Bull!

by Maggie Mahar

  Jennifer Postlewaithe epitomized the individual investor of the early nineties.10 A tall redhead, Postlewaithe was modeling for clothing catalogues in Chicago in the early seventies when she met her husband, a history professor at a Midwestern university. In the years that followed, she gave up modeling but continued to work part-time in a local clothing store while raising their four children. Their joint income was modest, but both Postlewaithe and her husband were savers, and throughout the eighties they managed to make the maximum contribution to her husband’s retirement plan. Like most university professors, he was covered by a version of the 401(k) administered by TIAA-CREF, the world’s largest pension fund manager. Under the plan, he could not pick individual stocks, but he was given the choice between putting his money into CREF—which invested the money in a diversified portfolio of stocks—or TIAA, which invested in mortgages, bonds, and other fixed-income investments. Like many academics, he took the path of least resistance, investing 50 percent in stocks, 50 percent in fixed income.

  In 1994, Postlewaithe and her husband divorced. They were still putting two children through college, had no savings other than the TIAA-CREF retirement plan, and owed $75,000 on a home worth roughly $125,000. Postlewaithe, who had just turned 51, had no recent work experience except her part-time job at the clothing store, which paid only minimum wage. The one bright spot was that it was an amicable divorce and she and her husband agreed to split their assets 50/50. After selling the house and paying the broker, the closing costs, and the divorce attorneys, she wound up with nearly $90,000—$70,000 of it in an IRA that had been rolled over from her husband’s retirement plan.

  TIAA-CREF was one of the nation’s most respected pension fund managers, but Jennifer Postlewaithe thought she could do a better job of managing her money. For one, she believed that her husband had put too much of their savings into fixed-income investments. “He had no interest in the market—or anything to do with business,” Postlewaithe recalled. “If it didn’t happen in the 17th century, he didn’t care.”

  The bull market was beginning to roll, and she itched to try her hand at picking stocks. “I had grown up on a farm, and so I was familiar with markets—the whole idea of buying and selling,” she explained. “And my mother always had owned a few stocks.” In the eighties, Jennifer Postlewaithe’s appetite had been whetted by watching her best friend and next-door neighbor play the market. “Vicariously, I followed her investing career.” She remembered when her friend bought Apple, and then Microsoft. As she drove her children to school, to hockey practice, to their friends’ homes, Postlewaithe started listening to what was said about the Nasdaq on the radio. “It was like following a sport,” Postlewaithe recalled. “I didn’t have any money to buy individual stocks myself, but it was a game—seeing how much it had gone up—feeling a little depressed if it went down.” Meanwhile, her friend’s portfolio grew: “She remodeled her kitchen; she and her husband took vacations to Europe—and with all that spending, they still had far more savings than we did.”

  No longer yoked to her stick-in-the-mud husband, in 1994 Postlewaithe set out to do some research of her own. Following her friend’s advice, she went to the library and consulted Value Line, a financial service that produces in-depth research reports. Microsoft was one of her first investments. Then, Dell and Intel.

  “I was proud of myself. Here I was, independent for the first time in my life, investing my own money.” Before long, her original $90,000 had grown to $150,000…then $200,000. Postlewaithe was elated. She bought AOL and Amazon.com. “I really didn’t want to spend any of the money,” she recalled. “I just liked buying more shares—and watching my holdings mount. First, I’d buy 100 shares of something, then another 150…often they’d split. And I liked the idea that I would have something to leave to my children—something of my own.” By 2001, Postlewaithe was managing a portfolio worth more than $500,000—though roughly a third of that was “on margin,” stocks she owned with money that she had borrowed from her online broker.

  Jennifer Postlewaithe was just one of many women who flexed their financial muscles in the nineties. Shirley Sauerwein was another.11 Sauerwein, a social worker in Redondo Beach, California, first dipped her toe into the water in 1991. “I had never considered buying stocks,” said Sauerwein. “I didn’t understand the market.” But one day in August of 1991, the 47-year-old heard a story on her car radio about a local company that had signed a contract with Russia. It sounded interesting. After calling for more information, she set up her first brokerage account and bought 100 shares at $12 each. Eight years later, that company had a new name: MCI WorldCom. Sauerwein’s original $1,200 investment was now worth $15,000—part of a mid-six-figure portfolio that included Red Hat, Yahoo!, General Electric, and America Online.

  Sauerwein’s husband, James, who was a program manager at Hughes Aircraft, had a 401(k); in time, she would take a hand in managing that, too. But since her employer did not offer a retirement plan, Sauerwein kept her shares in a taxable brokerage account. Like many American families, the couple now had most of their savings invested in stocks, and in 1999, The Wall Street Journal singled out Sauerwein as an example of the individual investor’s new power: “Along with Wall Street’s heavy hitters, Main Street investors like Ms. Sauerwein have emerged as a powerful financial force in the 1990s, simultaneously boosting their net worths beyond their wildest dreams and helping to propel the market to records. Indeed, individual investors now account for more than 30% of the New York Stock Exchange’s trading volume, up from less than 15% in 1989.”

  By 1999 Sauerwein had cut back her social work to weekends and was spending weekdays trading full-time from home. “I make a few buys and a few sells each day,” she said. In one year, she had made $150,000. On the face of it, when The Wall Street Journal left her in 1999, Sauerwein sounded like a lamb just waiting to be shorn. But when a runaway market finally hit a wall, she would emerge from the wreck, a survivor.

  “I’m not a smart cookie,” Sauerwein insisted, yet she turned out to be a very shrewd investor. Throughout the nineties, she never subscribed to the decade’s mantra, buy and hold: “I never thought it would last. I just thought, ‘I’ll get in and buy some tulips,’” she said, referring to the infamous Tulipmania that swept 17th-century Holland.

  Shirley Sauerwein combined commonsense savvy with investment discipline. “When I was a little girl my grandmother and I would play the horses on paper,” she recalled, “and I found it’s a good thing to do with stocks. Before buying a company, I followed it on paper.” But she would be the first to admit that luck played a role in her investing career, and her awareness that investing is a game of chance as well as skill protected her against falling in love with her own portfolio. “It is safer to be a speculator than an investor,” economist John Maynard Keynes once remarked, “in the sense…that a speculator is one who runs risks of which he is aware and an investor is one who runs risks of which he is unaware.”12 Sauerwein knew that she was speculating. It was like playing the horses. As a result, she was humble before the market: “If a stock goes up, it’s not because I’m a whiz,” she said, “and if it goes against me, I don’t stick around. I tried to follow the advice given by Investor Business Daily’s editor—‘sell when it’s down 7 percent.’ The Wall Street Journal never told you that,” she added. In general, Sauerwein learned to take the advice served up by financial journalists with a grain of salt: “Whenever I bought anything that Money magazine recommended, I lost money.”

  “WHAT IF THEY GOOF UP?”

  In the nineties, Postlewaithe and Sauerwein were just two of the many Americans who ventured into the market for the first time. In 1992, The Wall Street Journal published a story that raised a rude but unavoidable question: “By the year 2000, employees will be managing $1 trillion of their own money in 401(k) retirement plans. What if they goof up?”13

  It was a brave lead. In the last decade of the 20th century, anyone who suggested that individual investors m
ight “goof up” risked being branded an elitist. And in a decade that prized the idea of a democratic market, “elitist” had become a particularly dirty word, observed social historian Thomas Frank. He quoted Time magazine contributor William Henry: “‘Sometime in 1992, it dawned on me that the term ‘elitist’…has come to rival if not outstrip ‘racist’ as the foremost catchall pejorative of our times.’”14

  Yet it was only common sense to suspect that an individual investor might well lack the training, the time, and the talent needed to navigate markets: “Many a man or woman who would not expect to be successful as a circus clown, opera singer or grocer, without some kind of preparation or talent, nevertheless expects to be successful right off in the stock market—probably the most intricate and difficult game on earth,” warned Fred Kelly, an author and professional investor, in 1930.15

  Of course, in the nineties, the small investor had far more information at his fingertips than his counterpart in the twenties. But bits and bytes of information can be more dangerous than ignorance. Or, as Malcolm “Steve” Forbes Jr., heir to the Forbes publishing dynasty, once confessed, “My grandfather told me you make more selling information than you do following it. So let that be a warning.”16

  Later in the decade, 401(k) investors who had been burned by bad information would realize that the traditional pension had offered one major advantage: no matter how well or how badly the market did, the pension promised a check for life. Still, the guaranteed pension checks were usually quite small. And while a small paycheck is certainly better than no paycheck, inflation could easily turn a fixed payment into a pittance, as so many retirees learned in the seventies. Unlike Social Security benefits, pension payments were not adjusted for inflation. By contrast, if a 401(k) investor stashed his savings in stocks, he could keep up with inflation—or at least that was what he was told.

  That this had not been the case in the seventies was largely ignored. From 1971 to 1981, inflation averaged 8.3 percent a year, while the total return from equities, even after reinvesting dividends, was just 5.8 percent: in other words, an investor who had entrusted his nest egg to stocks lost an average of 2.5 percent a year, year after year. Over the next 10 years, however, the S&P 500 whipped inflation. By 1991, real (inflation-adjusted) total returns had averaged 13.7 percent a year for a decade.17 Understandably, small investors wanted a piece of the action—and they were beginning to suspect that the pros running their pension funds lacked the nerve to ride a bull.

  Critics groused that the professionals who ran the old-fashioned plans were too conservative. Many of the pros were still haunted by the harrowing market of 1966–82, the 16-year span that began and ended with the Dow at 1000. Even if they had not lived through the market of the seventies, they heard the stories from colleagues who survived. True, a bull market had begun in 1982, but no one knew how long it would last. Some state pension funds were not even allowed to invest in stocks. Pension fund sponsors felt the burden of their fiduciary responsibility: while the market might fluctuate, a pension could not. When the time came, the employer could not tell a retiring employee: “Well, you’ll just have to work a few years longer—or get by on a little less.” (This, of course, is precisely what many employees would have to tell themselves, a decade later, when they took a look at their shriveled 401[k]s.)

  The pros may have had their reasons for erring in the direction of caution, but some went way overboard, putting too many eggs in the bond basket. Until 1990, for instance, 100 percent of New York City’s Teacher’s Retirement Fund was invested in fixed-income investments. Admittedly, this was an extreme case, but at the end of the eighties the average corporate pension fund allocated only 45 percent of its assets to equities, while public-sector pension funds stashed just 37 percent in stocks.18

  Observers charged that such a stodgy strategy would never produce the billions needed to support the legions of boomers who would begin retiring in less than 20 years. Already, payouts were pyramiding while contributions were dwindling. By 1991, 20 percent of all corporate pension plans were underfunded according to estimates by the Pension Benefit Guaranty Corp. (PBGC), a federal agency set up to insure private funds.19

  What no one knew in 1991 was that over the next eight years, both the stock market and the bond market would soar. Arguably, the plush profits of the bull market could have made up for the shortfalls—though slippery accounting makes it difficult to assess just how profitable the nineties were. More to the point, corporate managers had many other uses for those earnings: awarding themselves stock options, buying back shares to offset the dilution of earnings per share created by the options, acquiring other companies in an effort to boost their balance sheets, paying lawyers and bankers for their services as financial engineers…. Creative accounting was expensive.

  Meanwhile, companies that continued to offer traditional pensions failed to use the boom as an opportunity to build a hedge against the next bust. Rather than piling up a fat surplus, most cut back on their contributions—as if double-digit returns would continue indefinitely. To be fair, many companies had no choice. If bullish projections showed that they were 150 percent funded, they could not add to the pension fund without losing their tax break.20 When the bear market hit, most turned out to be as unprepared as many 401(k) investors. By 2003, traditional pensions at some of the nation’s largest corporations were facing a crisis: employers needed to step up their contributions at a time when earnings were anemic, at best.

  Still, by 2003 it was apparent old-fashioned pensions offered many employees better protection than a 401(k). For one, under the traditional pension system, an investor’s exposure to his own company’s stock was limited. Federal law made it illegal for an employer to invest more than one-tenth of the pension’s assets in company stock on the grounds that if both an employee’s livelihood and his savings pivoted on his company’s financial health, he would be carrying too many eggs in one basket. But the law did not shield 401(k) investors—by 2001, the average 401(k) would have nearly 40 percent of its assets tangled in company stock.21 Moreover, 401(k)s were not insured. By contrast, in 2003 the federal government guaranteed old-fashioned pensions up to $3,600 a month.22

  In 1991, the advantages of the 401(k) for both employer and employee had seemed clear. Twelve years later, observers began to ask: Was the 401(k) really such a boon for employees?

  The answer would vary widely, depending on who you were, how much your employer contributed to your account, whether he made his contribution in cash or stock, whether you took profits as stocks spiraled—and, above all, how early you got into the bull market of 1982–99. If you were very, very lucky, you were part of the generation that began saving and investing in the early eighties and retired in the late nineties, moving most of your money out of equities and into fixed-income investments, just before the millennium ended. If very unlucky, your prime years of earning and saving coincided with the final years of a bull market that crashed a few years before you retired—while 90 percent of your nest egg was still invested in stocks. As always, in any market, everything pivoted on how much you paid when you got in—and when you needed to cash out.

  Gary Wasserman would be one of the lucky ones, not only because he began investing early, but because he had been chastened by nearly 15 years of experience before Act II of the bull market began.23 Professionals like Bill Fleckenstein, a portfolio manager in Seattle, pointed out that even pros learn how to ride the market only through direct, often sorrowful, experience: “No matter what they tell you on television, information is not knowledge,” Fleckenstein warned. “You know what you have to do to be a good investor? Make a lot of mistakes—and learn from them. The market has a lot of tricks and curves, and you have to encounter each and every one of them to learn.”24

  Wasserman, who began his career as an investor in the mid-seventies, had plenty of time to make mistakes. At the time, he was in his 20s, teaching at a college in Brooklyn. Like Sauerwein’s husband, he was covered by TIA
A-CREF and had the freedom to decide how to divide his nest egg between CREF—the fund that invested in equities—and TIAA, the fixed-income fund that invested in mortgages and bonds. Without too much thought, Wasserman bet $3,000 on bonds and $5,000 on stocks.

  On the side, he played the stock market himself—without much success. “I just lost and lost—all of the time,” Wasserman remembered cheerfully in 2002. “It was always only a question of how much I would lose. I found that if you lost money on stocks, you got more speculative,” he continued. “Rather than buying two shares of a $50 stock, I would get 50 shares of a $2 stock”—a strategy not unlike playing the long shots at the track. “This is how sophisticated I was. Luckily, I didn’t have much money, so I didn’t have much to lose. It was like playing Lotto. It wasn’t investing. I wasn’t setting it aside for something in particular. I was gambling.”

  By the early eighties, Wasserman had moved out of teaching and more or less forgot about his nest egg in TIAA-CREF. “As both the market improved and my own situation improved, I did get a little better at investing. I started putting money into an IRA, and always put it into a T. Rowe Price mutual fund.” But, he recalled, this strategy also backfired. The T. Rowe Price family of funds offered the opportunity to transfer between money market funds and stock funds, “and I always switched at exactly the wrong time, investing through the rearview mirror,” Wasserman explained. “The problem was that I had too much control over it. That was also a lesson. In the eighties I finally moved to funds that wouldn’t let me play games by switching back and forth. To this day, I avoid families of funds.”