Ben Stein Watch: October 14, 2007

Ben Stein had an intimation of mortality about a week ago, and before he dies, he wants to share with us, his readers, his "best possible thoughts". And, amazingly, it turns out that Ben Stein's best possible thoughts are, mostly, rather sensible. Don't smoke, he says; don't drink too much; kittens make you happy; buy and hold index funds; speculation has a nasty habit of backfiring. The most dubious advice in the whole column is to let your dog sleep in your bed, and I have neither the expertise nor the inclination to quarrel with that.

Of course, a Ben Stein column wouldn't be a Ben Stein column without at least one minor economic fallacy, and Stein doesn't fail us in this one. In talking about down markets he says this:

It is painful to have to sell stocks into one of these down slopes. It is much better to be able to live off your cash reserves.

This is what is known as the sunk cost fallacy: the idea that if you bought a security high, you should avoid selling it low. But the fact is that for every investor who has held on, in such situations, until the price of the security recovered to above the price he paid, there is another who held on until the price of the security cratered all the way to zero. If you have investments and you need cash, then sell those investments to raise cash. The price at which you bought those investments is a sunk cost, and should not, if you're being economically rational, affect your decision. (Stein ignores tax considerations here, so I shall too.)

Stein's approach to risk management is to be sit at all times on a comfy pile of someting cashlike, and then to invest the rest of your money in index funds. Which is not a bad one-size-fits-all piece of advice, although it's easy to envisage situations where it's not a good idea.

But while I'm being charitable towards Ben Stein, let me just clarify one thing for him. He writes this:

Just for my own bad self, I suggest the Fidelity Spartan Total Market Index fund (FSTVX), a very broad index fund of domestic stocks; the iShares MSCI Emerging Markets Index fund (EEM), an exchange-traded fund that invests mostly in developing countries’ markets, and the iShares MSCI EAFE Index fund, for Europe, Australasia and the Far East (EFA),which invests mostly in highly developed in Europe, Japan and Australia. This has allowed the rank amateur to take advantage of the long fall of the dollar because the stocks are priced in foreign currencies that have appreciated against the dollar.

This is very close to the denomination fallacy that we've seen Stein make in the past. In fact the great thing about ETFs like EEM and EFA is precisely that they're not denominted in foreign currencies: they're denominated in dollars, and trade in dollars on the New York Stock Exchange. They buy stocks of companies which are headquartered all over the world, and some of those stocks might well be ADRs, which are also denominated in dollars and trade in New York. The important thing is that the companies do business in countries whose currencies are doing well against the dollar. When that happens, the value of those companies, in dollar terms, will tend to rise. But that happens whether you're talking about an Australian company whose stock is quoted in Aussie dollars, or whether you're talking about an American company which does business mainly outside the US.

In any case, one wouldn't want to start making big macro bets on the future direction of the dollar. After all, that's speculation, and we retail investors shouldn't be doing that. Stein himself says so – and he's right.