Failure Is Unlimited

I feel as though I would be remiss if I did not discuss Occupy Wall Street somewhere in this blog, so tag this entry with #OWS.

Too bad no one argued that banks were "Too big to bail."

For the past several years, the phrase "too big to fail" has been a buzzword in these shaky markets. Certain corporations, especially in the banking and insurance industries, have been granted various benefits to keep the company afloat under the guise that they are too important to our economy to risk failing. It mostly started in the fall-out of the Lehman Brothers bankruptcy, and it was deemed a necessary measure to prevent the country from falling into an extensive recession or another "Great Depression."

It has been a controversial phrase in the finance industry since the beginning, mostly because it is a blatant oxymoron. While it has arguably been a success in keeping the economy going, the inherent flaw in the concept is destructive to long-term growth. The dissenting opinion of this tactic is that if large companies are endangered, then their structure is flawed and their collapse will see several new companies emerge from the ashes. Former Federal Reserve Chairman Alan Greenspan simplified it when he said, "if they're too big to fail, they're too big."

The Occupy Wall Street movement has pushed this issue and similar issues to the forefront recently. The(se) protest(s) is (are) mostly against this tactic and other methods to protect the country's wealth, which unfortunately has translated into protecting the country's wealthiest.

The Dow Jones Industrial Average (DJIA) or "The Dow" is comprised of 30 components. By components, we mean corporations or stocks. There are more than 2300 companies actively traded on the New York Stock Exchange. The reason the Dow is cited most often is that its history dates back to May 1896, so it compares today's markets to 100 years of history in a single measure. However, the reality is that while the DJIA is the most cited index, most index funds have far more than 30 stocks in them. Case in point, the Vanguard 500 Index Fund has 500 companies, mirroring the S&P 500. When one of those companies falls from the S&P 500, it is sold from the fund and the new company entering the S&P 500 is purchased. There is a constant "out with the old, in with the new" methodology built into the index fund itself. Likewise, the Vanguard Total Stock Market Index Fund has over 3,000 companies, so the Dow is quite literally 1% of the total stock market.

Unfortunately, the exact demands of OWS have been conceptual and the protests are unclear. Personally, I had a vague idea of the issues central to the movement, but I had to research OWS at length before I could discuss it. Most recently on "Market Watch with Mo Ansari" (an often-cited radio program), there was a guest who opposed "too big to fail" methods and proposed that what our country is facing would be the "lost decades," as opposed to the singular "lost decade" (2000-2010). At the center of his discussion, though, was a pitch for a plan to balance the country's budget in 10 years. He said several other groups tackled the proverbial Rubik's Cube known as the nation's deficit, and his proposal was the only one to wipe it out in 10 years (conversely, the average of most other proposals was 40 years).

Social Security would continue, he promised, but it would be limited to the population who needed assistance, and the population who did not need the financial assistance would stop receiving the benefits. At that point, I had to wonder: where is the incentive to be a productive member of society? I stopped listening to the guest and started pondering the question for myself. I remembered when my ex-girlfriend told me that she had to pay income tax, and I was genuinely excited for her! She moved out of state and started paying all her bills herself for the first time in her life. On top of that, she was earning enough that she owed taxes at the end of the year. Every single part of that filled me with vicarious joy. She, on the other hand, was not excited.

It seems most conversations about Occupy Wall Street begin and end at this troubling concept.

What exactly was the one demand?

Since the guest on the program mentioned lost decades, it is only appropriate to debunk that misconception as well. If a mutual fund (or individual stock) were trading at $10 today and you invested $1,000, then you would obviously have 100 shares. If the fund (or stock) rose to $17 in five years and then fell to $9 two years later, but then rallied back to $10 three years after that, then it seems as though you would have the same $1,000 again from ten years ago.

Except each year, sometimes each month or each quarter, the fund (or stock) will pay a dividend. For bonds, this is the interest earned on the debt. For stocks, it is a portion of the profit paid out to the owners of the company (stockholders). If you are investing in a tax shelter, such as a 401(k) or IRA, then you are most likely reinvesting dividends. This may not apply to complex portfolios, but the assumption of reinvesting dividends is usually a safe bet.

Therefore, you spent 10 years going between $9 and $17 per share, but your $1,000 investment is substantially higher because, periodically, the fund paid dividends and put money back into itself in the form of more shares. Ten years ago, you had 100 shares trading at $10. Ten years later, you could have 125 shares trading at $10. The investment's earnings would be 0%, but your actual return would be 25%.

However, these "cumulative returns" are often overlooked. While the media is viewing the markets at a 0% return and naming it a lost decade, your wealth has grown 25% in this single investment. The first investment in my Roth IRA was on March 11, 2003, and it went into the Vanguard 500 Index Fund. Lucky for me, that day was the lowest point in the market of the year. I did not invest any more money into that particular fund (future Roth IRA contributions went into other funds) but this investment has given me a bird's eye view of cumulative returns, so trust me when I say it was not lost time for me. The only real "losers" of the Lost Decade were the people sitting on the bench and not getting into the game.

Catchphrases and hooks grab attention. Personally, where my money is and what it is doing is enough to get my attention. And I don't have to outsource that attention to the financial media. "Too big to fail" and "lost decades" are worth discussing, but they should never drive personal investment decisions. Like Mo Ansari often reminds his listeners, you have to invest based on what the markets do, not what they should do. Which is to say, the markets rarely listen to the what financial media says. Follow the market, not the media.