Archives for August 2018

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Why Stock Prices Are Still Volatile in an Efficient Market

A reader writes in, asking:

“Last month Facebook’s price fell because the new European privacy law hurt their advertising revenue. I always see the ‘experts’ saying that we shouldn’t invest in individual stocks because an ‘efficient market’ makes it impossible to pick winners and losers. But the idea that every stock is perfectly priced all the time seems wrong on its face. I can tell you right now that if the U.S. passes a similar privacy law, Facebook’s share price will fall again.”

The idea of an efficient stock market isn’t that the stock market can predict the future. Nobody knows what is ultimately going to happen (either with Facebook or with any other company/industry/country).

That is, the market price for a stock doesn’t mean that this is where the price will stay; it’s simply the consensus best estimate, given the information that is currently available.

By way of analogy, imagine that I’m hosting a raffle, in which the winner gets $100. I’m going to sell exactly 100 tickets to the raffle. How much is each ticket worth?

Each ticket is worth $1, because each ticket has a 1% chance of winning $100. (That is, $100 prize x 1% probability of being the winning ticket = $1 value.)

Of course, the reality is that, of the 100 tickets, 99 of them will turn out to be completely worthless, and one lucky ticket will turn out to be worth $100. But we don’t know in advance which ticket will be the lucky one, so until the raffle actually happens, each ticket is worth $1. (In probability/finance jargon, we say that each ticket has an “expected value” of $1.)

The point of the efficient market concept isn’t that an efficient market would successfully predict which raffle ticket will be the winning ticket. Rather, the point is that an efficient market would successfully price each ticket at $1 prior to the raffle.

With regard to Facebook, there’s a possibility that new regulation will come along that impedes the company’s profitability, in which case the stock will be worth significantly less than it’s worth right now. Or, maybe no such event will occur, and the company’s stock price will rise back to what it was before all the hullaballoo.

But because we don’t yet know what’s going to happen, an “in the middle” price is the current consensus price, even though everybody knows it will ultimately turn out to be wrong (i.e., even though everybody knows the value of the company will ultimately turn out to be more or less than the current market value — just like everybody knows that none of the raffle tickets will ultimately be worth $1).

Investing Blog Roundup: “Open Social Security” Updates, and Retirement Microadventures

Three noteworthy updates to the Open Social Security calculator went live recently.

First: The calculator now provides a table as part of the output, with year-by-year benefit amounts for the recommended strategy (and another table if the user chooses to test alternative claiming ages).

Second: The calculator now considers voluntary suspension possibilities. For example, if one person in a couple filed at age 62 and is currently age 65, the calculator will consider whether they should suspend their benefit from FRA until 70 (or some earlier date).

I don’t expect that this second change will affect that many people, but it was a necessary prerequisite for implementing functionality for people who are receiving disability benefits — which is my next major goal for the calculator.

Third: When the “advanced options” setting is selected, there is now an option (below the input for discount rate) to assume that Social Security benefits will be cut by a selected percentage, effective as of a selected year in the future. (Several people requested this functionality in order to test various assumptions about depletion of the Social Security OASI trust fund.)

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Thanks for reading!

How to Change Somebody’s Mind About Investing

A reader writes in, asking:

“How do you convince somebody that they are making a bad investment decision? A member of my family often brags about his latest money move. Apparently he is always getting in or out of a stock at just the right time or making an options bet that paid off. I’m sure we are not hearing about all the bets that DONT pay off. But none of this seems like actual prudent investing…not even remotely.”

I usually don’t even try. If somebody is telling me about their investments, I just listen, unless they explicitly request my opinion. And even then, my standard reply is just, “I don’t follow or invest in [individual stocks/Bitcoin/gold/options/whatever] at all. I’m just a boring index fund investor.” That is, I am open about what I do with my own money, but I don’t try to convince them that they’re making a mistake.

That’s not to say that I haven’t tried. I used to. Given my line of work, it’s pretty common for friends/family/acquaintances to ask my opinion about a particular investment decision they’ve made. But what I found over the years is that in most cases, the other party’s only goal for the conversation is to be congratulated on having made a smart decision. They don’t actually want or care about my opinion, unless that opinion is, “great job!”

There have been occasions on which the other party was in fact seeking to have a conversation about the pros and cons of a particular investment strategy — and in such cases I’m happy to have that conversation of course — but that’s not the most common outcome.

And really, that’s just human nature. When was the last time that you had a conversation with somebody, in which they convinced you that a decision you were making was unwise and you decided to make a different decision going forward? It happens, sure. But not very often.

Personally, I find that when I change my mind about a topic, it’s usually because of something I have read rather than something somebody said. There’s something about sitting down to read a book (or a piece of research) that puts me in a mindset where I’m ready/willing to question and change my current views on the matter. I am certainly not in that same mindset when somebody starts providing unsolicited opinions about my life decisions.

So, if you’re looking to change somebody’s mind about investing, my best suggestion is to:

  1. Lend them your copy of a book (e.g., A Random Walk Down Wall Street or The Four Pillars of Investing — or Bogle’s Little Book of Common Sense Investing if you suspect that the person would not read a longer book), and
  2. Pitch the book in a subtle manner (e.g., “I was thinking about this book recently. It’s one of my favorites. And it occurred to me that you might really enjoy it as well, given your interest in investing.”) so that the other party does not feel defensive.

But even then, you have to be prepared for a scenario in which the attempt is entirely unsuccessful. It’s hard to change somebody’s mind.

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My Social Security calculator: Open Social Security