The prevailing urban myths of economics and finance.
1. Investment creates jobs. How often have you heard that line, especially from a Republican politician defending tax breaks for the wealthy? This economic claim is 180 degrees out of alignment with reality. The point of investment is to eliminate jobs.
The modernization of agriculture does not replace 100 farm jobs with 100 farm machinery jobs. If it did, there would be no point to the exercise. You might as well have those workers out in the fields as sweating over parts bins in a Deere factory. They’d get more fresh air and sunshine.
No, the point of mechanized farming is to replace 100 farm jobs with only 50 factory and dealership jobs, or maybe only 5. On such job elimination is built the improvement of living standards over the past two centuries.
2. Tax cuts make you better off. Here’s another wild claim from the pols. Too bad it isn’t true. If it were, the Bush tax cuts would have us in an economic boom.
If you want to reduce government’s drag on the economy, cutting taxes doesn’t do the trick. You have to cut government. That means cutting programs, which is tough to do.
Milton Friedman understood the difference. The economic damage done by big government, he said, is measured by the resources it yanks away from people. It doesn’t matter whether the yanking is done by levying a tax or issuing a bond or printing $100 bills (all of those methods being in active use today).
This explains why Ben Bernanke’s ambitious money-printing scheme is such a bust. The money just sits there, in bank accounts and sock drawers. People don’t want to invest or spend it because they know their tax cuts are going to boomerang sooner or later.
3. Performance fees pay off. A standard arrangement at hedge funds is that the investor gives the operator a bonus for success. Besides the base management fee, you are expected to cough up 20% of gains, or sometimes 20% of returns exceeding some benchmark.
We get rich only if you do, says the operator. The 20% take means you might have to pay a big fee, but then that would be a nice problem to have, wouldn’t it?
Suppose the fund scores big. It shoots up 40%, and after the bonus fee you have 32% left. That looks like a terrific deal.
It isn’t. It’s a terrible deal.
4. Dividends are good for you. Investors are in love with dividends. They pour billions into dividend-seeking ETFs, they put up with clunky companies whose only attraction is a fat yield, they rhapsodize over prospects for getting more dividends from Apple.
What’s wrong with dividends? Just that you have to pay tax on them. Shareholders would be better off if corporations disbursed cash by buying in shares instead. That’s what Berkshire Hathaway aims to do.
But corporations going the Berkshire route confront a wall of criticism from commentators who have convinced themselves that buybacks are risky and potentially injurious to shareholders?
Whence comes the theory that a buyback is worse than a dividend? From a misunderstanding of the arithmetic. It looks as if buying in shares just before the share price falls is a waste of corporate assets. It isn’t, but understanding why it isn’t is hard, just as it is hard for a seven-year-old to understand that there could be such a thing as a negative number.
5. Rebalancing boosts returns. The experts tell you to rebalance your portfolio so that it has fixed percentages allocated to different categories, such as domestic stocks, foreign stocks, bonds and so on. If you aren’t disciplined enough to do this on your own then you are supposed to hire one of the experts.
So far in the 21st century, stocks have bounced around while going nowhere and bonds have done pretty well. Someone who rebalanced over the past 12 years would indeed have earned more than someone who allocated his money only at the beginning and then stood pat.
Pick a different time frame, though, and you get a different result. Analysts at Vanguard looked at stock and bond performance over the 74 years through 2009 and found this: Someone who bought 60% stocks and 40% bonds at the start, and then did nothing, would have averaged a 9.1% annual return; someone who rebalanced to 60/40 every month would have averaged only 8.5%.
Rebalancing is fine if all you are trying to do is sleep better at night. But the idea that it increases your expected return is balderdash.
6. Investors are fleeing stocks.
If you believe the stories about investors fleeing, you are sorry for all those little people who got burned in the 2008 stock crash and then departed just in time to miss the market’s recovery.
Where do these stories come from? Sometimes, from journalists who look at the exit of assets from mutual funds but fail to notice that money is pouring into ETFs. Almost always, from journalists who fail to notice that big corporations buy back $350 billion to $450 billion a year of their own shares.
In economic effect, those buybacks are just substitutes for dividends. But in the statistics they get treated as departures from the stock market.