MountainTops

Uncle Sam Should Not Be Your Financial Advisor

Friday, July 31st, 2009

Whenever there is a financial issue on the table, there is usually a broad range of strategies and financial products available to provide a solution. The details can make many money decisions seem quite complex, but here’s a general principle that’s relevant to all financial decisions:

FIND THE FREE-MARKET SOLUTION. IN THE LONG RUN, IT’S THE APPROACH THAT WILL DELIVER THE BEST RESULTS.

Since the Great Depression, the US government has tried to improve the financial lives of Americans by providing government-sponsored alternatives to solve the financial issues of life. While well-intentioned, these programs inevitably have not delivered on their promises.

To understand the dynamics, here’s the general pattern: The free market will always include some adverse outcomes and shady dealers. Not all investments work out, and someone will lie, cheat or steal. As a result, some people will lose money, lose work, lose financial security. At that point, someone will say “there ought to be a law!”

This is music to politicians’ ears. Politicians look for chances to right wrongs, defend the downtrodden (and get reelected). And making laws is one of the things politicians do best.

Alas, even with good intentions, the political, law-driven approach to solving problems (financial or otherwise) usually misses the mark. In fact, the historical record of political problem-solving is that most people end up worse off than before. 

Meanwhile, the free market will grind away, eventually finding an effective (and cost-efficient) method to deter adverse outcomes and bad behavior, because people operating in a free market environment have strong incentives to preserve the integrity of their businesses and their markets. Over the long run, free market dynamics produce better regulation, better behavior - and better results.

Think of the many financial issues where government already plays a strong role, either as a direct provider or regulator:

Banking (Federal Reserve, FDIC)

Retirement (Social Security, the Pension Benefit Guarantee Corporation, qualified retirement plans)

Medical insurance (Medicare)

Mortgage lending (Fannie Mae, Freddie)

Housing (FHA)

College funding (Pell Grants, student loans).   

In any of these areas, you could make a strong argument that a free-market alternative would work better. Unfortunately, once government programs get started, it can be hard to unwind them; constituents who have become dependent on subsidized benefits can’t afford to give them up, and politicians have no incentive to stop delivering benefits and buying votes.

You can see this pattern played out with Social Security. Amid the Great Depression, taking care of the country’s elderly citizens was a legitimate concern. The social and financial structures of life were changing, and many were unprepared to deal with the financial stresses of living longer but not being able to work. Out of this crisis (exacerbated by the Depression) came the cry “someone ought to do something.” And government did.

The short-term results seemed ideal. The payoff to the retiree was huge when matched with the contribution. For the first time in recorded history, an average citizen could retire - they could stop working and live comfortably on a guaranteed monthly income. But the good times didn’t last.

Because of its format (a legalized Ponzi scheme in which current workers fund benefits for current retirees) Social Security has delivered an increasingly poor return to its participants. Even worse, everyone (including the politicians) now knows it the program is unsustainable in its current form, and must either be scrapped or drastically reduced.

In the meantime, the free market has developed several workable private alternatives. Life insurance and annuities have been modified to offer many of the same long-term retirement benefits to a broader section of the American public. Mutual funds have become an avenue for smaller investors to participate in the opportunities in the stock market.

Consider all the taxes a typical 60-year-old American has paid into Social Security over the past 40 years. If you apportioned that same amount into a mix of private life insurance, annuities and investments, the guess here is that 60-year-old is looking at a better retirement package than the one promised by Social Security - more insurance, more income, more options, and better promises. Because unlike Social Security’s formula, insurance companies project their payouts based on specifics and known variables; the amount invested, the age of the annuitant, and real mortality experience. In the long run, which program would work better?  

The problem of course, is that Social Security is mandatory - almost everyone has to participate, has to pay. This compulsory factor makes it harder for the average American to afford a better choice. In fact, the typical American retiree “needs” his Social Security check because he hasn’t established much in the way of alternative retirement resources. It may have taken 70 years to reach this point, but the average American is now dependent on a government retirement plan that can’t deliver on its promises.

This long-term result is not unique to Social Security. The next time you face a financial decision, think long and hard before signing up for government-sponsored programs. Better yet, look for the free market alternative. Uncle Sam has not proven to be a reliable financial advisor.

Posted in Financial Planning, free market | No Comments »

The View From the Mountaintops: Why It Makes a Difference – Part I

Monday, July 27th, 2009

What you see depends in part on where you stand. Whether you are in the valley or on the mountaintop, you may be able to see the sun, the sky, the rivers and the mountains. But how you see these things will be affected by your location. The view from the mountaintops will be different - even if you are looking at the same thing.

This difference in what you see depending on where you stand applies not only to scenic vistas but to the pursuit of Prosperity. And we believe there are good reasons for seeing and understanding the Mountaintops perspective on Prosperity, even if the other perspectives (from in the valleys or the hills) are valid. Here are a few thoughts to encourage you to take a look at the Mountaintops perspective.

Success is rare and Prosperity is not the default option in life. A quick survey of the human condition (from whatever vantage point) should be enough to confirm that success, in any endeavor, is not the norm for humanity. People don’t “naturally succeed;” they don’t automatically learn to read, grasp algebra, build a skyscraper, write computer code, or make fortune. Rather success is developed, through a combination of passion, education and effort. And because success requires passion, education and effort, not everyone succeeds.

But some people do.

This information (that success is not the norm, but that some people do succeed) prompts a simple question:

If you want to be successful, who should you study and perhaps emulate?

The obvious answer is “Those who have been successful,” right?

But quite often, this logical conclusion is rarely pursued or applied. Instead, the focus often changes to “why aren’t the rest of us successful?” Instead of trying to understand the view from the Mountaintops, many people are saying, “why can’t I see the same thing from down here in the valley?”

You may think this is a subtle distinction, but it has a huge impact.

Richard Thaler and Cass Sunstein are the authors of Nudge, a 2008 book with the subtitle “Improving Decisions About Health, Wealth and Happiness.” The book is a behaviorists’ perspective on how to guide, prod - or “nudge” - people toward a beneficial decision or behavior that they might not be able to make own their own.

One of the basic premises of the authors is that most people have little or no chance to make the right choices, even if they want to. They are too busy, too ignorant, too distracted, too lazy, too emotional - just “too human” - to make good decisions about their finances, their health, their relationships.

Since this is the case, most people would benefit from external nudges to make the right decision easier. In what Thaler and Sunstein characterize as “libertarian paternalism,” these external nudges would be provided by governments and social institutions, usually in the form of incentives or default options.

Automatic enrollment of new employees in an employer’s 401(k) is an application of this thinking. Rather than offering participation during an open enrollment period each calendar year, employees are automatically enrolled. Participation is not mandatory, but the employee must initiate the decision to not participate, by filling contacting Human Resources, filling out a form, etc. Studies show that inertia tends to prevail with most people - they do what’s easiest, and tend to keep doing what they’ve been doing - so they once enrolled, they tend not to opt out. Instead, they get used to having the deductions taken from their paycheck, and accept their participation in the retirement plan as a good thing.

According to the behaviorists, if there wasn’t the “nudge” of automatic enrollment, participation in a retirement savings plan wouldn’t happen for many people. And indirectly, the statistics validate this assessment, because 401(k) participation is higher when employers make participation the default option.

This “nudging” might seem relatively benign. Behaviorists would argue that most people are better off because of the nudge. But there’s something missing in the conversation:

What if you’re not “most people?”

Thaler and Sunstein note that numerous behavioral studies show it is human nature to follow the herd - if the group believes something, the individual will often follow, even if it conflicts with his own assessment. Hence, the desirability of having “choice architects” arrange things so that the group will choose the “right” choice.

But even these tests note that while the majority may be swayed, some are not. Most people may follow the herd, most people may make poor decisions, but some do not. And they don’t need nudges.

Mountaintops attempts to offer the wisdom, experiences and perspectives of those people who, for whatever reason, have already grasped that they want to be different, want to be better, want to reach their full potential.

If you don’t want to be most people, Mountaintops is a place where you can explore how to be different. While the perspectives “most people” have may be valid, we seek to be a vital source of “alternative” information, because we believe that when you see things differently, you may like the view a lot better.

Posted in Prosperity | No Comments »