During Saturday’s panel discussion some questions from the audience focused on issues relevant to personal investors who follow the market closely and trade on a fairly frequent basis in order to safeguard their retirement income. I wasn’t ad rem enough to respond adequately on the spot so I’d like to speak my mind here!

I. One of the questions raised was, how to assess a stock’s value if different analysts all come up with widely divergent views on what it is worth. My strongly held opinion is that one should ignore the lot of them! The current stock price is a better guide to the stock’s value, as it represents the combined views of all the people who have put their money where their mouth is by actively expressing a willingness to trade at that price.

Regarding analysts: in-house analysts are essentially salesmen for their firm’s investment banking services. An investment bank with reliably bullish analysts is going to draw in business and that remains true even if the analysts’ compensation is not explicitly linked to that. Their hiring and firing decisions will reflect that. I found the spate of analyst scandals a few years back incomprehensible: how could anyone ever have thought that analysts were disinterested in the first place? Would you expect an ad agency specializing in cigarettes to go out of its way to draw attention to lung cancer? Now that all the dust has settled, the fact remains that analysts still have a fundamental conflict of interest and their pronouncements, however sincerely felt, should still be taken with a heavy dose of skepticism.

II. On how to safeguard one’s retirement income by staying alert and trading actively, the best strategy is not to trade actively but to buy and hold a well diversified portfolio that trades off risk and return in a manner appropriate to your needs. That is, avoid churning your investment portfolio on the basis of the latest news: it has already been incorporated in the stock price thanks to the countless thousands of other traders who also read the newspaper and interpret current developments. All you do by trading is incur the costs of trading (explicitly, commissions; implicitly, bid-ask spreads) - these are small these days (normally well below 1% even for a small trade) but they do add up if you trade often. This is a consensus view from decades of academic research, elegantly expressed in Burton Malkiel’s perennial classic A Random Walk Down Wall Street.

If you actively enjoy thinking about stocks and trading them, fine, go ahead! Some people enjoy going to Las Vegas and playing the slot machines. On average, they lose money, but I guess the thrills and excitement along the way make it worthwhile! Since trading costs are quite small for liquid stocks these days, there is scope for a lot of entertainment value at a fairly low cost.

There is one exception to my wet-blanket view of active trading: if you have genuinely unique insights into security values based on your own life experience or analytical skills – I am sure there are quite a few retirees in New York City in this position. Personally, after over 20 years of teaching and researching finance, I can count on the fingers of one hand the instances where I have had genuine inside insights, ripe for conversion into trading gains (for example, some software innovations were rolled out in academe before becoming available to a wider audience; daily familiarity made me one of a small group of people best able to evaluate their likely success in the wider marketplace). But who is to say? After a lifetime of success in business and/or the professions, there are surely many NYC retirees who have the unique capabilities needed to outwit the thundering herd.

Over the last decades retirement plans have steadily migrated from defined-benefit to defined-contribution plans, where instead of being promised a guaranteed annuity in some form, the retiree simply reaps the fruits of his/her investment decisions. This shifts investment risks from employers (and their shareholders) to the beneficiaries, who may not have the time, skills or inclination to avoid exposing themselves excessively to fluctuations in securities market returns. And with pension contributions basically invested in a limited range of alternatives on behalf of dispersed beneficiaries who bear all the risks without having much of a say in how their money is managed, we’ve built up a second layer of separation between ownership and control: under a defined-benefit plan, at least the company responsible for providing the benefits is the residual claimant and would have a strong incentive to enforce appropriate money management. Finally, an additional uncomfortable effect of the trend is that one of the biggest risks we face, namely longevity risk, is no longer automatically insured (those who go to the trouble of buying annuities face prices which can be staggeringly unfair in actuarial terms).

III. Regarding the comment about recent innovations like municipal bond ETFs: these broaden the range of affordable options open to small investors, because the trading costs are not as punitive as those for the underlying individual municipal bonds. The municipal bond market is notorious for its murky pricing. The underlying reason: individual munis are so thinly traded that it makes no sense for any market maker to spend the time and effort needed to quote continuous prices at which he stands ready to trade. And this does require a lot of time and effort because the market maker needs to stay abreast of all the news: if the municipal sewage plant in Nowhere, USA malfunctions he’d better know about it fast, or he can be sure there will be sellers unloading the munis onto him before he finds out. For more thickly traded securities, market makers are willing to quote prices anyway, because they see enough ordinary trading volume to recoup such occasional losses – but not in the muni market. As a result, there is no firmly quoted, easily identifiable going market price for a muni. The price paid by ordinary investors for munis can be substantially less advantageous than it should be (deviations of 5% between prices paid at roughly the same time are commonplace), with only the professional competence, energy and sense of duty of the broker limiting the extent of price gouging. Now, bundling munis into mutual funds or ETFs spreads the risks considerably; and so the bundled instruments can be continuously priced and traded at quite low bid ask spreads (though about double those on highly traded stock ETFs).