QI'm 26 now and just got my first "career" job. So I've been thinking more about investments. I have a macroeconomic/fiscal cliff question for you. While I intend to invest in the way that's best for me, if I were being completely unselfish wouldn't bonds be better? After all, sales of stock (other than IPOs) just shift money from one investor to another and sap money from corporations through dividends. Things like municipal bonds, on the other hand, can result in necessary infrastructure being built. Especially with talk of changing the capital gains tax rate, it seems like it would be easy enough to raise it for stocks but leave it at 15 percent for bonds, and indirectly promote huge private investments in infrastructure.
A Congratulations on landing a career job. Your question raises several important issues and my editors will rebel if I try to address all of them. Still, I have a couple of reactions.
A big problem with the current tax code is the different treatment of investments. As much as possible, the tax code shouldn't bias investment decisions. Yet, at the moment, the tax code is far too heavily weighted in favor of housing. For example, the cherished mortgage interest deduction is a classic case of government spending masquerading as a tax break to subsidize homeownership.
Tax geeks have long debated whether the federal government should subsidize state and local government borrowing, especially with the benefit largely geared toward high net-worth individuals and families. (Municipal bonds are most attractive to those in the top tax brackets.) The Simpson-Bowles deficit reduction plan, for instance, proposes eliminating the preferential rate on capital gains and dividend income compared to ordinary income and getting rid of the tax exemption for state and local bonds. Both moves would be an improvement over the current system.
The stock market is critical to the economy. The popular image of the market as a casino played by investors prone to bouts of enthusiasm and depression, overestimating and underestimating risks, is true. Nevertheless, the capital markets are a dazzling social and economic institution for communicating through price changes all kinds of data, information, knowledge, rumor, gossip and noise. A byproduct of the frenzy is that money eventually finds its way toward backing productive enterprises and fleeing from failed management strategies. Adjusted for manic mood swings, stock returns reflect corporate earnings growth.
The market also allows investors to change their minds and quickly buy and sell stocks, a task that takes a long time with private companies. The cash flow paid out in dividends is real.
"Our country's businesses will continue to efficiently deliver goods and services wanted by our citizens," wrote Warren Buffett, the stock-picking Wizard of Omaha, last year. "Metaphorically, these commercial 'cows' will live for centuries and give ever greater quantities of 'milk' to boot.''
To end on a practical note, I would encourage you as your career unfolds to build a financial foundation with low-cost, broadly diversified investments, such as equity-indexed mutual funds. You might want to own a high-quality portfolio of tax-exempt bonds, too, depending on your income and tax bracket.
Chris Farrell is economics editor for "Marketplace Money." His e-mail is email@example.com.