Investors validating 'stupidity theorum'

By DAVID MOON, Moon Capital Management, LLC
August 29, 2010

Albert Einstein once wrote “only two things are infinite: the universe and human stupidity, and I’m not sure about the former.”

I am afraid that we are seeing examples of this in investor behavior.

The big investment house Fidelity reported that a record number of retirement plan participants made hardship withdrawals from their 401(k) plans in the second quarter of this year. This comes on the heel of a separate report that plan loans have reached a ten-year high.

What’s worse is that 45 percent of the people who took hardship withdrawals in 2009 have already taken out a second hardship withdrawal in the first six months of this year.

I’ve never seen a study about this from the Ten-Year Plan folks, but I’m fairly certain that it is better to withdraw money from a retirement plan than to starve. Cable TV probably falls a bit further down the priority list. Nevertheless, it is a very, very expensive way to access money.

The withdrawn amounts are taxable. If you are taking a hardship withdrawal rather than an outright distribution, you are probably still employed. Even the lowest marginal tax rate is 10 percent.

Perhaps a worse cost is the opportunity cost. If you are selling equity funds to make the distribution, you are selling those funds at prices that are likely 40 percent below their highs.

Assuming you are in the lowest tax bracket, these would combine to cost you about 46 percent to take the withdrawal.

Even a lot of folks who are leaving money in their plans are making investment decisions that are, in my opinion, questionable.

June marked the 30th consecutive month in which investors put more money into bond mutual funds than stock funds. During those 2½ years, bond funds attracted $559 billion in new assets, while investors withdrew $234 billion from stock funds.

The last time the bond-to-stock money flow was this extreme culminated in 1987, just before the Dow Jones Industrial Average began a twelve-year run in which it increased 500 percent.

Am I suggesting that stocks are about to begin a decade run that will carry the Dow to 65,000? No. I have recently documented plenty of problems both in the overall stock market and economy.

This investment quandary is not simple.

There are few investors who have experienced interest rates going from zero to ten percent or more. They think of bonds as a safe haven. Even Investment News magazine describes the popularity of bond funds as a “rush to less-risky investments.”

Don’t assume bonds are necessarily risk-free, even government bonds.

The investment arena isn’t the only area where Einstein’s universal stupidity theorem is being tested. Everywhere we turn we can find – or overlook – obvious nuance that the world is losing its mind. Things like new roofs built of grassy weeds in the name of being green, or the government buying paintings and calling it economic stimulus.

Only time will tell if Investment News or Albert Einstein is right.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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