JEFFREY BROWN: So what does all this volatility mean for everyone who’s not a Wall Street trader or analyst?
We turn to two people who’ve written extensively about personal finance and markets. Jane Bryant Quinn is a best-selling author and columnist for Newsweek and Bloomberg.com. Burton Malkiel is a professor of economics at Princeton University and author of one of the best-known books on finance of the last few decades, “A Random Walk Down Wall Street.”
Well, Jane Bryant Quinn, help people understand this in the broad sense first. Is this just what markets do? Or do you see different kinds of risks today for personal investors?
JANE BRYANT QUINN, Newsweek/Bloomberg.com: In terms of the volatility of it, we’ve seen this before. I mean, people saw this huge drop in 1987. There was another bad market with the early ’90s when the recession came then. There was a bad market in that 2000-2001 recession.
So it’s not that people haven’t been through this before. We have. It’s that every decline is scary in its own individual way.
And what is really scary about this decline is the banking crisis that we’ve gone through. You just heard about what’s happening with the banks and some of the failures in the system. And that is new, and that’s unusual.
So when people see something new like that, they say, “Hey, what’s going on? Is this worse than it’s ever been before?” I’d say, so far, it seems to me like declines we’ve had before that you shouldn’t expect it to be the end of the world.
Consumers still underinformed
JEFFREY BROWN: Well, Burton Malkiel, it's been much talked about the last years, the increase in participation of Americans. So many of us are now involved through our 401(k)s. Has the understanding of the markets and risk increased along with that participation?
BURTON MALKIEL, Princeton University: I would hope so, but I'm not sure it has. I think one of the things we know about individual behavior is that people put most of their money into equities. They move money from their 401(k)s into equities generally when they are very optimistic.
More money went into equity mutual funds at the beginning of 2000, at the height of the bubble, than at any time before. And money comes out of equities just at the lows.
In 2002, in October, just about at the low of the market then, we saw more money come out of equities. And what worries me is that there will be a tendency, as people get scared, to do exactly the wrong thing, to pull out just when the bargains are there and to go in just when buoyancy is at its height.
JEFFREY BROWN: What do you think about that, Ms. Quinn, about the savvyness of investors and how they look at a moment of turmoil like this?
JANE BRYANT QUINN: I agree with Burt on this. It's been very, very difficult to try to explain to individual investors that you're supposed to buy when stocks are low.
Do you know -- if a winter coat was on sale somewhere at 15 percent off, you'd flock and you'd go and buy it. And you'd think you have a deal.
Well, stocks, the big stocks in the U.S., are on sale at 15 percent off. And people kind of recoil and say, "Oh, I'd better not buy it." So they wait the price of the stocks to go up again and then they buy it high.
And this is an absolutely human thing to do, but it's better to be inhuman when you're looking at your investments. When you get stocks on sale like this, what you should say to yourself is, "Hey, I should probably buy."
And if we're going to have a recession, stocks may go lower. Well, you say, "Gee, stocks went lower, but I should probably put some more money in," because when you look back 10 years, 15 years from now, you're going to say, "You know, when I bought in early 2008, I bought at a really good price."
Age, diversification matter
JEFFREY BROWN: Well, what about, Professor Malkiel, the psychology for different investors at different levels or different ages? What if you are retired or near retirement now, and you're looking at what is going on, and thinking we might be in the beginning of a long-term slump? What's the psychology then? What's the advice?
BURTON MALKIEL: Well, first of all, I think there are two things to say. One is that everybody should be diversified. I don't care how old you are. You ought to have not only equities, but you ought to have some bonds.
What diversification does for you is we've just heard how the Federal Reserve has worked aggressively to lower interest rates. Bond prices have been going up. The 10-year treasury yield has gone down to 3.5 percent.
So when you are diversified, you get some asset classes that are actually balancing the declines that you see in equities. So everybody should be diversified.
The other thing is, there's no question about the fact that your age has a great deal to do with the amount of risk you can take. A 20-year-old woman beginning her business career can afford to take risks. She has a salary. She has many years to ride out the ups and downs.
She can be far more heavily in equities than the widow in ill health for whom, if the equity market goes down, this may directly cut into her standard of living.
So having said that I think people should stay the course, this doesn't mean that the right amount of equities is the same for people with different risk attitudes and in particular for people in different age groups.
JEFFREY BROWN: And, Jane Bryant Quinn, are the risks for American society different now because we hear so much, the baby boom generation is now getting ready to retire? You'll have a lot of people thinking about the stock market in those terms. And here we are, again, with talk about a potential long-term slump.
JANE BRYANT QUINN: Well, here again -- I want to second what Burt has just said on this. We're sort of going back and forth saying the same thing to individuals, and that is this question of diversification and how important this is.
And it's more and more important for people to understand it because we're going to be relying on our 401(k)s. And when you get out of your company and you get money from your 401(k), you have to go and invest it yourself in an individual retirement account.
You just have to learn to understand how to balance the risks of stocks against the safety of bonds. And I want to say something that so many people say, "Why do I want bonds? We all know that stocks do better than bonds over the long run."
I want to say, one of the best-kept secrets in Wall Street right now is that if you look at what happened over the seven years, from the peak of the market, stock market in 2000 through the end of 2007, the big stocks measured by Standard and Poor's made 1.6 percent a year. That's all, over the seven-year period. Bonds, intermediate treasuries, made 6.8 percent a year.
So looking back over the past seven years, bonds have done better than stocks, which is something that people find it very hard to believe. But this is the reason for diversification.
And this is the reason why it's also, as Burt says, important as you get older to have a higher percentage in bonds than you had when you were younger, reason being that, if the market happens the way it's happened in the past few months, and you're drawing money out of your account to live on, you want to have an account that's safe so you don't have to sell stocks when they're going down.
And that's important, really, really important for older people. But I have to say to younger people, this diversification is just key. I mean, look at how well you'd have done in bonds over the past seven years. And it didn't occur to you to buy them.
Role of international stocks
JEFFREY BROWN: And one more question, Professor Malkiel, about how to think about the markets today. In that first discussion, we heard so much about the globalization. I mean, this is something we hear about for many years now that has changed in the markets and which countries affect U.S. investors.
Should the personal investor these days worry a bit more because the markets are so global?
BURTON MALKIEL: Globalization has certainly tied markets together far more closely than was the case a decade or two decades ago. We see this. The contagion during the Asian crisis, the contagion went from Asia to the United States. Recently, the contagion has gone the other way, from the United States to Asia.
So there's no question that markets are definitely far more closely correlated than they have been. I still, however, believe very strongly that the diversification that Jane and I have talked about also should go to not simply domestic stocks, but international stocks, as well.
If you're in the automobile industry, you maybe have some General Motors, but it's probably important to have some Toyota and Hyundai, as well. And I think one does need to have some exposure into the most rapidly growing economies of the world, such as China and India.
JEFFREY BROWN: All right, Burt Malkiel and Jane Bryant Quinn, thank you both very much.
BURTON MALKIEL: Thank you.