MintLife investing expert Matthew Amster-Burton is answering questions from Mint.com Facebook fans. If you’d like to ask Matthew a question about investing, retirement planning, or saving for college, drop us an email.
MintLife reader Patrick asks:
Would you consider an ETF like QQQ or SPY for a 5- to 7-year investment, or are these funds overvalued in the taper or non-taper environment?
and reader Nandar asks:
Heard the stock market may crash again soon. Should I sell those stocks that look overpriced?
Nandar, I have bad news, buddy. It’s absolutely true that the stock market may crash again soon. It’s also true that it may not.
For illumination, let’s look at a couple of guys who won the Nobel Prize in economics this year.
Eugene Fama is a finance professor at the University of Chicago. He’s famous as the father of the efficient market hypothesis (EMH).
The EMH says that the price of a stock (or a bond, or a mutual fund, or any freely traded financial instrument) includes all of the available information about the security.
This is sometimes called the “Price is Right” theory, because it means that the market is at least as smart as you are.
If you think you have some special information about when a stock will rise or fall, you’re wrong: that information is already factored into the price.
Wait a minute, says Yale economics professor Robert Shiller. What about asset bubbles?
Sometimes markets go crazy. The price of tech stocks in 1999 or Florida houses in 2007 wasn’t the product of an efficient market; it was the product of greed and hysteria.
And if we can recognize bubbles, we can profit from them by betting against them, by getting out before the bubble bursts, or by just not getting involved in the first place and waiting until they blow over.
What does any of this have to do with Patrick and Nandar’s questions?
Well, both questions are about whether we can predict what will happen to the market in the short term.
QQQ and SPY are both exchange-traded funds that mirror the price of a basket of stocks, the Nasdaq 100 in the case of QQQ and the S&P 500 in the case of SPY.
And the answer is, you can’t.
That doesn’t mean you have to believe, as Fama does, that there’s no such thing as a bubble and Shiller was just lucky when he warned about the housing bubble.
You can agree with Shiller and still recognize that the performance of the stock market over the next few years will be driven by factors you can’t predict.
That could be good or bad economic news, human irrationality, or alien invasion.
Indeed, if you look at the Shiller PE Ratio you can see that stocks are overvalued compared to their historical average.
You can also see that stocks have been overvalued by this measure almost continuously since 1997. Yet patient investors have made plenty of money in stocks during that time.
All you can really do is invest for the long term and according to your own risk tolerance. Anything else, to use a dirty word, is speculation.
MintLife reader Bryan asks:
Are bitcoins worth investing in, given the stagnation of the world’s economy?
Speaking of speculation, even before I learned what a Bitcoin was, I knew I didn’t want any.
Exciting new investments are like new party drugs: maybe chill out for now and let the body on the dance floor be someone other than you.
Then again, I’m a boring guy who invests in boring stuff like stocks, bonds, and Reese’s Peanut Butter Cup variations (I’m bullish on Reese’s Sticks, bearish on white chocolate cups).
Maybe I’m missing out on something important. What is Bitcoin, anyway?
Bitcoin is a virtual currency. It’s designed to be beyond the control of any national government, immune to inflation, and capable of anonymous (or at least pseudonymous) transactions.
For a very complete introduction to the currency, read Felix Salmon’s essay, which has been much-commented by Bitcoin experts.
That’s the utopian way of putting it. Most coverage of Bitcoin has focused on two facts: Bitcoin is frequently used for black market transactions, like buying drugs online, and its value has fluctuated wildly since the currency was introduced in 2009.
I don’t really have a position on whether Bitcoin has a future as a currency. It’s definitely interesting. But “interesting” is a bad quality in an investment. It means two things:
In the short term, speculators rush in and out. As I write this, the value of one Bitcoin in US dollars has ranged from $175 to $901 in the past month.
In the long term, we have no idea what these things are worth. Most merchants don’t accept Bitcoin. (One exception is OkCupid. I’m not sure I’m ready to date someone who pays in Bitcoin.) As an investment, Bitcoin is like gold: you’d buy it because you think everyone else will want to get in on it during an economic crisis. But who knows whether that will work?
So if you want to buy a couple of Bitcoins and see what happens, sure, give it a try. As a significant portion of your portfolio, however, it would be an insanely risky move.
If you want a new thrill, have you tried the Reese’s Big Cup?