"Pop Finance" is a pretty good book

This is a review of "Pop Finance," by Brooke Harrington. You can find all my previous book reviews here. If you're interested in buying a copy, I hope you consider using my Amazon Associates referral link.

I first heard about "investment clubs" from my Italian immigrant barber back in New England. He and some of his business associates and cronies get together once a month and contribute a nominal sum to a common pot. They then vote on which stocks to buy with that month's contributions.

My barber seemed to realize that this was a strange way to invest in the stock market, but explained that the real point wasn't necessarily to pick winning stocks, but as a forced savings vehicle: if you wanted to hang out with your buddies, you needed to find $50 to save each month, which was enough incentive to get people to save money who otherwise wouldn't bother.

With that in mind, I was excited to stumble across "Pop Finance," an ethnography of investment clubs in the San Francisco Bay Area written by Brooke Harrington. The principle research behind the book was conducted over the course of 1998 — in other words, at the peak of the 1990's tech bubble — with followup research in 2004, in the midst of the Bush Administration stock market doldrums.

Mass participation in the stock market is something that requires explanation

Today, popular ownership of publicly-traded shares, either individually or through mutual funds, is so common that it seems part of the natural order of American economic life. So it's worth pointing out that this isn't the only way that it's possible to save money, whether for retirement, health care, or educational expenses.

To this day, it's perfectly legal to simply save half your salary from age 25 to age 65 in FDIC-insured vehicles like savings accounts and certificates of deposit that earn market interest rates on the money saved. That volume of savings would allow you to then continue spending the same amount of money (half your lifetime salary) from age 65 to age 105, with a little left over depending on where market interest rates happen to fall during your lifetime.

Of course, Social Security exists, so you don't need to replace your entire annual consumption through savings — Social Security will replace 18-90% of your income (depending on your lifetime earnings), so you only need to replace the remaining portion, meaning you can spend more than 50% of your income and still spend the same amount during your working life and your retired years.

A private pension replacing even more of your income would mean even less savings would be required to smooth out your consumption over your entire lifetime.

Harrington convincingly argues that mass participation in the stock market, in her case in the form of investment clubs, was the result of two factors that made the above logic fall apart in the 1990's:

• Corporate defined benefit pensions were replaced with defined contribution plans, often self-directed and invested in stocks and bonds;
• Between 1985 and 1995, real wages declined while corporate profits tripled. In other words, for the average American, saving half their salary in FDIC-insured savings vehicles would mean a decline in living standards in retirement, while purchasing "the market" would mean an increase in living standards in retirement, or even early retirement.

Finally, I'll add that obviously the overwhelming majority of Americans today are incapable of or unwilling to live on half their salary. There are many reasons for this: status anxiety, a feeling that they've "earned" the right to enjoy their money, and of course in the case of prosperous coastal cities, the accelerating cost of living.

Ultimately, that means either settling for a much lower standard of living in retirement, or investing in riskier assets with a higher potential rate of return than FDIC-insured savings vehicles.

Day trading is a very intuitive way to invest in the stock market

Once you've decided that the stock market is the only way to secure the lifestyle you envision for yourself in retirement, day trading is the obvious method of doing so: since different stocks move in different directions on a daily basis, by buying stocks before they go up, and selling them before they go down, you can earn more on a daily basis than in a whole year of FDIC-insured interest.

In fact, if your wins are big enough and your losses are small enough, you don't even need to be right a majority of the time! After all, one 10% gain offsets four 2% losses with 2% left over as your profit, not annually, but daily!

Investment clubs are day trading by committee

Investment clubs, like day traders, also purchase individual stocks for short term profits. The problem is that unlike an actual day trader, investment clubs can't react quickly to changes in the prices of their stocks. At the beginning of March a club may vote to buy Pfizer, the stock may peak in mid-March and be lower than where they bought it by the time they get together again in April. And at that point, they have to vote on whether they think it'll do it again!

One club Harrington profiles attempts to deal with this problem by putting stop-loss orders on all their stock holdings: if a stock declines by 20%, they sell the stock — then frequently buy it again at their next meeting, when the price has had time to recover!

This is not a good way to invest

I believe virtually all people should save for retirement in Vanguard target retirement date funds.

But even if you have a different risk tolerance than the ones reflected in Vanguard's target retirement date funds, you probably should implement that risk tolerance through low-cost indexed mutual funds.

But even if you believe that you're preternaturally gifted at predicting the short-term movement of stocks, you should simply act on your gift by buying and selling stocks, not waiting weeks at a time and then spending time convincing your fellow investment club members that you know which direction a stock will move before your next meeting.

But creative forced savings mechanisms are pretty cool!

That brings me back to my Italian barber. He is really convinced that many members of his investment club would save nothing if they weren't saving $50 a month in monthly club contributions.

And at the same time, over a working lifetime, $600 per year invested in the broad stock market really will return more than the same $600 invested in FDIC-insured savings vehicles.

So I'm all in favor of crazy schemes to force yourself to save! Here a few I came up with that make at least as much sense as investment clubs:

• Every time you withdraw money from an ATM, withdraw an extra $20 and set it aside for a monthly retirement savings contribution;
• Deposit your credit card cash back rewards into a designated retirement savings account;
• When you redeem your miles or points for an award trip, deposit the cash value of the trip into a designated retirement account — be your own mileage broker!

A final note on tax-advantaged accounts

It's no secret that I'm a strong advocate for simplifying the US income tax code. Not simplifying it and reducing rates, just simplifying it, full stop.

One reason for that is that the current configuration of tax advantaged savings vehicles (employer-based retirement and health savings accounts, traditional and Roth Individual Retirement Accounts, and the mortgage interest deduction) leads people to spend extraordinary amounts of time gaming the tax code instead of simply saving money.

In other words, once you've maximized your tax advantaged savings vehicles by contributing to a 401(k), IRA, and buying an unnecessarily expensive house, you feel like you've done all the savings necessary (perhaps adding a 529 College Savings Plan as icing on your tax-advantaged cake).

But that's ridiculous: it's perfectly legal to simply buy stocks and bonds. You can invest in a Vanguard target retirement date account in a taxable account, and it will generate the same long-term returns as the identical fund held in your tax-advantaged accounts. You just have to pay long term capital gains on the returns when you eventually sell (although you avoid the 10% early withdrawal penalty on the exact same fund if held in your IRA).