The Road to Ruin

I have often warned against the dangers associated with conventional wisdom. With the onset of the financial crisis and the corresponding plunge in asset prices, I noted that people who were wealthy or who were close to retirement were the ones getting clobbered. New evidence now confirms this: Americans nearing retirement took the biggest hit after the financial crisis.

The sad truth is that their road to ruin was, in many cases, paved by conventional wisdom about investing.

That wisdom had many believing that, over the long run, stocks produce the highest returns; that a diversified stock portfolio protects you against loss; and that the risk of owning stocks is small, if you hold them for a long time.

While the number of decades in which U.S. equities underperform other asset classes may be small, the size of the shortfalls, when they occur, can be huge. For those who are near retirement, the shortfalls can be devastating. As a recent study from the Pew Research Center shows, the plunge in asset prices that followed the financial crisis has resulted in “a lost decade of the middle class,” with the median real net worth in America now resting roughly where it was in 1983.

And if that’s not bad enough, those folks might not ever get a shot at making up the loss in their lifetimes. As Catherine Rampell’s recent reporting in the New York Times shows, median household income has fallen most sharply among 55–64 year olds, since June 2009.

Diversification is useful, in varying degrees, most of the time. But there are occasions when all stocks dive simultaneously, and in these cases a diversified stock portfolio won’t save you.

Beware of conventional economic wisdom. Some 95% of what you read in the financial press is either wrong or irrelevant.

Author Steve H. Hanke