The Wild West of Online Trading

The term Wild West has deep historical significance but is also used broadly to signify, as Merriam-Webster puts it, “… a period characterized by roughness and lawlessness.” That’s where I think we are right now with the melding of social media and the surge of people using online trading platforms like Robinhood. But isn’t confined to just one firm. The frontier is wild, and the law is too slow in catching up.

My industry is heavily regulated, but you wouldn’t know it by much of what’s posted online these days. I take industry rules seriously because they’re there for a reason, usually the result of shenanigans that cost people serious money. So I really look askance at unregulated “influencers” giving investment advice on social media platforms. Many of them cheapen the process, as if the decision to buy or sell a stock was like any other product review. Bad online purchases can be annoying and inconvenient but buying the overpriced stock of a silly company just because some bloke suggested it online could cost you bigtime. Simply put, lots of people are being taken advantage of right now and the regulators, the “law” of the Wild West, are wondering what to make of it all.

As you can imagine, I’m not the only financial planner who feels this way. But what to do about it? After all, many of us don’t play in the social media sandbox and easily get drowned out by all those talking heads on YouTube. Instead of joining them, maybe it’s better to educate one investor at a time.

Along those lines I’m doing something a little different this week. Sara Grillo, an industry insider, has written a good “explainer” piece to send to anyone who may be considering day trading. I usually remove imbedded hyperlinks from articles I post, but I’ve left them in this time as they provide further explanation on important topics like defining margin debt, what real stock analysis is, and so forth. The idea is that this piece could be a helpful tool for anyone getting started with trading and needs help (or maybe a reason not to start).

Let me also add that I don’t want to stop anyone from trading stocks if that’s what they genuinely want to do. Instead, I hope they do some homework and try to develop an understanding of how complicated it is and, hopefully, don’t go overboard with the dollars they invest. Ideally, a first trading account should be thought of like money being set aside for that trip to the casinos with friends. It’s fun money, money that you could lose without repercussions aside from feeling silly. Start out trading with more than that and you’re really asking for it.

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The Emerging World of Prop 19

As I sometimes do, this week I’d like to address questions I’ve been hearing from clients in recent days. The questions revolve around Prop 19, the proposition passed in November that takes effect today, a deadline that seems to have snuck up on folks, me included.

The idea behind Prop 19, so far as I remember from the political ads, was to free up the ability for seniors and certain others, such as wildfire victims, to move more easily about the state while taking their lower property tax base with them. There was also talk of freeing up more of the housing stock that was stuck, for lack of a better term, while folks waited to pass their homes to heirs. The emphasis was on favoring owners of primary residences over owners of rental properties. Helping fire fighters and providing for additional fire prevention was in the mix too.

To pay for this it was necessary to slam the door shut on what many viewed as a loophole allowing unfair tax breaks for those inheriting long-held family homes. There were (and still are) many notable examples of this. A 2018 story from the LA Times (a link is below) circulated about the actor Jeff Bridges and his siblings easily earning enough in a few weeks of renting an inherited family home to pay for a years’ worth of property taxes. Those taxes, according to the newspaper, were a small fraction of what they would have been if not for Prop 13. That late-70’s legislation and an additional inheritance tax break passed later capped taxes on certain properties and let those low rates carry over to heirs. The proponents of Prop 19, however, wanted would-be-landlord heirs to pay property taxes on the current value, not the much lower value the parents were assessed on. In other words, reversing an unintended consequence of Prop 13. The result is either a huge tax revenue opportunity for counties, or an unfair wealth redistribution strategy, or both, depending on your perspective.

While the ramifications of Prop 19 are positive for some, ordinary mortals without the deep pockets of celebrities may feel like they’re getting the short end of the stick. As this goes into effect people are wondering if they should be concerned, if there’s anything to do, and so forth. On the one hand, folks 55 and over will have expanded ability to move about the county. That’s a good thing that we’ll leave alone in this post. But others, those who will have to “pay” for Prop 19, have lots of questions.

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A Mild Rant

By now you’ve likely heard about what some news outlets are making out to be a David vs Goliath sort of battle playing out in the stock market. Day traders (The Little Guy) are battling short sellers (big institutions, or simply Evil Incarnate) by pushing up values on a handful of stocks like GameStop and AMC movie theaters, even Bed Bath & Beyond.

Prices are currently far beyond reasonable for these stocks. It would be perilous at best to enter the fray, but oddly enough people still do, either lusting for a quick buck or trying to avoid the dreaded FOMO, or both. Ordinarily this kind of thing would end with people paying big fines or even going to jail for market manipulation, but nothing seems normal these days.

It’s unsettling for investors when stories like these make national headlines because, among other things, it causes reasonable people to wonder about the health of markets. What does it say about the system if stock prices can be swung around to this extent by people in online chat rooms? If they get together and agree to buy shares of a company’s stock in coordinated fashion to drive the price up, for whatever reason, shouldn’t that be illegal? If they can do it, why couldn’t anyone? Among the many problems with this is it seems to confirm what many already think: the system is rigged. It’s rigged by others who hoard all the goodies and only share with their friends. Except now it’s not only the Fat Cats on Wall Street gaming the system, but also retail investors congregating on sites like Reddit and elsewhere.

The “rigged” narrative is applied to many aspects of our society of late and it’s a shame that it’s also used to describe markets, but it’s true. Or at least partly true.

The true part has to do with exactly what we’ve been seeing with this group of stocks. Prices rose because a lot of day traders made a concerted effort to make them so. Previously, stocks like GameStop were heavily “shorted”, meaning investors such as hedge funds were (and still are) betting against them because they think the share prices will fall. Other traders started fighting this and, over time, many more followed the herd to create a “short squeeze”, or pressure on those firms betting against the stocks by driving up share prices and forcing the shorts to ante up more cash or simply sell at a loss. Regardless of their original intentions (some allude to the nobility of finally sticking it to the hedge funds, and that sort of thing), this is market manipulation, or rigging the system, and it happened in broad daylight.

Many of these traders follow, whether they admit it or not, something referred to as the Greater Fool Theory. The idea is that one could pay a ridiculous price for a stock today because some poor schmo would always be willing to pay more later. We know that throughout history this sometimes works for a little while and is where the theory came from, of course. It’s also what keeps people coming back for more. But most end up being too late and, ironically, become the fool they sought to fleece in the first place. 

Ultimately, it’s clear to just about anyone that prices can be manipulated in the short term through a variety of means, including this latest example. But all is not lost. As I mentioned last week, the real money in investing is made over time, through diligence and patience. Many today have a holding period of moments or days. Instead, think in years and decades. There will from time to time be those who luck into making a lot of money in a short period. History shows us those folks often end up losing their gains eventually because they lack a strategy and the discipline to carry it out. In other words, there are no shortcuts, only scams masquerading as effective strategies that usually end up making someone else rich.

Speculation is as old as time and it’s important to know when too much is exactly that. Lots of people out there in the markets right now have no idea what they’re doing. They think investing is a game. Some brokerage firms and the media reinforce this to make money (what a shocker).

For the rest of us, we’ll try to leave the shorts and other forms of trader behind. Their antics make for interesting reading and, yes, sometimes anxiety in the markets. But as long-term investors we’ll focus on controlling that which can be controlled and the truth that, over time, markets are efficient and always come back to financial and economic principles. That way we can have the best shot at de-rigging the game by not playing it like one in the first place.

Have questions? Ask me. I can help.

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The Paycheck Protection Program was an important part of the CARES Act passed by Congress last March. While there are stories of unfairness and even outright fraud involving the program, it helped many small businesses stay afloat during the first wave of the pandemic. But as the virus wore on that initial round of PPP money needed to be refreshed. Congress did that prior to year-end and is poised to do so again in the next week or so as part of the broader stimulus legislation being worked on. And fortunately there will be added emphasis on getting money to small businesses more easily.

The new round of PPP is much like the last but with some important differences. This time to qualify you’ll need to show (or perhaps simply attest, verify that with your lender or tax advisor) that your business suffered a 25% decline in revenue during any quarter in 2020 over the same quarter in 2019. If so, and if you plan to spend at least 60% of the money on payroll and the rest on a host of other eligible business expenses, you should be able to have the loan completely forgiven. And yes, this also applies even if you participated in a prior round of the PPP so long as you suffered enough of a revenue decline. Below are sections of an article from an industry publication, Financial Advisor, addressing this at a high level so you can see if you’re likely to qualify.

But, as they say, the devil is in the details. Work with your current business bank to do the application and they should be able to walk you through it successfully. These banks have had lots of practice since last March, especially with small businesses that are typically looking for relatively small loan amounts.

And as I mentioned a moment ago, small businesses are finally getting some favoritism in this new round of stimulus. Just yesterday President Biden announced that Congress will open a special two-week PPP application window this Wednesday for businesses with fewer than 20 employees. The Wall Street Journal reported about this yesterday, so I’ve also included a link for further details on that as well.

So if you, or perhaps a small business owner you know, might be eligible the time to act is now (or tomorrow, you know what I mean).

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A Trip Down Robinhood Lane

I’ve written several times about the rise in retail day trading last year but, frankly, I am surprised at how many people jumped on the bandwagon in recent months. Millions of new taxable brokerage accounts (industry jargon for not being a tax-deferred retirement account) were opened last year, many in the final quarter, and many of those were opened by Robinhood, the upstart firm that’s been in the news so much lately.

Now, I’ll freely admit to admiring the firm’s espoused principles of making investing and financial education accessible to everyone regardless of net worth. This is laudable and necessary, I think, for a variety of reasons. For one, a large portion of the adult population doesn’t own stock or even have enough in savings to cover an emergency $1,000 expense. Getting those people as much financial knowledge as possible as quickly as possible would benefit the entire country. I don’t know that these folks need to jump right into trading stocks on their iPhone, however.

I also admire how the firm shook up the industry back in late-2019 by offering free stock trading. Other major firms quickly followed and we’re now at a place where investors can buy and sell most investments without paying a trade commission. This dramatically lowered the barrier to entry for new investors. It was also destabilizing in other ways but was still positive, I think, on balance.

The issue I have with Robinhood (and other companies like it) is the so-called gamification it employs to reel you in and hold your attention. This gins up enthusiasm among its customers, at least half of whom are apparently brand-spanking-new to the complex world of investing. From what I understand, the education provided by the firm drives new customers toward trading as opposed to more, shall we say, boring but sound investment strategies.

Robinhood makes more money when its client’s trade more frequently, so it naturally leads me to be a bit skeptical of the “we’re out here for the little guy” routine. Robinhood then sells client orders to third parties to the tune of hundreds of millions in annual revenue, so the firm isn’t in the buy and hold business. In other words, the free trading I just mentioned should be thought of as more of a freemium. It’s the free drinks while playing the tables at a casino. To be fair, this sort of thing isn’t unique to Robinhood. All the major brokerage firms make money like this, just perhaps with less confusion about the firm’s motives.

We know that gamification impacts our psychology, but it can easily be downplayed as something that happens to other people. Along these lines, here’s an article from Jason Zweig, The Intelligent Investor, at The Wall Street Journal. This is from December and I had wanted to bring it up then, but other things took priority. Anyway, check it out for an illuminating look at how easy it is even for the well-informed to get sucked into the Robinhood platform. It should be read as a cautionary tale, even though for Mr. Zweig it was a reporting assignment with little money at risk. Many haven’t been so lucky, and they won’t be the last.

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Saving for Retirement in 2021

Last week I wrote about some important 2021 updates for folks of a certain age who are taking distributions from their retirement accounts. But how about everyone else who’s still scratching and clawing to save enough to eventually retire?

There weren’t many twists and turns in recent Acts from Congress for those actively saving for retirement. Instead, most of the changes were aimed at people who lost their jobs or were (and maybe still are) impacted financially by the pandemic. Understandably, saving for retirement when you’re just trying to put food on the table is hard to do, if not impossible. For those lucky enough to be able to save, however, there are still critical numbers to be aware of in the year ahead.

Here’s a simplified list covering most situations.

The annual contribution maximum for Individual Retirement Accounts (IRA) is $6,000. Those 50 or older get an extra $1,000 of room for a total of $7,000.

Your income needs to be below a certain threshold to deduct Traditional IRA contributions on your tax return. These are listed below as ranges because deductibility phases out as your income goes higher.

Single individuals (and filing as such with the IRS) can make from $66,000 to $76,000 if they also contribute to a retirement plan at work.

Those who are married and filing jointly can make from $105,000 to $125,000 if they’re also participating in plans at work. If one spouse isn’t, the income threshold jumps to $198,000 to $208,000.

For contributing to Roth IRAs, it’s single filers at incomes from $125,000 to $140,000 and others who are married and filing jointly at $198,000 to $208,000. There’s no tax deduction for Roth contributions, so that’s why the thresholds are higher.

As a reminder, you can contribute to a Traditional IRA and a Roth for the same tax year, but it’s still the one annual maximum between the two.

401(k) plans are set up through your employer (or yourself if you’re self-employed) and have different maximums. For 2021, individuals can save up to $19,500 if they’re younger than age 50. Otherwise, you get an extra $6,500 of room to save. This doesn’t include any matching dollars received from your employer, so you could end up saving more after all’s said and done.

But what kind of investment outlook would you be saving into? I’m going to risk omitting important details to provide a brief rundown of where things stand right now with the markets.

Stock prices are elevated but performance across market sectors has been uneven. Certain tech and pharmaceutical stocks have been riding high for obvious reasons and you’ve likely heard about current market darlings like Tesla and even cryptocurrencies like Bitcoin. Those shares have been volatile while seeing their prices rise astronomically in recent months. Stories have been in the news about folks lucking into these huge runups and paying off their mortgage, buying lots of bling, and so forth. Another, GameStop, the gaming store, is currently in the news because it’s share price has risen almost 170% in the past week and over 2,000% since July!

There will always be these kinds of stocks and these sorts of stories. The characters are primarily short-term speculators in options and “short-sellers” who can lose almost as much as they gain, if not more. They typically play with borrowed money as well. Margin debt, or money borrowed against stocks to buy more stocks, is at extremely high levels. GameStop, for example, is riding the wave of borrowed money and options investors who cumulatively have way more “interest”, as it’s called, in the stock than is available to buy in the markets. This means that while some short-term traders can make a killing, most will lose their shirt. It’s like the childhood game of musical chairs except all the chairs can be pulled out at once. But this craziness isn’t impacting the whole market yet.

Instead of all this day-to-day craziness, be a long-term investor. It ain’t easy, however. The S&P 500, the major stock index seen as a proxy for the US market, is trading at about 31x the annual earnings of its average company. This is higher than the 20x long-term average, but not the highest ever. Part of what’s driving this high level is expectations for more relief money from Congress and continued support from the Federal Reserve. Don’t fight the Fed, as the saying goes. We could easily add Congress to that saying, at least in the near-term.

Households have also been savers during the pandemic, on average holding a record amount of cash per person by some estimates. We don’t live in the average, of course, and this number is probably skewed to the uber-wealthy who have been hoarding cash. The point is that there’s a lot of savings sitting around right now. This money, plus pent-up demand from nearly a year of pandemic life, plus more Government stimulus, will eventually enter the economy at some point. Hopefully this year but certainly by next. That’s what many investors are expecting, at least, and that’s the main reason prices are elevated right now.

There’s lots of risk to this outlook, however. Millions are still unemployed and many of those jobs won’t be coming back anytime soon. Millions are also delinquent on their rent and mortgage without the means of paying it all back. And the nation is now vaccinating about 1 million people per day over the past week, but it could be many months before all who want to be vaccinated are. The psychological impacts of all this, both positive and negative, will continue to play out in the economy for some time.

Could investors be getting ahead of themselves in their rosy outlook for corporate earnings? Certainly. Is there likely to be volatility this year as plans for more government spending run into opposition and inevitable issues arise with vaccine distribution? You bet. Will there be one or more unanticipated shocks to the system this year? Plan on it. Will short-term trading equal long-term wealth accumulation for many of the folks playing in the markets right now? Probably not.

So, with that dose of realism, as you look ahead to saving for retirement remind yourself that the real money in investing is made over the long term. Your regular contributions, dividends earned, and compounding will work with the highs and lows of the markets over time. As the saying goes, it’s time in the markets and not timing the markets that makes for successful investing.

Have questions? Ask me. I can help.

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