The Stock Market Crash Begins...

The front page of the “Money” section of the November 30, 2001, issue of USA Today had a large color photograph of a fifty-eight-year-old man. His hair is gray, his arms are crossed, he is intelligent and distinguished-looking. Although he could pass as the CEO of a large corporation, he isn't. Instead he is a loyal employee of Enron, a company where the CEO and other top executives may have personally made millions of dollars but the company is now bankrupt.

The reason this man is on the cover and not the CEO is because this loyal employee's 401(k) has been devastated due to the stock market crash, a down economy, and the downfall of the company he spent a lifetime working for. At one time his company's stock was worth nearly $100 per share. This loyal employee felt rich and bought more and more shares of the company he worked for and put those shares into his retirement plan. On November 30, 2001, that same company's stock was worth less than 35 cents per share and falling. At one time, his 401(k) was worth $317,000 and today he estimates its worth to be about $100,000. It is beginning to dawn on him that he may never be able to retire. He is nearly out of his most important asset, time. Some twenty-five years after the original passage of ERISA, rich dad's prophecy is starting to come true.

The December 2, 2001, edition of the Miami Herald ran a headline calling for government reform in 401(k) retirement plans. The journalist who wrote the piece argued that we have laws requiring people to wear seat belts in cars but we don't have laws requiring investors to invest wisely. I say, why not tell our school systems that?

Soon thereafter, every newspaper, and television and radio station, was shouting words of outrage. “How could the government let this happen?” one local broadcaster insisted over the radio. “Why didn't the accounting firm of Arthur Andersen warn the shareholders?” “Employees who are ready for retirement can now never retire.” “How can the senior management of Enron run off with hundreds of millions of dollars and leave the employees with nothing?” Other stations went on to compare Enron to a disaster like the attack on the World Trade Center on September 11, 2001. I finally heard a voice of reason say on television, “While Enron is an extreme case, it is not an isolated case. What about all the millions of employees who have lost billions of dollars in their retirement plans? What about the employees working for hundreds of other companies who may not have lost everything, but have lost years of retirement savings in the stock market? How do they feel now knowing that their dreams of retirement may never come true? Do they feel more trust of the stock market or less trust today? The lack of confidence among investors is growing and is the bigger problem. There is more to this problem than simply Enron and questionable accounting.”

In response, a few stations had financial planners repeat the standard company line of, “This problem would not have happened if the employees had diversified.” Another famous mutual fund manager with his John Kennedy good looks and Boston accent came on and said, “We have always advised our clients to diversify. Why didn't the management of Enron advise their employees to diversify their portfolios? If they had diversified, they would not have the problems they are having today.”

If rich dad were asked, he too would agree that Enron was an extreme case, extreme because of the magnitude of greed and apparent corruption involved. But he would also know that it is not an isolated case. In the last few years, not only did Enron employees take sizable losses, but so did employees of Ford, Cisco, Coca-Cola, Xerox, Lucent, Maytag, Polaroid, Rite Aid, United Airlines . . . and on and on. If rich dad were asked to comment on the plight of the Enron employees and all employees who have money in the stock market, he might say, “The problem is not the lack of diversification. The problem is a lack of financial education and financial sophistication . . . flaws that simple diversification alone cannot solve.”

Two thousand one was a year of sensational news . . . the unimaginable attack on the World Trade Center and the Pentagon. Just as we were coming to grips with that tragedy and pain, news of Enron and the questionable accounting of Arthur Andersen burst into the headlines. Even the war in Afghanistan had taken a back seat to Enron, at one time reportedly the seventh largest company in America, and today the biggest bankruptcy in U.S. history . . . so far.

During all this media sensationalism, the public often misses the more important points . . . because the real problems are not front-page news. During this meltdown period of Enron and then WorldCom, one of the many flaws in the pension reform was brought to light in that same December 2, 2001, edition of the Miami Herald. To me, more important than the Enron fiasco is the simple question that this retiree asks of a certified financial plan ner who regularly contributes to the paper.

QUESTION: I am 70 years old and retired, hoping that my IRA would sustain me when the time came. Since I have to begin with drawing next year, I would appreciate your advice. I was advised sev eral years ago to invest my IRA in mutual funds. For a while it was great, but along with so many other people, I have lost a great deal in the last two years. Should I take my losses and reinvest in a secure savings even though the interest rates are low?

ANSWER: If ever there was a time to stick with the plan, it's now. The ups and downs of the market are to be expected, and if you've been an investor for more than a few years, you've ridden a few waves yourself; mostly up markets, just no down markets this long and nasty. I feel your pain, but 2 percent CD's and no growth aren't going to cut it.

Check your mutual funds and make sure they're solid and leaning more to the conservative growth and growth income funds. Aggressive funds tend to be more volatile. Instruct your custodian to send you your required minimum distribution monthly by selling shares of your funds. This is called a systematic withdrawal and it works like a charm.

Did you pick up one of the flaws in the law? Did you notice the statement by the seventy-year-old retiree who wrote, “Since I have to begin withdrawing next year, I would appreciate your advice.” Did you notice the response from the financial planner? “Instruct your custodian to send you your required minimum distribution monthly by selling shares of your funds.”

As I said, while most of the world was sipping their coffee and reading about Enron and thinking Enron's problems were not their problems, this retiree's simple question points out how Enron is everyone's problem. One of the flaws that rich dad noticed twenty years earlier was the requirement that the retiree must begin withdrawing from the market, by selling shares monthly, at age seventy and a half. Now that may not sound like a big deal, but as most of us know, it's the little things that make big things big . . . or small.

In other words, as the years go on, more and more people will, by law, be required to withdraw by selling shares while younger workers are required to buy shares. Now, it does not take a rocket scientist to see the flaw in this plan . . . a flaw that will get bigger and bigger as more and more people get older. In other words, how does the price of a stock go up when more peo ple are selling than buying?

The question is more important simply because of the numbers of people involved. While the ripple effect of the Enron disaster will affect hundreds of thousands of people, in one way or another, this seventy-year-old retiree's question will affect tens of millions of people, maybe hundreds of millions, in one way or another . . . just because of its ripple effect.

Speaking of large ripple effects, Japan, once a financial powerhouse, a nation with hardworking, diligently saving people, is on the brink of financial ruin. Is it the fault of the Japanese people or the fault of the leaders of their country? In other words, if America, the richest country in the world, falters and Japan, the second largest economy in the world, goes down, the ripples may soon turn to tidal waves, waves big enough to cause the need for an ark in the desert.

When the December 2, 2001, issue of the Miami Herald ran, the retiree's question has little impact simply because at the present time, only a relatively few people are over seventy and less than half have DC pension plans. Most still have DB pensions, which operate via different rules. Also, many of those born before 1946 had good paying jobs, made money on their home they sold at a high price to a baby boomer, and many actually had sav ings. So the question this retiree asks is shoved to a back page . . . yet it is a most important question to be asking.

The question is, what happens when millions of baby boomers are required to begin withdrawing money from the stock market? Will the stock market still go up by 10 percent, 20 percent, or 30 percent per year as it did in the 1990s? If you were born after 1946, and have a DC pension plan filled with stocks, bonds, and mutual funds, for your sake, I hope the market keeps going up and never stops . . . but history is against that fantasy.

Because there are so few people over seventy with DC plans, this flaw has had very little effect on the market. But by the year 2016, when the first of the 75 million baby boomers begin to turn seventy years of age, many of them will have DC pension plans . . . and each year, more and more will be added to that list. When rich dad made his prophecy, he was not using Tarot cards or tea leaves to look at the future. He was using the change in the law, time, market experience, and the fact that people do get older. In other words, he was not guessing . . . he was just using facts, history, and realities.

The price of shares of stocks or mutual funds, or bonds, or anything for that matter, goes up as long as there are more buyers than sellers. Between 1990 and the year 2000, the stock market boomed because there were so many thirtyto fifty-year-old baby boomers entering the stock market, saving for their retirement in their DC pension plans . . . so there was a stock market boom. There was a similar boom in the 1970s when baby boomers left home, left college, and began buying their first home. If you are old enough to remember those years, you may remember the mania over real estate . . . a mania that was also followed by a panic and a bust when interest rates went over 20 percent. Interest rates were raised in order to slow down inflation . . . inflation caused partially because 75 million baby boomers had entered the job market and now had money to burn. In other words, 75 million people buying anything will cause a boom. The reverse is also true. Seventy-five mil-lion people selling anything will cause a bust. It is the basic law of economics, the law of supply and demand.

Within the next few years, but most certainly by 2016, if they haven't already figured it out, people will begin to understand that stock markets do not always go up by 20 percent per year as they did in the 1990s. Unfortunately, millions of employees will not exit their 401(k) or IRA plans or may only exit after it is too late. Millions of baby boomers may not sell early even though they know the market is crashing because of governmentimposed tax penalties for early withdrawal. So instead of withdrawing, they will stay in the market, diversifying, moving money from one mutual fund to another looking for the next hyped safe sanctuary. Most people already realize that they are in financial trouble but still do not realize the full impact of the many flaws of the law. When this realization hits critical mass, a panic will occur as people fight desperately to save their retirement and their lives. Unfortunately, all the diversification in the world will not save them from a crash of that magnitude.

Warren Buffett, reportedly America's richest and smartest investor, has this to say about diversification. He says:

“Diversification is a protection against ignorance. It makes very little sense for those that know what they're doing.”

I point out that Warren Buffett is not saying to not diversify. He has re peatedly said that he does not diversify . . . but he is not advising you or any one else to not diversify. He is simply saying that diversification is protection against ignorance. In other words, if you don't want to diversify, get edu cated. If you're not financially educated and have no plans on becoming fi nancially educated . . . then diversify, diversify, diversify.

Rich dad, being more blunt, would have said, “If you're financially ig-norant, diversify.” He did say to me way back in 1979, “One of the many flaws is that the law has failed to advise people to get financially educated. President Ford and Congress changed the law but failed to tell the educational system to provide for the proper financial education . . . the financial literacy required for people who have DC pension plans. Instead, the politicians have left the job of financial education up to the people of Wall Street.”

On a more sarcastic note, rich dad later said, “Asking Wall Street to pro-vide financial education is the same as asking a fox to raise your chickens. If the fox is smart, the fox will be patient and raise very fat chickens. The fox works hard to gain the chickens' trust . . . so he cares for them by providing slick brochures, branch offices, and good-looking salespeople who have been trained to sound like investors. The salespeople are all trained to use the same intelligent-sounding financial jargon disguised as advice, such as, ‘Invest for the long term, have a plan, choose a family of funds, sector funds, small cap growth funds, tax free municipal bonds, 20 percent in cash, REITs, Roth IRAs, rollovers, tech stocks, blue chips, the new economy, and of course, diversify, diversify, diversify.' ” As rich dad pointed out to me, “Pension reform will change the vocabulary we use, but most people will not have a clue what the new words mean.” Meanwhile, the fox smiles and knows the chickens are happy. They feel safe in their new sanctuary. They have a safe secure job and they have their money safely entrusted to financially astute people. Then they see the stock market go up and up in the 1990s and they feel even more intelligent and well advised. They know their financial planner is looking after them, will make them rich and protect them from the harsh cruel world outside the chicken coop.

But in March of 2000 the world began to change. The tech bubble burst and the stock market began to deflate. TV commentators began to say, “The recovery will come in the next quarter.” But the next quarter came and went . . . and the TV commentators again said, “The recovery will come in the next quarter.” Financial planners began to say, “Be patient . . . invest for the long term . . . diversify.” The chickens began to feel a little more secure. They knew they were doing the financially intelligent thing. They were in it for the long term, they were diversified, and they knew the recovery was right around the corner.

September 11 dropped the market but the market bounced right back. Again the chickens felt more confident as the market began to climb. Then Enron hit and suddenly many very fat chickens from all over America began to cluck loudly from the sanctuary of their securely wired chicken coops. Although they clucked and cackled loudly, the foxes again said, “Be patient. Invest for the long term. Diversify.” One of the reasons the biggest stock market crash in the history of the world did not take place right after the Enron collapse is because the foxes aren't ready for their chicken dinner yet. They know that these chickens have a few more years to get a little fatter and they know that by law . . . the chickens will have to keep coming to the stock mar-ket, buying more mutual funds and diversifying. The problem is, some of the chickens are getting nervous and are beginning to ask questions . . . questions

such as the one the seventy-year-old retiree in Miami asked . . . and got the standard financial-planner-disguised-as-investor, preprogrammed sales an swer . . . “Don't worry, be happy, buy more, and diversify.”

Now I want to go on to restate that the advice of “Invest for the long term, be patient, and diversify” is solid advice for those who have limited financial education and investment experience. The point I want to reinforce is the idea that you as an individual have three basic choices. They are, (1) do nothing, (2) follow the same old financial planning advice of diversify, or (3) get financially educated. The choice is yours. Obviously, I recommend long-term financial education . . . and today, many other people are joining the chorus.

In February of 2002, Alan Greenspan, the head of the Federal Reserve Bank, concerned about the loss of confidence in the stock market and in the accounting profession, went before the nation and spoke about the need for financial literacy to be taught to our school kids. He knows that if people lose confidence in the stock market, capitalism as we know it is in trouble. Without investor money, the economy begins to implode. Due to that concern, he addressed Congress and said that this country needed to financially educate its children. As related in an Associated Press article on February 6:

Schools should teach basic financial concepts better in elementary and secondary schools. A good foundation in math, Greenspan said, would improve financial literacy and “help prevent younger people from making poor financial decisions that can take years to overcome.

“It has been my experience that competency in mathematics, both in numerical manipulation and in understanding its conceptual foundations, enhances a person's ability to handle the more ambigu ous and qualitative relationships that dominate our day-to-day finan cial decision-making,” he said.

Immediately after the live telecast of his speech to Congress, the finan cial news television station on which I was watching Mr. Greenspan's speech asked the head of a large and famous mutual fund to comment on Greenspan's remarks. Immediately, this famous mutual fund manager said, “I agree with Alan Greenspan. I agree we need to teach financial literacy . . . and financial literacy means diversify, diversify, diversify.”

“Thank you for your wonderful words of advice,” said the TV host to the famous mutual fund CEO. “If we are going to teach our kids financial literacy, we must teach them to diversify.”

If rich dad were alive, he would say, “Alan Greenspan did not say ‘diver-sify.' Alan Greenspan called for the need for financial literacy to be taught in our schools. Greenspan stated that for our nation to make progress and evolve, financial education is essential for a First World nation to remain a First World power.” Rich dad might have also said, “Financial literacy does not mean diversify. The definitions are not even close. Saying that financial literacy means diversification is just another example of the fox teaching the chickens.”

Now all of us who are in business want customers who buy our products or services forever. The same is true with mutual fund managers and owners of financial television stations. You do not have to be a genius to see that the primary advertisers of this financial news TV station are mutual funds. So nat-urally they would have a mutual fund manager comment on Alan Greenspan's call for financial literacy rather than Warren Buffett . . . a man who does not advertise with that TV station simply because he does not have to. Warren Buffett's own mutual fund, Berkshire Hathaway, is possibly the most expensive fund in America simply because it is so well managed and successful. His fund is so successful and expensive that he has been known to tell his investors not to invest in it because he believes the price of his fund is too expensive. If he is telling people to not invest in his fund, he obviously does not need to advertise on any financial news television station . . . which is why he probably was not asked to comment on Greenspan's comment. The station invites someone who pays them ad revenues . . . a paying customer . . . and naturally that mutual fund manager will say what is best for his mutual fund.

If rich dad were alive, he would probably say this: “A mutual fund manager advising you to diversify is like a used car salesman saying, ‘Don't buy one car . . . buy many cars. You never know when the car you are driving may break down and you may not get to work. So instead of risking buying just one car, diversify that risk, buy six cars and pay me for them every month for forty years until you stop working and retire.” I ask you, what businessperson would not want millions of customers like that? The reason most of us do not buy the line of needing to diversify to six cars to protect us from car trouble is because most of us are better educated than that. But when it comes to financial ve-hicles, vehicles such as stocks, bonds, and mutual funds, most people are clueless as to the differences between different financial vehicles. That is why rich dad saw the lack of financial education as one of the major flaws in pension reform.

Because of this reform, one of the fastest growing professions is a group known as financial planners. Schoolteachers, housewives, ex-real estate agents, insurance salespeople, retirees, plumbers, firefighters et al. are taking a three-day to three-week to six-month course and suddenly they are qualified to advise you on the security of your financial future.

The problem with the financial planning industry, as rich dad noted, is that not all financial planners are equal. While many financial planners are well educated and dedicated professionals, many planners lack the proper training and financial education to be dishing out financial advice . . . ad-vice that will affect a person's financial future and financial security. The profession of financial planning is very confusing because of this huge variance of expertise, not to mention varying methods of compensation. When your financial planner gets paid on selling you something, do you really feel comfortable that it is the right buy for you? So let the buyer beware. Just because someone says they are a financial planner does not mean they know anything about financial planning, much less investing. It is this lack of professional training that rich dad saw as one of the flaws . . . a very big flaw in pension reform because millions of people are now taking financial advice from people who are often poorer and less educated than they are.

The May 5, 2002, “Business” section of the Washington Post discussed this very issue in an article titled “When Hiring a Planner Know the Bottom Line,” with the subtitle “Financial Planners Proliferating in Largely Unregu lated Market.” In it the following observations were made:

Experience points to a growing issue in financial planning, where many different types of professionals now offer services in a largely unregulated marketplace. And even more players will presumably be attracted to the planning field as the big boomer generation contin ues its inexorable march to retirement and beyond. . .

Full-fledged financial planners come in several versions, CFPs, 39,500 strong, being one. CFP certification entails testing, continuing education and course work. CFPs charge fees (as an hourly rate, a flat rate or percentage of assets under management), commission or a combination of the two.

Another group's members charge only on a fee basis . . . the 16-yearold National Association of Personal Financial Advisors (NAPFA). . . .”

This growth in the financial planning field is in response to a demand for investment education and advice. To repeat because it is important to repeat: One of the biggest flaws in pension reform is that it failed to tell the educational system that financial education was no longer an option . . . it is now mandatory.

This flaw truly shocked rich dad. To him, Congress not requiring the schools to teach basic financial literacy after the law was changed bordered on criminal negligence . . . a crime far more serious than the crimes allegedly committed in the Enron scandal. When Congress passed that law and left the job of financial education up to the people who work in the financial markets, rich dad smelled a very big rat. Not a fox . . . a rat. When that law was passed, rich dad realized that many people in Congress knew exactly what they were doing. Many of our leaders knew that they had just made it mandatory for millions of workers to turn trillions of their hard-earned dollars over to those who run the financial markets.

Let me be clear again. Rich dad was not against investing money in the stock market . . . or against investing becoming more or less mandatory. Rich dad was angry at men like my real dad, the schoolteacher, who had absolutely no idea what was going on in Congress. Rich dad was against the sleight-of-hand and the lack of formal financial education. To him, leaving financial education up to those that profited from financial ignorance was criminal.

There are now thousands of professional financial planners, stockbrokers, real estate agents, insurance agents, accountants, and attorneys all handing out investment advice for money. Rich dad's concern was that most of these people are not investors. They do not live off their income from their investments, which a true investor does. He constantly reminded his son and me that the majority of people dishing out investment advice are salespeople, working for commissions, salary, or a fee. It is these salespeople who do the financial education for the financial institutions and, obviously, most will say what the institution tells them to say and promote, or they lose their job. Then we wonder why we have millions of people who grow more and more worried about their future financial security. They grow insecure because instead of receiving unbiased financial education, they receive a sales pitch disguised as financial education from a salesperson. As rich dad often said, “The reason salespeople are often called brokers is because they are often broker than you are.”

Warren Buffett has this to say about financial advice from Wall Street. He says:

“Wall Street is the only place that people ride to in a Rolls-Royce to get advice from those that take the subway.”

Again, I must clarify something. I love the salespeople who sell me financial services and investments. Some of them are my best friends. Some of these salespeople have made me very rich . . . which means I like them even better. In other words, I need them as much as they need me. I pay my commissions because I want the people who sell me investments to prosper. If they prosper they bring me more deals and they often bring me the best investments first. Investors who hate paying commissions always get the worst investments . . . as they should because they are cheap. In fact, I have friends who will tip their waiter 20 percent for a burger and fries and then refuse to pay the commission on an investment that could make them rich. Talk about being wired up with a poor person's financial value system. You tip those who make you poor and hesitate to tip those who can make you rich. I have several friends like that. The point is, as an investor, you may want to become better educated and find advisors you can trust. If you are not educated, then one financial salesperson is just as good as another.

In other words, if you want to do well in the future, do not leave your fi nancial education up to someone else.

In closing, let's review the two flaws in pension reform. The first is that the law requires participants to begin selling once they hit seventy and a half years of age. Within the next few years we will see the panic begin. When the first of 75 million, 83 million if you count immigrants, of the baby-boom generation reach the age of seventy, simply put, more and more money will be-gin to come out rather than go in. While the year 2016 is bandied around as when this occurs in a major way, beware that the financial impact may begin much earlier. You do not need advanced math to figure out that it's tough to keep prices going higher when, each year, more and more people are selling.

The second flaw rich dad saw was that financial education was left up to those that made more money if the investor was less educated. Hence fi nancial education today is really a sales pitch.

In the next chapter, I will go into the third flaw in the system . . . and again that flaw was glaringly obvious in the letter from the seventy-year-old retiree who wrote the newspaper asking for advice. As I said, while most people were sipping their coffee reading about Enron and Arthur Andersen, glad that they were not affected by the scandal, many of these people were missing the im portant facts, facts hidden in the back pages of the newspaper—flaws in a system that will affect them today and tomorrow.