How the mutual funds'invented their own worst
scrutinizing their party line.....nest egg requirements for Baby
Boomers to retire...
Jim Jubak is the Senior Editor
ofWorth Magazine and author of "The Worth Guide to Electronic
Why are people in the market right now?
Basically they're in the stock market because there's no place
else to go. They rightly feel that Social Security isn't going to be there for
them when they retire, that real estate which fueled their parents' retirement
isn't going to the produce the kind of returns they need. So if you're
looking for a decent retirement, saving for college for your kids, there really
isn't any other place to put your money. So that's where it's going and that's
where it's gonna stay.
Do average people have the appropriate mentality to handle the stock
It's a very curious question because the answer is both yes and no. I
think people do understand that the stock market is volatile but they don't
seem to be able to behave as if that's true. For example, a number of mutual
fund companies have done studies looking at what people get in real terms,
given the way they move in and out of the market in funds, such as Magellan or
the 20th Century Funds, highly volatile funds. And what they've discovered is
that people trade in and out of the market at exactly the wrong time. So that
while the returns on Magellan over a long period of time are around 20 percent,
the real returns that people are getting are more like 12. Very clear that
people buy at tops and sell at bottoms, as opposed to what they ought to be
What about people who haven't experienced a bear market for like 14
or 15 years?
I was talking to Hugh Johnson, who's the market analyst for First
Albany, and his experience is a core experience that he has is that father
was in the market in '73-74, the last great bear market and lost, a
considerable amount of money. What Johnson says basically is they went from
being well-off to being poor, and I think you need to take that in relative
terms. But what Johnson talked about and what interests me is that investors
always fight the last war. It's like the French before World War II. You
build the Maginot line to defend against World War I and the Germans
then sweep around your flank.
I think investors who have been in this market for any length of time think
that 1987 is a typical bear market and it's really not. It went down in a very
few days. People basically had no chance to get out. So they really didn't
have a chance to do the wrong thing. I think people are behaving as if that's
what they how to really worry about so that basically you have a kind of
history that reinforces the buy-and-hold mentality that worked in 1987. If
what we're talking about, however, is a bear market like '73-74 where you had
this grinding decline over months, with the market constantly looking like it
was going to rally, the bear trap, as it's called, so that people had a chance
to go, "Well, gee, it's down 20 percent, but it's come up in the last few days.
I'll put more money into it," it went up just enough for them to get more money
sucked in and then went down again. That kind of market absolutely no one is
prepared for. There really isn't anybody on the individual investor level
who's been through that experience. It's too long ago.
What are people trying to get out of the market?
I think one of the things that's been really interesting about
this big run-up.. steadily uphill since October of 1990 -- recent events
haven't really, to my mind, dented that completely, but I think you've got
people looking at that and finding three different motivations. One is you
have greed. I think these are the people who basically say, "Well, a high
flyer like Press Tech or a company like Omega," which really don't have any
sound fundamentals behind them, "I know a guy who made a lot of money in that
stock, so I'm going to make a lot of money in that stock," will just go out and
buy it. I think you have people misunderstand the way the markets works. The
whole hot hand theory. You've had people looking at aggressive stock funds and
go, "Oh, well, they're up 35-40-50-60 percent. And that will continue because
we know these guys are hot."
The last one, though, I think is the one that's most interesting, which is that
I think you do have a kind of behavioral change that has a lot more to do with
the way people's behavior changes when the pot of money goes up in a lottery
than it really does about much that goes on in the stock market.
Talk about that more.
When the stock market is yielding 10 percent, I think it's
fairly easy to be a rational statistically driven investor. You know that you
can get seven percent in bonds. Stocks are much more volatile than bonds. So
you're willing to take that trade-off. When you get a year like '95, when the
stock market was up 35 percent, it becomes harder and harder to do that. In
some sense the stakes have been raised in the game. You get more people sucked
in because the returns look so tremendous. It's like a lottery where the prize
has gone up to $40 million, "So why won't I take a chance?" I mean people's
behavior does change when the game seems to be changing. And we do have a
situation where the game seems to be changing. I don't think that's the right
way to think about it, but I think there are a lot of people who are assuming
10 percent returns are the norm, year-in/year-out, and from my interviews with
individual investors, almost no one believes 10 percent anymore. I mean we're
now talking about people who expect 15 percent. They expect 20 percent. They
may think that there's going to be a 1987 stock crash, but the market will
bounce back and they really are entitled to get 15 to 20 percent year after
What is wrong with the party line?
I had a long conversation with Paul Samuelson about the long-term 10
percent return theory that the fund industry as well as lot of other sort of
investment advisors, push. And Samuelson hates this. He thinks it's a
misunderstanding of how statistics work on a number of areas. One is that we
really only have 70 years or so of equity market history. To argue that,
therefore, that's a long enough period for us to prove anything is, in his
mind, wrong and I tend to agree with that.
Second, is that it's really not important whether over the long term you're
going to make 10 percent on average. What you really need to know is what
you're going to get over any particular length of time. On average doesn't
fuel your retirement. If the market crashes before you have to get out, the
fact that it's been yielding 10 percent for the 30 years up unto that point is
really irrelevant. The way to think about this really is, "What do I need to
retire on? What are the consequences of my losing my money?" So that if we're
talking about somebody who has to retire, yes, you may need to play this
market, but people are tending to make the time period that they have to play
this market in shorter and shorter.
You now have people who are five years away from retirement believing they
still should be playing the stock market and they're still counting on a 15
percent return. All the conservative, old rules of hat that in many ways were
too conservative are also getting thrown out, ad hoc. So that you no longer
have people saying, "Well, as I approach retirement I ought to get more
conservative in my investments." Nobody is saying, "I'll get out of the stock
market at 65" anymore, because we all that we're going to live to be 80 and,
therefore, we have to stay in the market for a longer period of time.
How much do people need to retire?
There are two different sums that people need to retire. There's
one that's the kind of actuarial amount that you can get a financial planner to
do. The other is what people think they need to retire on. The first is an
almost meaningless exercise, for people of our generation, the Baby Boom
Generation. There've been some interesting studies about what has happened
with our parents' generation, a generation that has retired far better than
their parents. And the question, of course, is will we retire better than our
parents? And if you look at what the average retirement income is for our
parents' generation, it's remarkably small, less than $20,000. That's better
than their parents did. That better is also fueled by real estate and Social
Security, things that we're not counting on.
So the issue really is, "Well, how much money do you and I think we need to
retire on" And if you talk to somebody who's making $100,000 now, we all
expect that we're going to have 70 percent of that or 80 percent of that when
we retire. So we're trying to figure out a way to save a nest egg that will
give us $80,000 a year income that we won't out-live, imagining that we're
going to, at worst case scenario, live to just a mere 95. You start to talk
about people needing nest eggs of $4- to $5 million. And there's very little
way to get there except the stock market. We asked a planner to take a couple
who are now 45-42, making $100,000 a year, have about 250 in their portfolio,
how much do these people need to save, to get to a reasonable retirement as far
as the planner is concerned?
And we started talking about needing to put $25,000 away every year. And the
number of people who can save $25,000 on $100,000 income as well as put a
couple of kids through college and continue to pay off their mortgage is
infinitesimally small. That's one of the things I think that's driving
the market. There's no doubt that there are people who don't understand the
market. There's no doubt that there are people who are greedy about returns,
but you also have people buying the lottery tickets in full knowledge of the
unlikelihood of collecting, but also realizing that the alternative, which is
saving $25,000 out of a $100,000-a-year income is simply not tenable.
What do you think of the fund industry's party line?
The fund industry spouts a line that says, "Keep your money in
the market long enough, basically there's no risk. You'll earn 10 percent a
year." And they have facts to support this. There are numbers that really
show that since 1926 the average return on a portfolio of large cap stocks is
about 10-1/2 percent right now. There are real problems with that, however.
One, statistically, we really only have about 70 years worth of decent equity
market data to argue that's a large enough sample, so that we can say the
future will look like the past -- is simply wrong. Second is that it ignores
the way that people really do invest. We know that there's an incredible
amount of volatility hidden in that average number. Market has been down 40
percent. The market goes up 50 percent. People tend to buy when the market
has been really high and sell when it's really low, which, of course, then
means that you're not getting the 10-1/2 that you would get just by buying and
holding. And the last is just a question of what does a 10-1/2 percent
return, on average, really mean to an investor. You don't care about "on
average". You care about what the returns have been during the period you're
in the market. If the market is going to yield 10-1/2 percent on average for
all the years until the year when you need to get out, the 10-1/2 percent
becomes irrelevant. If you then suffer through a 30 percent correction, crash,
bear market, whatever you want to call it. The 10-1/2 percent is a nice
statistical abstraction. It doesn't really mean very much for people trying to
How much do Baby Boomers think they're going to need to retire?
If you go to a financial planner and ask, "What do I need to
retire on," the formula tends to be something around 70 percent of your income.
That doesn't tell you the large number at the end because if you then factor in
the fear of out-living your money, the fact that your life expectancy is
longer, you're starting to talk about a nut of, oh, $3- to $4 million as a nest
egg to retire on for people of the Baby Boom Generation, if you're making
Is that the reasonable expectation to make the kind of nest egg in
the stock market?
If you do a simple sort of back of the envelope scenario and say, "Well,
I'm making $100,000 now. I've got about 20 years to retire. I'm expecting
that I'm going to get, 10 percent in the market," well, I have to then save
$20,000 a year. If I invest in something that's a little more conservative
then stocks and I get eight-and-a-half percent, I've got to save $25,000 a
year. That only gets me to a portfolio of about $1.3 million in 20 years.
That's not going to do it. And if you could imagine somebody saving, $25,000
on $100,000 income and still not getting where they need to go, I think you can
get the dimensions of the problem.
When did middle class people first start to really pay attention to
the market ...
I think for the Baby Boom Generation, the whole '80s is a kind
of educational experience, an education in the stock market. You have the
invention of retirement vehicles that encourage people to participate in the
market at the same time as you have a raging bull market giving people returns.
So I think there's a kind of cocktail party indicator that starts to kick in
the '80s. You start to have people with relatively modest amounts of money in
a mutual fund or the stock market because they may have an IRA and they've put
away $2,000 a year, but that fuels the conversation around the barbecue pit
that says, "Well, I put my what this guy named Peter Lynch in this new fund
called Magellan and I'm up 25 percent this year." It may have only been
$4,000, but suddenly you're talking to somebody across a hot dog and that
starts to kick in this belief that the stock market is the place to be.
Put that together with a sort of collapse in real estate prices, or at least
a failure for the value of a home to grow in most parts of the country, and
then when 401Ks kick in so that people have more and more money put into this
you start to get --everything rolls together.
More money in the market, a market that's fulfilling people's expectations, an
industry called the mutual fund industry that grows up and tells people this is
where they ought to be, an industry like mine, which is the personal finance
magazines which tell people how to invest this and they need to be in the stock
market and you get the mantra repeated over and over again of "Be in the stock
market for long term. It gets you 10-1/2 percent a year," great return when a
CD is paying five.
Why did mutual funds become the vehicle of choice for the Baby
I think that mutual funds were such an attractive vehicle for some
sound financial reasons as well as some emotional reasons. The sound financial
reasons were that this is a very easy way to take part in the equity market.
You didn't have to pick stocks. They were a safe pool. All of the reasons
that mutual funds exist, which are true, that they allow you broad
diversification were a way for middle class people to participate in the
market. Second is the emotional reason, which is that they put human faces on
portfolios so that you -- I don't think you can downplay the significance of
someone like Peter Lynch, who became this kind of icon from mutual fund
success. All you had to do was to bet on the jockey and we had a proliferation
of jockeys. Lynch is still probably the best known name for this audience, but
I think that the comfort with "I'll give my money to a human being who's done
really well in the market," is also a major part of why mutual funds have
attracted the Baby Boom middle class.
Talk about Peter Lynch....
I think Peter Lynch is an absolutely crucial phenomenon.
If the mutual fund industry has not had a Peter Lynch, someone would have had
to have gone out and invent Peter Lynch. This is not denigrating his
investment skill at all, but here you had a face that you could put on an
investment pool. "I'm giving my money not to this bureaucracy; I'm giving it
t to Peter Lynch. He comes across as a smart, but down-to--earth, but
commonsensical kind of guy. I'm giving my money to a mutual fund manager who
gets great returns, but who tells me that the way he finds his returns is he
goes shopping with his wife in the supermarket and looks at what she's buying."
People can understand what Lynch was all about. That comfort is absolutely
crucial to a growth of the mutual fund industry. The sense that "I'm giving it
to a human being who is not doing really wacky things or computer intensive
things, but things that I can understand, and my money's really going to grow.
I trust Peter Lynch. I'll give my money to Peter Lynch." And he's really just
the first of the stars, and we've had a continuing start system which has
helped drive the mutual fund industry.
Talk about the horse race aspect of the fund industry and its appeal
for the press and for the investor.
If you look at the mutual fund industry in the early years, that's
really an educational experience for the investor. What happens as mutual
funds become more and more popular is you get this kind of self-reinforcing
phenomenon which is that the press writes about a Peter Lynch, a Ken
Hebner, a Gary Pilgrim. People look at those returns go, "Gee, I really
ought to put my money with one of these guys as opposed to the faceless mutual
fund I have it in now." Publications like Morningstar come out with
their ratings. So suddenly you now have five-star funds. And you get this
kind of increasing competition, the horse race becomes more and more
interesting to investors. And the pressure put on Morningstar recently
to do one-year stars ...
Have mutual funds helped fuel the speculative market of the last two
or three years?
I think the mutual fund industry has invented its own worst nightmare in
some ways, that in the last two-three-four years you've taken a vehicle which
was basically designed for long-term buy and forget solid returns and you've
turned it into a tool the many investors use to bet on the market, to momentum
invest. There are software products out there that let people chase hot funds.
There are people which pour over the tables in the newspaper or whatever other
data source they have looking for the hot fund of the last quarter. And it's
become so easy to move money from one fund to another through a mutual fund
supermarket or inside a fund company itself, that people actively do that. All
the evidence is that mutual fund investors are getting more aggressive about
chasing hot funds rather than less aggressive. And all the evidence also is
that they're very bad at timing. They tend to buy when the fund has been hot
just before the fund cools down.
Is Van Wagoner's fund an example of that kind of phenomenon?
I think that Garrett van Wagoner's fund is exactly an example of
investors chasing the hot funds. I think he's a good manager. He's got a
strong track record, but if you look at how people have reacted to that fund,
basically you've got a tremendous amount of money in that fund that came into
the fund after it was up 40 or 50 percent or 60 percent with the expectation
that that's what the future is going to look like. These are people who are
absolutely buying a style of very aggressive IPO-driven returns at a time when
that style looks like it's in trouble. And that's what mutual fund investors
have tended to do in the recent market.
Where were you in October '87?
I was working at a business magazine and a friend came into the
office and said, "The market is in melt-down." And at that point I had almost
no money in the market, and basically not because I was smart, but because I
had no money. And I said, "Oh, neat. Let's see how far this can crash." And
it got to watch, and then it bounced back and at that point I learned the
lesson that, is I think the operative lesson for everybody now investing in the
market, which is the thing that I remember about '87 is not the pain of the
crash. The thing I took away from '87 is the fact that I was stupid not to put
money in at the bottom, that I didn't invest when the market was down 500
percent I think -- 500 points. I think that's what people are waiting for.
That's how people have been trained. That's their lesson from 1987.
Why has so much money flowed into the fund industry in the past
If you look at mutual fund flows in 1995, about 125 billion came to the
mutual fund industry. That's the entire size of the industry in 1980. What's
driving that is a general love of the equity market, but, more importantly, you
now have that love of the market institutionalized through the 401K phenomenon,
which has become "the" way to fund retirement in the corporate world. I talked
to people at a couple of mutual fund companies, that are very active in this
market and what they're saying is that, "Well, we have this big educational
effort because people do not have enough of their portfolio in mutual funds."
but what they really mean is that people don't have enough of their portfolio
in equities. So you've got this education attempting to drive people who have
this retirement pool of money suddenly created and it's all pushing people
toward the equity market.
What do you think about what happened to Vinik?
I think Jeff Vinik's departure from Magellan should sent
up cautionary flags for the mutual fund investor. Here, you have a guy with a
really good track record over the four years that he's run the fund who
suddenly starts underperforming the indices. I'm not saying that that's not a
problem. All investors want somebody to outperform, but here, we have somebody
who has made a disclosed bet. He said, "I think the market is too risky. I
think that the way to make money for my investors is to put it into bonds."
And this man gets incredible flack from the financial press, from all kinds of
observers about that bet.
I don't know whether that bet is right or wrong, but it certainly seemed like a
reasonable thing to do. Basically Vinik took an incredible amount of heat for
doing what he should do, which is try to maximize return for his investors and
to minimize risk. I don't know whether he was right or wrong, but,
nonetheless, what he did was a reasonable thing to do. And his departure means
that people are really not willing to take a short-term under performance in
the expectation of future return. I think that's the really scary thing, that
he really only under performed for a couple of quarters.
Do middle class people not understand the risk?
I don't think the Baby Boomers understand what risk means at all.
I think that for the Baby Boomers, what they've done basically is take the
mutual funds invest for the long term and the average is 10-1/2 percent a year
and they've turned that into a slightly different, but similar, sounding
statement which says "Invest for the long term and you're guaranteed 10-1/2
percent a year." I don't think anybody is really worried about short-term
volatility. I think the lesson of '87, which was when the market crashed, is
buy, certainly hold on, don't sell at the bottom, has turned into one where it
ways, "I don't need to worry about volatility. It will always come back." So,
no, I don't think the Baby Boom middle class mutual fund investor understand
risk or is behaving appropriately.
What's going on in the market right now?
I think if you look at what happens in the last week, basically
you had a Monday where the pros basically went out and said, "Gee, everything
looks rosy," and at the end of Monday it turned out that Motorola was gonna
under perform its estimates and so is Hewlett-Packard.
I think what you got on Tuesday is the pros panicked. Not the individuals.
They didn't even have time to react to this news. You basically had the
institutions and the mutual fund managers and all the momentum players on the
institutional level dumping stock. I don't think this has ironically been a
market driven by what all the professional investors fear, which is the mutual
fund the stupid mass of mutual fund investors. It's been a down market with
volatility because of the professionals. I think that's interesting.
Do you have money in the market?
I have lots of money in the market. I have all my 401K in the
So you're playing the same game as everybody?
Yeah. I have my money in the market because I believe that
the market is the only place for me to get returns that will beat inflation
over the long term. I try not to chase styles. I try to have my money in
diversified array of funds. I don't have all of my money in aggressive equity
funds. I own a lot of value funds. I try to have some money outside the
United States so that if the US market crashes, I've got some money in markets
that aren't correlated totally with New York.
But I think the observation of the Baby Boom Generation is "What other game it
there" is essentially accurate. Where else could you put your money at the
point in time and believe that it's going to grow faster than inflation? My
experience, and, like all investors, I tend to fight the last war -- my
experience as an investor is I started investing money seriously in the '80s.
And one of the first investments I made was a Paul Volcker-Jimmy Carter
zero coupon bond, which at that point was yielding 13 percent to maturity. I
remember the double-digit inflation. I remember double-digit returns in fixed
income investing. I know that I'm not going to get those double-digit returns
from a bond anymore, but I certainly do expect, in my heart of hearts, that we
could have another spike-up of inflation and I remember that the only place you
can really beat inflation over the long term is the equity. That's the war I
fought before. That's the lesson I learned. That's why I'm in the equity
Is it hard for you to resist chasing the hot funds?
It's incredibly difficult following the investment world and
mutual funds not to chase the hot stock, the hot fund manager. My information
is a little better than the average investor, and all that really means in many
cases is that I see the hot manager emerging a little before everyone else and
I try not to do that, but I get this whammy down the road, which is that "I've
found this guy. I didn't put my money in, because I try not to chase trends,"
and then three months later it turns out that everybody else had discovered
this guy and they all pile in and I'm sitting there on the sidelines going,
"Well, gee, this guy's going to be up 60 percent this year. Shouldn't I have
One of the problems about being a smart investor during this period, and I'm
not saying that I'm a smart investor, but anybody who is smart investor during
this period is, what do you do about the fact that following the trends, being
a momentum player does work over the short term? If you're really smart, you
know that it's over the short term, but you also believe, in your heart or
hearts, that you can beat the game, that you know it's rigged, but you know you
can get in faster than anybody else and you can get out before everybody else
wants to rush for the door. The real trap for any investor in a market that's
been as volatile as this one where rumors sweep through on the Internet, where
financial publications tout managers, is believing that you can get in early
and you get out early and you can beat the consequences. And, of course, if
everyone believes that, it means no one gets out early.
Do you have a little pang that you didn't invest in Garrett's fund
when you first saw it?
I really don't have a pang about not investing in Garrett van Wagoner's
fund. I try to invest in funds or stocks that I can understand. I look for
fund managers with methodologies that are pretty simple. His methodology,
which seems to work, is highly, highly intuitive and that doesn't make me very
comfortable. This is simply a personal emotional choice. I like people who
have long-term track records pursuing methodologies that are pretty simple to
understand, and so the results are predictable to me. I have a high
predictability demand in my investing.
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