Need money advice? Don’t ask an American

Are Americans smart enough to manage their own retirement savings? No, as a matter of fact, they’re not. Americans are amazingly dumb about investing.

Take my friend John. An auto mechanic, John was an absolute genius under the hood of an Alfa Romeo. But he was vain. A crook called offering to get him into commodity options, and John thought he had entered the gates of high finance. He forked over 10,000 of his hard-earned dollars. Of course, they disappeared.

Now, if John had caught someone stealing the $30 radio in his car, he would have ripped him to pieces. But he accepted his $10,000 loss like a sweet little lamb.

“Aren’t you angry?” I asked him. No, John replied. He understood that the investment was risky. Had it gone well, he could have become very rich. John had been rolled and didn’t even know it.

That was an out-and-out con, and an extreme case. But every week, fresh evidence bubbles up that Americans don’t get the basics of ordinary investing.

Rule No. 1 is to diversify. This means spreading money around different investments.

That’s exactly what many Enron workers did not do. Rather than invest in a good mix of securities, they put most of their 401(k) money into Enron stock. The stock lost 99 percent of its value in one year, devastating their retirement accounts.

You’d think the Enron fiasco would be a lesson for us all. But just three years later, the same thing happened at Marsh &McLennan, the financial-services company. Thousands of workers had filled their 401(k) retirement accounts with Marsh &McLennan stock. A scandal sent the shares into a tailspin. What makes this tale extra sobering is that the Marsh &McLennan employees worked in finance. They were more sophisticated about investing than the average Joe and Jane.

People still haven’t learned. A Hewitt Associates survey of 500 companies looked at workers who keep their employer’s stock in their 401(k)s. It found that an average 41 percent of those accounts were invested in that one stock.

Richard Thaler has made a career of cataloguing the blunders of amateur investors. A University of Chicago economist, Thaler ticks off the mistakes: People tend to be overconfident in their ability to pick stocks. They are unwilling to admit a mistake and make matters worse by holding on to losers. They put more money in the market as it nears its peak. When a market is rising, they think it always will.

The federal government has been a model for giving workers control over their retirement accounts. Too bad federal employees haven’t been model investors.

After stocks soared in the ’90s, many federal workers did exactly what Thaler predicted they would do. They took money out of safe-but-dull Treasury bonds and put them in an S&P 500-stock index fund. The Wall Street bubble burst, and their retirement accounts lost big.

People in every age group make unwise 401(k) investments, according to the Employee Benefit Research Institute. For example, young people should be heavily invested in stocks. But half of workers in their 20s have too little or no money in stock funds, the institute reported. Older workers should keep more of their money in bonds. But many workers in their 60s had nearly all their 401(k) money in stocks.

Don’t get us started on real estate. Economists across America warn that housing prices are a bubble about to go splat. But the University of Michigan recently found a growing confidence in the promise of ever-rising property values. According to its consumer survey, 22 percent of households think that real estate is now a great investment – double the share of 15 months earlier.

Americans may be dumb about investing. That doesn’t mean they are dumb. They’ve just never worked at it. I’m smart enough to fly a Boeing 747, but I don’t know how.

No one would ever put me behind the controls of a jumbo jet, but I can buy a stock as easily as Warren Buffett. Adding danger are the flattering words of brokers and politicians pushing private Social Security accounts. They tell us we have what it takes. History would disagree.

Froma Harrop is a Providence Journal columnist. Contact her by writing to fharrop@projo.com.