3 things – Terrible ideas, bonds, ETFs

Weekend reading

Here are three things I think I’m thinking about this weekend:

1) Three terrible ideas that will not die

The Great Financial Crisis was great because it got people interested in economics. And it was terrible in that he has convinced many people that mainstream economics has got almost everything wrong. This has led to a resurgence of heterodox ideas that the mainstream has long trashed. Unfortunately, some of these ideas have crept into the national political debate, and others have even been implemented.

Luckily, we have Cliff Asness on our side to remind us how bad some of these ideas are. Cliff took to Twitter to remind us of three things that almost all mainstream economists agree on. I won’t mince words, so feel free pass over there and read what he had to say. It’s pretty good. In short:

• Rent control (and price control in general) is bad and never works the way politicians claim it will. Price controls create shortages by distorting prices and discouraging production. You might think that capping rents would lead to lower prices, but all it does is discourage new builders from renting out those apartments, which ends up driving up prices in the meantime.
• The greed narrative is appealing and intuitive, but that narrative really only applies to monopolies and non-competitive markets. In a competitive market, blaming corporations for inflation is like blaming gravity for plane crashes. I mean, did the “greedy” realize that corporations are trying to maximize profits?
• Tariffs and trade wars are the equivalent of putting boulders in your own harbors thinking you’ve made your economy more accessible for everyone, when all you’ve really done is make things harder for everyone.

2) The age rule in bonds is wrong

As you may or may not know, I have a time obsession with financial planning processes. It’s the current thing that my OCD won’t stop trying to fix right now. As someone who works with many retirees and people entering retirement, I am constantly trying to help people through this difficult time in people’s lives. And one thing I’ve become convinced of is that this is the most difficult time in one’s financial life because this is the time when your time horizon becomes the most uncertain.

When it comes to asset allocation, the old rule of thumb is roughly “your age in bonds.” The basic thinking is that you should become more conservative as you get older. But I think this is wrong. I think your bond/cash allocation should peak right around retirement. My basic thinking is that this is the time in your life when you have the most temporal uncertainty. In other words, when you’re young and old, investing is easier because you have much more clarity on your time horizon. When you’re young, you have a lot of time and leeway to make mistakes. When you’re old, you have less time and fewer leads, but you have more clarity on your specific time horizon. Or you will die soon or the goods will become someone else’s. The messy part is when you’re middle-aged and nearing retirement, because you accumulate a lot of financial debt that has different time horizons. This is compounded by dependents, who require short-term and long-term planning.

This is a very general way of thinking about things, and there are always circumstances that require more customization, but the image above is how I think about it more broadly.

3) When ETFs become weapons of financial destruction

I’m a big fan of boring ETFs because I think asset allocation should be boring. ETFs are great for helping people create low-cost, diversified, and boring savings portfolios. I’m not a fan of overly fancy ETFs that prey on people’s emotions and lure them into gambling. Asset allocation should be mostly boring. Build a financial plan, allocate assets that match that financial plan, diversify, reduce taxes/fees, etc. ETFs are the perfect vehicle for this, but as John Bogle has often observed, they can be weaponized to get people to do the things they do. it shouldn’t.

A disturbing trend in the ETF space is that it is becoming increasingly popular to create ETFs that help people trade in a way that is more like gambling than investing. For example, Bloomberg did an article about the Microstrategy ETF with 1.75X leverage. This is a fund that tries to replicate the 175% daily volatility of MicroStrategy Corp, the well-known Bitcoin company that does some enterprise analysis on the side. It is a highly volatile stock because it has become influenced by Bitcoin, a highly volatile asset. And now you can get even more volatility for the not-so-low 1.3% expense ratio. oh boy

Look, I’m all for free markets. If someone wants to start a fart jar ETF that costs 10% in annual fees and there’s a market for it, then great. People like weird things, and some people like to burn their money on fire. That’s all well and good. And there is nothing wrong with gambling for fun. But regulated financial markets are not casinos, and I think the line between gambling and savings is blurred when we position such products as “investment” products. They are gambling products. And again, that’s okay. There is nothing wrong with gambling. I have no problem with stock picking, speculation, day trading, anything else. I don’t think you should do those things in large quantities, but if you have to scratch an itch, then scratch it. But be sure not to confuse the process of prudent asset allocation with something that reflects reckless gambling.

Anyway, I don’t like this trend. Gambling seems to be an increasingly problematic endeavor in this country, and I don’t like that our financial markets are looking more and more like casinos instead of places where firms fund investments and savers allocate savings…

I hope you have a wonderful weekend.

Original post

Editor’s note: The abstracts for this article were chosen by the editors of Seeking Alpha.