advantage of Health Savings Accounts. At the same time, monitor your expenses so you know that the money you spend on a daily basis is going to enrich your life somehow rather than to disappear in a wasteland.

4. Stay as healthy as possible. Life does present you with some choices pertaining to your health. You can choose to eat healthier foods and avoid destructive habits. Healthcare costs for non-smokers, in general, are significantly lower than those for smokers, even when insurance tends to level the playing field somewhat.

But these choices can only take you so far. Bad things happen to people in good health, and that’s more than just accidents. You can’t control your genetics. If there is a hereditary issue that runs in your family, you have a high probability of exhibiting the same issue. The most you can do is prepare for it emotionally and financially.

5. Embrace the idea of preventative care. When I graduated college, I hadn’t been to the dentist in years. I probably hadn’t had a dental appointment since having my races removed during my senior year of high school. And I avoided going for another couple of years. But my father eventually suggested I go, and he gave me the name of his dentist. So I went, and I’ve been going regularly ever sense.

It took me a little longer to begin going to a general practitioner for regular medical check-ups. There was a widely-reported study that regular physicals do nothing to increase health (and reduce healthcare costs), and instead, facilitate more tests and expenses than necessary, so I’m not sure where I stand on visits to the doctor’s office. I do know that, for instance, I have a genetic predisposition towards Type II diabetes, so it’s important for me to watch my weight if I want to avoid the health problems and expenses associated.

I’m now living my life without an employer to subsidize my healthcare and health insurance costs. Perhaps that means I’ve retired, but I’m still trading my time and efforts for an income. I will never qualify for Obamacare subsidies, and I could continue paying for the most expensive health insurance option if necessary. I’m in a relatively unique position today, but if I had made different choices, or if some unforeseen problems arise in the future, affording health care could become difficult.

And thanks to people close to me who have had to make difficult choices, I can see how health care costs can be a significant problem for someone who doesn’t quality for Medicare yet.

How are you figuring the cost of health care in your plan to retire?

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CNN is sounding the alarm bells. The “Fear and Greed Index,” which is a strange measure of market sentiment, has passed the threshold into the “extreme greed” level.CNN is sounding the alarm bells. The “Fear and Greed Index,” which is a strange measure of market sentiment, has passed the threshold into the “extreme greed” level.

That’s one week after the level has been on the opposite end of the spectrum, “fear,” for several weeks.hat’s one week after the level has been on the opposite end of the spectrum, “fear,” for several weeks.

The editors at CNN devised the index by looking at seven factors in stock market prices, including the value of the S&P 500 index versus its 125-day maximum and other measures of price relative to recent history, demand for junk bonds, and the perceived benefit of stock investing versus Treasury bonds.

Here is what you can expect from the index:

When the S&P 500 (SPX) plummeted to a three-year low on Sept. 17, 2008 – the height of the financial crisis — the Fear and Greed index sank to 12. The index gained some ground to 28 before stocks finally bottomed out on March 9, 2009 and the latest bull market began.

This particular index is a volatile measure of the stock market, and using the index to inform investment choices is probably a bad idea. It’s easy to fall into the trap of timing stocks. While the greed index is high today, buy-low-sell-high logic seems to indicate that now would be a good time to sell. You can use the same logic to rationalize selling stocks now, with the S&P 500 above its 125-day moving average.

Unless you’re willing to accept a lot of risk or are playing with a small portion of your portfolio, you’re better off ignoring these indicators and holding onto stocks for the long term. You’re too liable to make mistakes when timing your investments, and the biggest problem would be getting “back into the market” before the increases in the stock market following dips — the same increases that justify long-term investing in the stock market in the first place.

I seem to have a good job of ignoring the market recently. I had no idea where the stock market was until I started looking at my portfolio for my monthly review. And this year, I’m participating in the “Grow Your Dough Throwdown,” a friendly competition among financial writers who all agreed to invest $1,000 of their own money at the beginning of 2014 and track their progress following a chosen investing philosophy.

At the beginning of the year, I invested $1,000 across several stocks or their equivalents, including Microsoft, Canon, Apple, Samsung, and Honda. I invested a small remainder in an index fund to round out the $1,000 investment. I included the transaction fees in this investment, which resulted in less money available for the actual investments from that $1,000.

Those fees. Five months into the year, and I still haven’t broken even because of those ShareBuilder fees. At the same time, the stock market as a whole, even the securities I chose, are performing better than my investment would have anyone believe. Because of those fees.

Here is my latest report. Here is my latest report.

Read the full article →

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Whether you’re making a decision that has apparent, immediate consequences that could affect the rest of your life, like deciding to quit your job and open a business, or making a purchasing decision big or small, it is worthwhile to gather information and think about the future. When you gather information, you have to be careful, because people, businesses, and even statistics that provide that information might contain inherent biases.

Survivorship bias is often hidden in plain sight, but recognizing the bias when it exists could be the difference between building wealth over the long term and going broke. If a logical argument neglects to recognize that failure is a possible outcome, the argument may be subject to survivorship bias. If a statistic reflects the outcome of only the successful set, ignoring the set of those who fail, survivorship bias is at play, and can give someone a false understanding of the data.

David McRaney, the author of You Are Not So Smart explains survivorship bias:

Survivorship bias [...] flash-freezes your brain into a state of ignorance from which you believe success is more common than it truly is and therefore you leap to the conclusion that it also must be easier to obtain. You develop a completely inaccurate assessment of reality thanks to a prejudice that grants the tiny number of survivors the privilege of representing the much larger group to which they originally belonged.

It’s probably easier to illustrate survivorship bias than to explain.

Survivorship bias in the stock market.

Mutual fund managers rely on survivorship bias for selling their products. Overall, and over the long term, actively managed mutual funds cannot beat the relevant market benchmark. Considering actively managed mutual funds are more expensive to own than their index counterparts, index-based, non-managed mutual funds are better choices. But mutual fund managers continue to attract investors because they’re able to advertise higher returns.

Money managers can advertise these higher returns overall because poor-performing actively-managed mutual funds are eliminated or merged into other mutual funds. This hides poor performance. As a mutual fund manager, kill the low performers, and when you report performance results for the funds that survive, your track record looks better than it is.

The danger in ignoring survivorship bias in the stock market. Well, it’s all about making the best decisions with your investments. If you are taken in by promises of big financial returns, you may not be putting your future self in the best position possible. When an investment manager says 90 percent of his or her funds beat the market, he or she isn’t including those that no longer exist. And your money could end up in an investment that, someday in the future, will no longer exist.

Survivorship bias in stock recommendation scams.

Step one: build a sufficiently large mailing list. Ten thousand names will do, if the recipients are already inclined towards buying.

Step two: Pick a stock, and send a letter to half the recipients on the list predicting the stock price will go up in the next week. Send a letter to the second half predicting the opposite.

Step three: In the following week, determine which half received letters that correctly predicted the stock’s performance. Delete the other names from the list of recipients.

Repeat steps two and three, each time eliminating the half of the mailing list that saw an incorrect prediction. After a few weeks, a couple thousand people will consider you a stock market prognosticating genius, and each week, you have a better chance of selling something to those who were lucky enough to be on the winning side of each prediction.

This approach isn’t limited to bottom-feeding stock scams. Hedge funds catering to the wealthy often employ a similar strategy by initiating many funds, waiting for performance results, and marketing and reporting to indexes only the successful hedge funds.

The danger in ignoring survivorship bias in stock scams. This should be apparent. If something sounds too good to be true, it is. Don’t invest in stocks recommended to you by a stranger. Or by a friend who thinks he or she has insider information. Or in individual stocks at all unless you are Warren Buffett, can negotiate for a discount, have a say in management decisions, or are conducting an investment experiment.

Survivorship bias in entrepreneurship.

Do you ever wonder why all business owners seem to be successful? In the classic book, The Millionaire Next Door, the authors point out that entrepreneurship is the path to success. This message permeates, and many people believe that owning a business is the best way to grow wealth. While investing as much as possible in broad stock-based index mutual funds can get you to financial independence over a long period of time, barring bad timing as many people who were in retirement during the latest recession might have realized, owning a business is said to be the key to speeding up wealth accumulation.

Of course business owners are better off financially than equivalent employees. If they weren’t successful, they would — and do — stop their pursuit of owning a business. In other words, those who don’t succeed drop out of the statistics.

The danger in ignoring survivorship bias in entrepreneurship. It’s easy to be seduced by the promise of riches that being a business owner seems to hold. Encouraging books and gurus often ignore the risk of leaving a job with a salary and benefits behind in favor of getting a project off the ground. At the same time, they emphasize the risk of staying in a job, subject to random layoffs and other stresses of answering to a boss. According to Bloomberg, eight out of ten new businesses fail within the first 18 months.

The remaining two become part of the statistics that show how worthwhile owning your own business could be, but chances are more likely any new business owner will eventually give up and no longer be counted among the “entrepreneur class.”

Survivorship bias in other aspects of life.

I go the gym three times a week to work out with a personal trainer. And after going this for about a year, not including time away for travel, I’ve made some progress. But I still look around the gym and see that I’m not nearly as in shape as just about everyone else. That’s to be expected, but not because of survivorship bias. Unless you work out constantly, every time you go to the gym, most of the people will be in better shape. The reason is that any person you see is a statistical representation of someone who is most likely to be at the gym at any particular time. And the people most likely to be at the gym at any particular time are the people who go to the gym the most often.

But survivorship bias manifests within fitness philosophies. An intense program can report high success rates for two reasons. First, the people who are most likely to fail don’t start in the first place. Second, people who being the plan but are destined to fail leave, and they are no longer included in the group of followers of the fitness plan.

Diets follow the same pattern. This phenomenon could also be considered selection bias, but selection bias is also important to marketers. If they can stop the “wrong” customer — someone not likely to succeed — from buying their self-help products initially, the seller can continue to report good success ratios with a clear conscience.

The key is to always ask questions.

I tend to be more skeptical than people I know. I don’t trust statistics immediately. I look to the source of information, and I try to think about logical holes, fallacies, and biases before making decisions. I may not always be perfect and may not always be the smartest person in the room, but recognizing biases has helped me make better decisions with my life.

If you’re only looking at successes for modeling your behavior, you’re missing an important piece of information. It’s quite possible that those who failed employed the same strategies as those who succeed. It’s also possible that failures vastly outnumber the successes, and are just not reported as such. So if you want to avoid failure, pay attention to potential survivorship bias.

Photo: Universitat Stuttgart (a tardigrade, Earth’s survivor)

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Welcome to Naked With Cash 2014

by Luke Landes

It’s time to get naked! (Again!) Last year, we started Naked With Cash, a series and feature at Consumerism Commentary. Last year’s introduction can provide you with the in-depth look at the purpose of the series. This year, I’m joined by Miranda Marquit to help organize the series. She, I, and the financial experts you’ll ... Continue reading this article…

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How to Balance The Future With the Present

by Luke Landes
Money

Financial self-help gurus, professional financial advisers, and bloggers who write about personal finance as a hobby or a job all tend to agree on a few basic tenets. One of these is that saving today can generate more financial freedom in the future. Financial freedom is important because it allows you to pursue activities you’d ... Continue reading this article…

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Should You Work for a Non-Profit Organization?

by Luke Landes
Non-Profit

As I’ve mentioned often on Consumerism Commentary, after a a false start or two with jobs following my undergraduate studies, I started my career working for a non-profit organization involved in the arts. I followed one of my passions without considering my financial needs. I want to be able to look back and see that ... Continue reading this article…

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Money Systems That Lead to Success: Always Ask Questions

by Luke Landes
Always Ask Questions

Last Thursday, I drove to the place that was my home for four formative years of my life, my undergraduate university. I’ve written before about how the degree and overall course of study during college isn’t directly related to what I do today. Nevertheless, I still feel strongly about the importance of music and arts ... Continue reading this article…

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