“The greater fool is someone with the perfect blend of self-delusion and ego to think that he can success where others have failed. This whole country was made by greater fools.”
– The Newsroom
What is The Greater Fool Theory? The Greater Fool Theory is a theory that states that the price of an object is not determined by its inherent value, but instead by the irrational beliefs and expectations of others in a market. The theory proposes that it is possible to make money by buying a security and selling it in the future at a profit because there will always be a person who is acting as a Greater Fool; someone that is willing to pay a greater price for the security. Following with the logic of the theory, a rational buyer will be willing to purchase a security, even if it is overvalued, because they truly believe that someone else will be foolish enough to buy it at a greater price later.
Are we in a market run by greater fools right now? A recent Barron’s article said, “Sentiment (in the stock market) is ebullient, to say the least. Investors Intelligence’s polling shows bulls at 63.1 percent of respondents, the highest reading since 1987. That makes 14 weeks in which the number has been over 55 percent — what II dubs the ‘danger zone.’ Bears were down to 16.5 percent, the lowest figure since July 2015. That put the bull-bear spread at 46.6 percentage points, the highest for the current market cycle.” Looking at the amount of positive sentiment in the market right now, even as the bear market continues to mature, we can see that the market is run by greater fools. By some measurements stock valuations haven’t been this overvalued since the 2000 dot-com peak. Investors continue to purchase securities, with either the intention that someone more foolish will come along later to buy their securities for a greater price, or because they actually believe that the securities they are purchasing have great value. According to the USLegal definition, The Greater Fool Theory, “reaches its height of popularity near the end of a bull market when speculation is high.” I believe that savvy investors are taking advantage of this high sentiment, buying securities and crossing their fingers that the greater fool will come along and buy their securities for an absurdly greater price… until the day that the market realizes stocks are overvalued, and the fools no longer remain.
– Eli Perlmutter
– Edited by Wyatt Swartz
4/18/2017
Commentary on Above Post
I think it is appropriate to give commentary on the above piece written by my associate intern Eli Perlmutter. Overall, I think it is a great piece providing investment theory, education, and current market conditions into one post, but feel there should be additional points made.
1. Theory is Theory
An intelligent theory is still a theory. When looking at economics, investing, or human behavior theories typically cannot be definitively proven or disproven. Instead they are often arguable from both sides.
2. Buying & Holding Stocks Over Long-term Periods is Very Rational
There are times where a stock’s price or stock prices are bought up based on irrational beliefs and expectations. We see that happen in the late stages of a bull market. However, buying shares of stock based on expectations can be very rational, in fact all the data suggests that buying and holding a broad range of stocks over long-term periods is about the most rational thing a person can do. When someone buys shares of stock they are buying ownership in a company, and that ownership gives them rights to future earnings and profits the same as if they were buying an ownership stake in their local diner.
3. It’s Easy to Argue that Stocks are Undervalued
At the start of this week forward P/E for the S&P was 17.23, forward P/E for the EAFE was 14.57 and EM was 12.16 per JP Morgan. Only the S&P is a little above average and it is nowhere near an outrageous level. Foreign developed market stocks appear to be undervalued, and emerging market stocks appear very undervalued. Perhaps Barron’s has very different data calculations or more likely they were grasping for any measurement they could find that created a juicy take. No articles get more readership traction than the ones forecasting collapse.
4. Above Average Stock Valuations and Sentiment Do Not Imply an Imminent Bear Market
Markets can be at above average valuations for a long time before running out of steam. If we looked at 1996-1999 I think we would likely find a long stretch of above average valuations. Bull markets can continue at above average levels for long periods.
5. Savvy Investors Do Not Cross Their Fingers as a Strategy
Savvy investors do not cross their fingers and hope. Savvy investors have a plan based on their goals, time horizon and cash flow needs. That plan should be formulated by an understanding of capital markets, and a sound investment process. Savvy investors understand that at times individual stocks or broad ranges of stocks can gain momentum and be bought up based on irrational expectations and greed. Savvy investors know that stock prices are a function of supply and demand, and that in the short-term demand pressures are the more powerful driver.
– Wyatt Swartz
– 4/21/2017
What is a SEP IRA?
A SEP IRA, Simplified Employee Pension, is a retirement plan to which employers can make tax-deductible contributions on behalf of eligible employees, including the owner.
Who Can Establish a SEP IRA?
Any employer with one or more employees can create a SEP plan for their business. This includes self-employed business owners. SEP IRA plans work for sole proprietorship’s, partnerships, corporations, and nonprofit organizations. Any employee who is over the age of 21 and earns at least $550 per year and has worked three out of the past five years for the employer is eligible to participate in the SEP plan.
What are some unique attributes of SEP IRAs?
SEP plans are easy to administer and the costs associated with creating and maintaining SEPs are low compared to 401(k) plans and other qualified employer retirement plans. Contributions are discretionary, allowing the employer to decide each year if they want to fund the SEP for that given year. Contributions to SEP IRAs are immediately vested. This means that employees have access to the funds at any time, regardless of if they are still working for the business.
What Are the Rules Regarding Contributions?
SEP contributions are decided by the employer each year. Employers can contribute up to 25% of an employee’s compensation, as long as the contribution does not exceed $54,000 (for 2017). Employers must contribute equal percentages of salary to each eligible employee. An exception occurs when 25% of an employee’s W-2 compensation would exceed the $54,000 limit. In this case the employee would be capped at the $54,000 limit.
SEP IRA Summary Details
Highlights of SEP IRAs
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Any employer with one or more employees can create a SEP plan
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Easier and cheaper to administer and maintain compared to other retirement plans such as 401(k)s
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SEP contributions are made on a discretionary basis
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Contributions to SEP IRAs are immediately vested
Taxation
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Employee and employer contributions are tax deductible
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Investments grow tax deferred within the account
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Distributions in retirement are taxed as ordinary income for the participant
Employer Eligibility
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Any employer with one or more employees can create a SEP plan
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Cannot have any other employer retirement plans in place
Employer Contributions
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Employer may contribute up to 25% of employee’s compensation up to $54,000 (for 2017).
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Employer contributions are discretionary and the employer may elect to not make any contributions in a given year
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Employers must contribute equal percentages of salary to each eligible employee
Employee Contributions
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Minimum: $0
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Maximum: $5,500, individuals older than 50 my contribute an additional “catch-up” $1,000 (for 2017)
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Employee’s contributions to their SEP IRA are counted towards their total allowable IRA contributions for the year. Meaning an employee (under age 50) that contributes $5,500 to their SEP IRA would not be able to make any contributions to a Roth IRA.
– Wyatt Swartz
– Contributions by Eli Perlmutter
– 4/7/2017
What is a simple IRA?
A SIMPLE IRA, Savings Incentive Match Plan for Employees, is a version of a traditional IRA for small businesses and self-employed individuals. Similar to other traditional IRAs, contributions are tax deductible and investments grow tax deferred until the account holder withdraws money in retirement.
What is the difference between a SIMPLE IRA and a SEP IRA?
SIMPLE IRAs allow employees to make contributions, unlike SEP IRAs. With a SIMPLE IRA, employers are required to make a fixed contribution or elect to match a higher percentage of an employee’s contributions. If the employer elects to make matching contributions, they are not required to contribute to the IRA unless the employee contributes.
What are the benefits of a SIMPLE IRA?
SIMPLE IRAs have higher contribution limits than traditional and Roth IRAs. They are cheaper less cumbersome to set up and maintain than most other workplace retirement plans, such as a 401(k) plan.
From the Employer Perspective
To set up a SIMPLE IRA plan, an employer must have 100 or fewer employees who are each earning more than $5,000 per year. This includes any employee who worked at any point in the calendar year. The employer can not have any other retirement plans in place besides the SIMPLE IRA. The company must use the same contribution plan for each employee.
How much can be contributed to a SIMPLE IRA?
An employee can contribute a percentage of compensation up to a limit of $12,500 for 2016. If the employee is older than 50, they can make an additional $3,000 “catch up” contribution. As long as the employer maintains the plan they must elect to contribute a fixed percentage of compensation, or to match the employee’s contribution up to 3% of compensation. If the employee does not contribute to their IRA and the employer elects to follow the matching contribution plan, then they are not required to contribute any amount to the employee’s account.
Is a SIMPLE IRA right for you?
SIMPLE IRAs are a good fit for small business owners or self-employed individuals who have not set up any other type of work-related retirement plans. Unlike profit-sharing or 401(k) plans, SIMPLE IRAs are easy to set up, administer, and maintain.
Self-employed individuals that plan on bringing on more employees also benefit from SIMPLE IRAs, as adding employees to a SIMPLE IRA is a relatively easy process.
SIMPLE IRA Summary Details
Highlights of SIMPLE IRA
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Employees can make contributions to the account
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Easier and cheaper to administer and maintain compared to other retirement plans such as 401(k)s.
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Tax Benefits
Taxation
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Employee and employer contributions are tax deductible
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Investments grow tax deferred within the account
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Distributions in retirement are taxed as ordinary income for the participant
Employer Eligibility
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Company must have less than 100 current employees
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Cannot have any other retirement plans in place
Employer Contributions
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Minimum: 2% of employee’s compensation or match 3% of employee’s contributions
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Maximum: $12,500 annually
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If employer elects to make matching contributions, and the employee does not contribute to the plan then the employer will not contribute to the employee’s account.
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Each employee must receive the same compensation plan
Employee Contributions
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Minimum Contribution: $0
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Maximum Contributions: 100% of compensation up to $12,500 annually