< — Go to Part 1
The Biggest Personal Finance Story of the Past 30 Years – Part 2
To understand what has happened to the market valuation of the financial services sector, particularly over the last 30 years, you should view Figure 4 on page 16 of the financial study by Jeremy Siegel and Jeremy Schwartz entitled: The Long-term Returns on the Original S&P 500 Firms.
Click the link to this .pdf document in the previous sentence, and a separate browser window will pop up. After you have studied Figure 4, then continue reading this article on The Skilled Investor.
By the way, in addition to the point we are making with Figure 4, the rest of this Siegel and Schwartz paper is well worth reading. This study shows that revisions of the S&P500 index over time have not enhanced the value of the index:
1) because new stocks tend to be added when relative valuations are peaking, and
2) because of the market trading impact of index funds that must buy these newly added firms, while they jettison those that are removed from the index.
In addition, this study is yet another proof that a passive, low cost, buy-and-hold strategy is superior over the long haul to all this frenetic active investing that individuals and investment funds do.
When you looked at Figure 4 of the Siegel and Schwartz paper, did anything seem stunning to you? I was stunned, when I first saw this graphic. Figure 4 shows that the “Financial” sector grows from next to nothing to become about 20% of the value of the S&P 500 by 2003. No other sector grows like this. Health Care expands, but not at as high a rate as Financials. Info Tech expands over the long-term but not at as high a rate as Financials. This graphic also shows how the boom and bust of the Info Tech bubble temporarily displaced the percentage market share of all the other sectors.
Beside Financials, Health Care, and Info Tech, all of the other sectors shrink in percentage terms over the 45 years of S&P 500 market capitalization percentage data that are presented in Figure 4 of the Siegel and Schwartz paper.
As of July 2007, the S&P 500 Fact Sheet on the Standard & Poors website indicated that Financials currently represented 20.77% of index market capitalization. The next four largest sectors in order of percentage market capitalization are:
1) Info Tech at 15.45%,
2) Health Care at 11.67%,
3) Industrials at 11.43%, and
4) Energy at 10.79%.
Concerning these four other sectors listed above, for years, we have very often heard about:
1) Info Tech sector — the growth, market bubble, and crash of the information technology sector with all its increasing technological marvels and productivity contributions to the world economy;
2) Health Care sector — the continually escalating costs of the U.S. health care system, the aging of the population and attendant medical costs, and the growing crisis of millions of uninsured and underinsured people;
3) Industrials sector — the continuing migration of industry manufacturing overseas with outsourcing, dramatic job losses, and huge balance-of trade-deficits; and
4) Energy sector — the escalating price of gasoline, natural gas, and heating oil, the negative impact of energy costs on consumer spending and economic growth, and quarterly record after quarterly record of energy company profits.
Yet, at the same time, the Financial sector has grown to be almost twice the value of the Energy sector in S&P500 market capitalization. Nevertheless, we have not heard a widespread media clamor about escalating financial services costs and profits. Instead, all we hear about are financial scandals related to greed, fraud, and scams. Even then, many of these scandals have faded from memory, as securities market values have risen in recovery following the market bust.
Why don’t we hear about the real financial sector scandal, which is the huge, growing, and continuous wealth transfer from individuals to financial intermediaries through exorbitant visible and hidden fees and costs? The financial media rarely focuses on exorbitant financial costs. Instead, we get “perp walks” of high profile fraudsters. It is as if we can just weed out some bad apples and get back to business as usual.
Catch John Rigas, Ken Lay, Martha Stewart, Dennis Kozlowski, and on and on. Walk them in handcuffs or prison fatigues before the cameras, and then everything will be okay. With regulatory and judicial slaps on the wrist, everything will be OK, if we can just stop the more visible scandals of mutual fund market timing, corporate accounting funny business, broker sales incentives, soft dollar payments, Richard Grasso’s compensation, etc.
Well, Figure 4 of the Siegel and Schwartz paper shows that things will not be okay after a few tweaks to the regulatory system and a few perp walks. Individuals have in the past and apparently will in the future continue to pay exorbitant banking, credit card, insurance, and securities costs. The wealth transfer will continue unabated.
Tags: personal finance
Personal Financial Planning
- Time Spent on the Wrong Financial Activities Is Bad for You (
Spending your valuable time on the wrong financial activities is just plain bad for you
A previous article, “The Solution - ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient,” suggested that individuals are much better off with a well-considered financial viewpoint. This follow-up article discusses the [...])
- Reduce investment expenses and control taxation – Step 7 of 10 Financial Planning Steps in the Right Direction (CLICK HERE TO READ THE SKILLED INVESTOR's OTHER ARTICLES ABOUT THESE "10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION
Even with optimal investment strategies, there is still substantial room to improve upon net investment performance through continued and vigilant focus on controlling investment costs and tax realization.
The fees extracted by the financial securities industry increased substantially [...])
- Benefits of Traditional IRA Contributions for Renters (
In a series of articles, The Skilled Investor compares different lifetime financial planning projections for Fran and Fred Frugal to illustrate the relative value of adopting different financial planning strategies. Fran and Fred, both age 30, are a married working couple with $100,000 in combined annual earned income. (See the "Fran and Fred's Baseline Lifetime [...])
- How unstable have stock market returns been over time? (Common stock equity market returns have varied widely in the past. The common stock equity risk premium has averaged about 4.1% from 1872 to 2000.
The equity risk premium is the equity market return less the risk free rate of return. The risk free rate of return includes both the inflation rate and the risk free [...])
- No Financial Planning Software or Calculator Can Predict the Future – Part 2 (No financial planning software and no investment growth calculator can predict the future - Part 2
The future in not predictable, even with automated financial planning software.
The future is fundamentally not predictable. The future of personal financial planning and investing is similarly unpredictable. The Skilled Investor's approach with VeriPlan is different. As a lifetime financial planning [...])
- The Optimal Investment Strategy for Individual Investors (The Solution - ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient
A previous article, "The Problem - Straight answers about personal financial and investment planning are difficult to find," summarized important reasons why individuals may experience difficulties, even if they are intent upon doing better with [...])
- Automated Tool Aligns Your Investment Risk Tolerance and Asset Allocation (Check out this automated tool for aligning your investment risk tolerance and asset allocation - A Tip from The Skilled Investor
Your tolerance for investment risk is a relative thing. Few people like investment risk, but some can handle it better than others can. The more investment risk you are willing to tolerate, the higher your [...])
- Mutual Fund and ETF Screening Requirements (
On-line screening of mutual funds and ETFs: minimum requirements
In this article, The Skilled Investor discusses minimum requirements for on-line mutual fund and ETF screening tools. This article summarizes our seven scientifically based fund selection criteria and reports on our survey of the capabilities of free on-line website tools to do screens using these criteria.
Automated fund [...])
- Stay Invested in Securities Markets to Earn Risk Premiums (You must stay invested in the securities markets to earn market return risk premiums
Securities markets pay risk premiums to risk takers
You have to have your money invested and at risk to be paid a risk premium. Attempting to avoid risk or losses by jumping in and out to "time the markets" does not work. Scientific [...])
- Pay Lower Expenses To Get Higher Investment Returns – Part 2 (
Pay lower investment expenses to get higher investment returns
While financial services industry sales people tell you that you need to pay more to get more, the correct answer is the opposite.
Excessive investment costs are a plague on your personal financial planning. Excessive investment expenses are one of the most significant barriers to lifelong family financial [...])
- The Cost of Investment Counselors When You Pay Investment Sales Loads (How expensive is financial advisor compensation paid via sales loads?
A sales load might be the method that you prefer to compensate your broker or advisor. If your advisor is truly competent and ethical, he may be able to manage properly the inherent conflicts of interest that are associated with commissioned investment product sales. Even if [...])
- Earned Income Drives the Personal Finances of Most People (Do-It-Yourself Financial Planning - Earned income drives the personal finances of most people
The ability to project your various income sources automatically over your lifetime is one of the first steps in creating a useful do-it-yourself personal financial plan. Whether from wages and salary or from self-employment, personal earned income drives the lifetime finances of most [...])
- Set a Minimum Portfolio Size Threshold for Mutual Funds and ETFs (
Choose mutual funds and ETFs with a minimum economical portfolio size
If you are going to invest in actively managed funds, then you should want them to have a sufficiently large asset base to fund the necessary research.
If an active fund is too small, then fund management quality can suffer or fees could grow. Index funds [...])
- American Funds – EuroPacific Growth Fund – Class A Shares (AEPGX) get a +2 Fund Authority Score (The diversified investment fund strategy of American Funds' EuroPacific Growth Fund
According to American Funds' Annual Report for the EuroPacific Growth Fund, the fund "seeks long-term capital appreciation by investing primarily in the securities of companies based in Europe and the Pacific Basin." American Fund's 497 filing on the U.S. Securities and Exchange Commission EDGAR system [...])
- Rational Mutual Fund and ETF Screening Rules (Scientific mutual fund and ETF screening criteria: a summary
Scientifically based selection criteria are rational methods to screen mutual funds and ETFs.
Recently, The Skilled Investor Blog published a series of articles on scientifically based selection criteria for mutual funds and exchange traded funds (ETFs). These screening rules help you to winnow down the thousands of available [...])