Ever since the mid-1980s, untold millions of Americans have increasingly come to view the stock market as being something akin to a comfortable chair, instead of the risky, unstable, unpredictable, incomprehensible, and downright dangerous place that it so clearly is.

Even the top financial minds on our planet, including those at the US Treasury, can’t seem to figure out the value of securities held on corporate balance sheets, but somehow you can? And, even though something like 80% of professional investment fund managers can’t beat the returns of the S&P 500 Index each year, somehow you will?

The realities of investing in the stock market could not have been made clearer over the past couple of months: it’s a very risky proposition, simple as that. And if Wall St.’s recent meltdown hasn’t changed the way you view investing for your retirement, then frankly you deserve whatever you get. The causes of our latest market meltdown, however, could not have been made murkier for the average American.

Some would have us believe that its “sub-prime borrowers” that caused our economy to go south. Others place the blame on the aggressive and greedy nature of our financial institutions. And still others are pointing the finger at our government’s lack of oversight. So before we examine whatever lessons there are to be learned, let’s clear things up a bit as related to what’s happened and why. Because the truth of the matter is, no single thing caused our financial markets to meltdown; no single thing has that much power. It truly is a case of “the perfect storm”.

How it all got started…

1.The Last Bubble – You remember the last market bubble that popped. The sound echoed from Silicon Valley to Wall Street, and we had one heck of a time getting the gum out of our collective hair. The “dot-com meltdown,” which began in 2000, cost Americans trillions, and threatened to send our economy into a very serious recession. We promised ourselves never to make such risky bets again. From now on we’d stick to things we understood… things of real value that would be safe… like real estate, for example.

2.Cheap Money – Lucky for us, our Federal Reserve was right there to support our newfound investment prudence, reducing interest rates to historic lows (essentially to zero if you factor in inflation), and off we went to assume our rightful positions as Real Estate Tycoons. Our dot-com inspired desire for the perceived relative safety of real estate, which was being fueled by the incredibly low interest rates, combined with an anemic stock market to create an enormous amount of available capital for mortgages. Too much capital, perhaps.

3.Too Much of a Good Thing – The abundant supply of money for mortgages was merging with a seemingly insatiable demand for real estate and creating a new bubble. With lenders now in fierce competition to make loans, credit standards were lowered and the number of so-called “sub-prime” loans increased. (It’s worth noting that “sub-prime” loans have always existed, they were just made at higher interest rates to compensate investors for the increased risk.)

Okay, so far? Good. Now it starts to get a little trickier:

4.The Secondary Mortgage Market – Most homeowners have come to understand that banks and other lenders who originate home loans, don’t keep them on their books… they package them up in bundles ultimately sold as “Mortgage Backed Securities” and “Collateralized Debt Obligations” to more long-term investors, such as mutual funds, insurance companies and pension plans. It’s referred to as the “secondary mortgage market”. By selling these packaged securities, lenders free up capital so they can go out and make more loans. The liquidity provided by this secondary market is a crucial component to our economy because without it, lenders would quickly run out of money to lend, as they waited decades for their available capital to be replenished as a result of mortgages being paid-in-full.

5.The Credit Rating Agencies – No, not the ones you’re thinking of, but the far less familiar ones that rate various securities and bonds, such as Moody’s, Standard & Poor’s, and Fitch. These agencies place ratings on various securities, such as the Mortgage Backed Securities and Collateralized Debt Obligations that were now being sold on the secondary mortgage market. Ratings are very important because they allow investors to make decisions about values and relative risks. For example, Standard & Poor’s highest rating, “AAA” means lower risk, and a rating of “D” means the risk couldn’t be higher. Investors expect high ratings to mean relatively low risk… and lower potential returns. And they expect low ratings to mean higher risk, with the potential for higher returns.

Enter: The Federal Reserve…

6.Fears of Inflation – The Federal Reserve’s Board of Governors vacillates between two key fears: recession and inflation. Ever since our economic recovery of the 1980s, the Fed has managed to keep our recessions relatively mild by controlling the nation’s money supply through its setting of short- and long-term interest rates, among other things. When it comes to the ability to control inflation, however, the Fed’s governors are far less confident. Inflation is a spiraling force whose momentum, as seen throughout the 1970s, has been proven difficult to contain. And by 2004, with everyone now congratulating themselves on their real estate investing prowess, people were spending freely and that was spooking the Fed’s governors.

7.Oil Prices Rise – Forget about how much we pay for gasoline at the pump, the bigger problem with oil prices is that rising oil prices mean higher everything prices. Not only is oil what fuels the transportation of goods, but it’s also used to make just about everything we use on a daily basis, from plastic bags to roofing tiles. With the Fed already nervous about consumer spending, as a result of our real estate wealth pushing inflation higher, now the price of oil looked like it would add fuel to the already burning inflationary fire.

8.Fed Fears Inflation More Than Recession – By 2005, the Federal Reserve was much more afraid of inflation than of recession. By July of 2006, they had already raised interest rates 17 times in a row! They had seen the need to slow the economy down a bit in order to reign in inflation, and they were working hard to do just that.

9.The Incredibly Adjustable Mortgage – During the real estate market’s boom times, as lenders were fiercely competing to make loans, they came up with all kinds of “teaser rates” and other loan features that provided people with lower monthly mortgage payments than would have been the case in fixed rate mortgages, and with real estate prices steadily rising, many borrowers took the deals. If interest rates were to rise, the thinking went, one would simply refinance their loan at a fixed rate.

10.They Did, But You Can’t – So, as the Fed continued to raise rates to control inflation, the new-fangled adjustable rate mortgages adjusted right along with them, which meant that lots of monthly mortgage payments, unless refinanced, would soon be going up. And, of course, those with the lowest incomes, who bought at the market’s peak, who have the least amount of equity, would suffer from the higher monthly mortgage payments first. Better refinance soon. But the higher rates were working to slow down the economy. Real estate prices started to level off and then decline, making it more difficult to sell or refinance a home.

11.Credit Ratings & Real Value – The problem started to snowball when some of the Mortgage Backed Securities (MBS) and Collateralized Debt Obligations (CDO) which had been rated “AAA” by Standard & Poor’s and purchased by large institutional investors on the secondary mortgage market, started to see some loans defaulting. You see, inside those MBS and CDO securities were a lot of “AAA” assets, but apparently there were some sub-prime loans and other complex financial instruments referred to as “derivatives” that should never have been rated “AAA”. Some of the investors holding these assets, such as pension plans and mutual funds, operate under by-laws that prohibit them from holding anything but “AAA” rated securities, so when the credibility of “AAA” ratings came into question, the investors had no choice but to sell them in a hurry, oftentimes at deep discounts.

12.The Problems With Rating Complex Securities – Some securities are easy to value and rate as to their credit worthiness. For example, bonds issued by corporations or municipalities both have markets and can be readily sold, so their value is fairly easy to ascertain. Other assets, especially those that don’t have markets through which they can be readily sold, are much more difficult to value. Your daughter’s old collection of Beanie Babies is an example. As long as there was a market of buyers for Beanie Babies they were “worth” whatever the market was willing to pay, but without that market of buyers, your furry little friends are only worth something to you. As the rising interest rates continued to push monthly mortgage payments higher, the secondary mortgage market of MBS and CDO securities dried up, as investors, now unable to trust the ratings, were also unable to establish the value and associated level of risk of these complex securities.

13.No Secondary Market Means Credit Tightens Fast – Without investors to purchase MBS and CDO securities, the secondary market for mortgages started to freeze up. Banks and other lenders, now in an environment far less liquid, immediately tightened their credit requirements for home loans. Now, homeowners with less than perfect credit, who would have been approved for a mortgage six months earlier, found themselves unable to refinance their home loans that were continuing to adjust up with the rising interest rates set by the Fed… to control inflation, remember? And, as credit tightened, fewer and fewer people could buy homes… and with less people now able to buy homes, the prices of homes started to fall.

14.The Downward Cycle Gains Momentum – As monthly mortgage payments continued to adjust up, as a result of the higher interest rates, more and more people found themselves between the proverbial rock and hard place. Their monthly mortgage payments were increasing beyond their ability to pay, but they couldn’t refinance. And now, with real estate prices dropping faster and faster, they couldn’t sell their homes either. Trapped. Foreclosures started to rise, which only caused further harm to the secondary mortgage market, which in turn led to tighter credit requirements, which in turn reduced the number of home buyers, which in turn brought home prices further down, which in turn made it harder to refinance or sell a home. The dominoes had started to fall.

One more ingredient and the perfect storm…

15.FAS 157 & 159 – Then, late in 2006, one more factor came into play and it created nothing short of the perfect storm. FASB is an acronym that stands for “Federal Accounting Standards Board,” and they are the group that sets the standards for the accounting practices of public companies. Partly in response to the dot-com collapse and partly as a result of ENRON’s bankruptcy, FASB had adopted two new accounting rules, FAS 157 & 159. These new regulations, referred to as the “mark-to-market” rules, require public companies to mark their assets down each quarter to the price that they would receive were they to sell them at that moment. It doesn’t matter what the company paid for the asset, or take into account whether the asset is performing or not. In other words, even if a company owned “AAA” rated mortgages that were all paying on time each month as agreed, since the value of real estate had declined and the secondary market for such securities had dried up, the value of that block of loans would still have to be “written down” on the company’s balance sheet.

16.The “Shorts” and the Cycle Continues – Throughout 2006, 2007, and into 2008, companies were being forced to write down these hard-to-value assets to the tune of tens of billions of dollars each quarter. Each time a company would announce another write down, the “shorts,” who are investors that seek to make profits from the decline in a company’s stock price, would start aggressively shorting that company’s stock. Now, the credit rating agencies, when rating public companies, take into account not only a company’s financial position, but also the number of short positions. The thinking is that if many investors are shorting the stock, meaning that they are betting that it will go down in the future, there must be a reason… and that company’s credit rating may be in jeopardy. For a company like AIG, or Merrill Lynch, or Lehman, or Morgan, or Goldman, or many others, if their credit rating drops, the amounts they have to pay to service their debts goes up… and in some cases, by billions of dollars. It’s just like a consumer with less-than-perfect credit being required to pay higher rates than one with a perfect credit score.

17.Like a Fire Burning Out of Control – More write downs led to more short sellers, which put more downward pressure on each company’s stock price, which threatened its credit rating and made it more difficult to raise the cash needed to balance its books as a result of the write down. And with no market for the hard to value MBS and CDO securities, they would continue to fuel further write downs, and so on… and so on. Meanwhile, the lack of a secondary market for mortgages continued to reduce the availability of credit for more and more Americans, which created more defaults and foreclosures, which led to even lower home values, and so on… and so on.

18.Too Little, Too Late – Of course, by 2007 the Fed had become less fearful about inflation and more concerned about recession, lowering rates seven times during that year. But it was too late. The lower rates were meaningless in an environment in which few people could qualify for loans and housing prices were dropping. And clearly, our politicians were either in denial or asleep at the wheel. By the time they realized what was about to happen, it was well into the eleventh hour. Now our government saw that they would have to “bail out” companies like Bear Stearns, Freddie & Fannie, AIG, and countless others who would be in line behind them.

19.Lehman Bros. – For whatever reason, Treasury Secretary Paulson chose to let Lehman Bros. go under. Why? I don’t think anyone really knows, and most in-the-know believe that Paulson regrets this decision. Paulson says he had no choice as Lehman had no collateral, as did AIG.  But the impact is undeniable. Allowing Lehman to default almost immediately froze the credit markets, placed AIG’s financial stability in jeopardy, and made a bad situation that much worse.

20.So Here We Are – It’s hard to imagine, but on September 15th, the Fed’s Chairman and Treasury Secretary had to get in their cars, literally run up to Capitol Hill, and explain to our clearly shocked leaders that our house was on fire and they would need to pass a bill creating the largest federal expenditure in history… in a week… or ALL would be lost. Now that’s cracker jack planning, don’t you think? Who should be more embarrassed? The guys at AIG or Lehman, or those playing politics on Capitol Hill or running the Federal Reserve and Treasury Department? You’ve got to admit, it’s a tough call.

21.Not the End, By Any Means – So, there you have it. A truly perfect storm. Lots of capital looking for the perceived relative safety of real estate, low interest rates, competition that created “teaser rate and zero down payment loans” made available to those with less-than-perfect credit (and worse), inflationary fears and rising oil prices, higher interest rates, unreliable ratings of complex securities, new accounting standards, leverage, short sellers, politicians and policy makers without a clue… and now an American public looking for some individual on which to heap the blame.

Will things get better? Of course they will, but it could take quite some time before they do. Like a decade, isn’t out of the question.  And our government’s response thus far, hasn’t been particularly helpful… to say the very least.

The government doesn’t have to mark its assets down to market value each quarter as public companies are required to do by FAS 157 or 159, so it planned to take over billions of dollars in mortgage related securities, hoping that the outcome would be lenders lending once again.

This was Paulson’s original intended use for the $700 billion TARP funds. He changed his mind, however, when he realized that this approach would take a significant amount of time, time he felt he didn’t have. The banks were willing to play chicken, demanding 100¢ on the dollar, and there was no way to determine what the assets were really worth.  So, he changed his mind mid-stream, deciding that the better course was to inject cash into financial institutions through the government’s purchase of equity in the form of preferred stock, which is more like debt than equity.

The outcome of the TARP thus far has been questionable at best. Lending has not even flirted with returning to “normal,” whatever “normal” should be. The banks that have received TARP funds have declined to disclose how they’ve used such funds, and now they’ve started paying these funds back in order to avoid having to comply with those bothersome restrictions on executive compensation.  The banks are keeping the trillions in FDIC guaranteed loans, however, as they don’t have such restrictions on compensation.

Many waited for President-elect Obama’s plans, as if they might have contained some sort of magic bullet solution. Alas, there is no magic bullet to be had. While there may not be a single bad guy or group of bad guys to blame for our troubles, it is the banking lobby’s interests that are no longer aligned with ours, and our politicians must hear that we demand that they stand up for the people, not just the banks.

Part of the problem we face in finding solutions to our economic issues is that defining our credit crisis as a sub-prime borrower problem conjures up images of a mysterious, irresponsible underclass, screwing up while all the conscientious people suffer as a consequence of their mistakes. Who would want to help this irresponsible group who so clearly have brought this on themselves? And, if we, as a nation, can’t come to terms with the numerous factors that have caused our economy’s problems, what chance do we have of fixing them?

The reality is, we (and when I say “we,” I suppose I mean our elected officials) have let the dominoes fall, and fall too far in the wrong direction. Now we need to look at ways of stopping those dominoes from continuing to fall unchecked, because allowing them to do so is clearly hurting all of us.

In order for our economy to begin down the long road to recovery, our housing market will have to stabilize, and that means that the current wave of foreclosures will have to stop. Some experts, including perhaps most notably FDIC Chair, Sheila Bair, have advocated loan modification programs, but the implementation has fallen far short of effectiveness. Others say that only the free market can fix what’s gone so very wrong, which although true in the long run, would be too painful for the tastes of our politicians.

So, at this point, one way or the other, we the taxpayers will have to buy the toxic assets that still exist on bank balance sheets before lending will come back at all.  If we buy them at asking price, we’ll lose hundreds of billions.  But if we buy them at a discount, we’ll leave holes in the bank balance sheets and have to give them hundreds of billions to fill those holes.  Do you see what I’m saying?  We the taxpayers are going to pay this bill one way or the other.  The banks bankrupted themselves and we’re going to pick up the tab no matter what.

The question is… how toxic will we let the assets in question get?  And that’s a question of stabilizing the housing market.  The lower it goes, the more we will all pay.  So, programs that stop the foreclosure crisis aren’t really about paying for your neighbor’s kitchen remodel.  And Rick Santelli of CNBC is an idiot for saying so.

Make no mistake about it, however, it’s not simply a “failure of the free market” that brought us here. If it were, then we wouldn’t have needed to pass a $700 billion “rescue bill” and provide the banks with untold trillions in FDIC guaranteed loans. It takes a lot to bring Wall St. to its knees… a lot to cause a global financial crisis… a lot more than any of the over-simplified explanations that attempt to place the blame on any one thing.

Regardless of what we do, looking ahead it will be much harder to get a loan than it used to be, no question about that.  With the dollar’s value sure to be kept low, the hope is that foreign capital will continue to pour in to the government’s coffers, but with the debt being what it is, that’s far from a certainty.

But until homeowners are able to refinance their adjustable and recasting mortgages into affordable loans, and foreclosures abate as a result, we’ll see no recovery. As they say, this too will pass… but not tomorrow, not next year, and not for a long time, unless we do more to push back against the interests of the banks, and stabilize our housing markets… and in that regard, we’re running out of time.

Some are calling it a “crisis of confidence”. Some say its a “liquidity crisis”. Or maybe it’s a “credit crisis”. Or a real estate crisis? A “mortgage meltdown”? A “market correction”? Or my personal favorite, “the worst economic crisis since the Great Depression”?

Even if we can’t agree on what to call it, can we agree on the cause of our latest national catastrophe? With every single economist, policy expert, and regulatory official apparently working on the problem, surely we’ve gotten to the bottom of it, right? Otherwise, how can we hope to fix it and prevent it from happening again?

Unfortunately, no. Some say the crisis is the result of deregulation. Others blame the devastation on “irresponsible sub-prime borrowers”. Then there’s the “aggressive lenders” camp. And the “hang the CEOs” crowd. Warren Buffet seems to think that derivatives deserve a large share of the blame. Or maybe it’s FASB’s accounting rules requiring mark-to-market treatment of hard to value assets? What about the credit rating agencies that rated anything they couldn’t understand “AAA”.?

I saw some talking heads on T.V. and they were sure that it’s Bush’s fault. Then a commercial came on and when I changed the channel it was the fault of House democrats like Barney Frank and Christopher Dodd. Changed it again and it was Bill Clinton’s or Alan Greenspan’s doing? And later that same evening, it was Hank Paulson, Ben Bernanke, and Chris Cox that should resign over their oh-so-obvious incompetence.

Well, let me just assure all of those involved… there are only three things that are obvious to me about the current crisis: One, no one seems to know what they’re talking about. Two, it is we, the taxpayers, that are going to pay for whatever has happened or will happen. And three, my house isn’t worth the paper it was printed on and my 401(k) is now a 201(k).

Other than that, there is NOTHING “obvious” about any of this, as far as America’s investors are concerned. Why did the market rally so strongly after its week of monumental decline? I know, some countries had an emergency meeting in Paris and came out smiling? Why did the market give back all of its gains a few days later? Let me guess… did someone important stop smiling? Rain in Botswana? Or are investors simply on drugs? Because that would actually explain a lot.

Then there’s the question of what investors “should” do amidst the wholesale destruction of their accumulated nest eggs. Hold tight. Don’t panic. Look for a rebound in Q3 of ’09? Pray for Obama to save the day? And who could forget CNN/Money’s sage wisdom on what investors can do to change their chances for a comfortable retirement: Save more, work longer, or… wait for it… save more and work longer. Brilliant! Thanks CNN!

I’ve studied the components of the current financial crisis in fairly significant detail and, although I can’t claim to know everything, I am certain that the following facts represent the truth of the matter:

1. The stock market is a risky and dangerous place to invest money. Period. Always has been, and always will be. In the last century, the DOW went from 66 to 11,497, which sounds like a lot until you do the math and realize that those numbers show compounded growth of just 5.3% a year. And, for those thinking that we’ll see the same kind of growth in this century, you’re forecasting that the DOW will reach two million by the year 2100.

2. We’ve been systematically deceived by Wall St. for so long we don’t even notice it anymore. The conventional wisdom, which says that as long as we diversify properly and hang in there for the long haul, our investments in the market will work out just fine… is puree unadulterated crap. Remember, big corporations have never been able to invest to consistently satisfy their future pension plan liabilities, so how the heck were we “we” as individuals supposed to have been able to do it?

We have bubbles every 7-8 years, at least. And, in case you wanted to know the definition of a “bull market,” it’s a temporary condition that tends to make investors feel like geniuses. The bubbles inflate and then go pop. And we spend the next so-many years trying to get the gum out of our collective hair. I’ve never even tried to calculate my average investment return over the last 20-30 years, and I’d bet that Wall St. prefers that I remain in the dark as to the outcome of such a calculation.

I saw the movie “Jaws” when I was 12, and was too scared to go in the ocean until I was 30. I saw the movie “Wall St.” when I was almost 30, and I’ve been losing so much money to the market sharks ever since that now I can’t even afford to vacation in a locale where I might be eaten by a real shark. Our penchant for investing in the market only started in the mid-1980s as a result of defined contribution plans and IRAs. Since that time we’ve seen the number of mutual funds go from hundreds to tens of thousands, each with its own advertising budget. And, as we might have expected, we’ve been deceived.

The truth is, that as we approach retirement age, the average return of the S&P 500 over the last 40 years is about as useful a number as the appraised value of our homes back in 2005.

3. The current crisis wasn’t caused by any one thing. It wasn’t caused by any two things either. Or any three, for that matter. Our current meltdown is the result of the convergence of multiple factors. The list starts with a post-dot-com bubble insatiable demand for real estate. People wanted to buy, and investors wanted to lend. After all, a house couldn’t fall to zero like our shares in E-Toys, or Pets.com, right? Then there’s the impact of complicated derivatives, known by acronyms like MBS and CDO. Rating agencies couldn’t figure them out, so they slapped AAA ratings on them and shipped them off to investors, many of whom were not permitted to hold anything but AAA grade securities.

Aggressive lenders (which is another word for “lenders”) went out and did their job of competing for loans. And people did their job by wanting to buy homes. The Fed did their best to yo-yo the interest rates, as its governors vacillated between fears of inflation and recession. Not to be outdone, FASB weighed in with FAS 157 and 159, causing the quarterly write down of untold billions, and the Bush administration maintained the status quo of denying that there was a problem beyond what the free market would soon resolve. Of course, everyone leveraged themselves to the hilt, and Paulson and Bernanke waited until the last possible moment to do their Chicken Little imitation. Well, very nicely done one and all! Cracker jack work!

4. There are 78 million baby boomers theoretically retiring in the next 20 years. I’m not sure, but I think something like 650 of them are financially prepared for their retirement years, and most of those 650 only made it as a result of receiving an inheritance. Still, our financial advisers, or “helpers” as Mr. Buffet refers to them, continue to spew out the lines they memorized in 1987, they continue to quote historic average returns, while telling us about past performance’s relationship to future results. Even more amazing is that we continue to listen like Kindergarten kids at story time.

Why are we here? Let’s be honest. As an investor, you know why we’re here, and whether you know the details or not really doesn’t matter. You’ve seen what the markets do and what they don’t. You didn’t see anything coming and you have little idea what you’re talking about most of the time. You didn’t buy Cisco Systems at $6 a share in 1996, and you didn’t sell when it hit $86. You’re no “Wizard of Wall St.” and you’re not much of a real estate tycoon either. You’re just a regular person who’s trying to do the best you can to accumulate enough money to retire someday, and still be able to afford prescription drugs and the occasional vacation to visit the grand-kids.

We need to stop kidding ourselves. We’re the first generation to even attempt retiring with defined contribution plans and stock market investments. It’s never been done before, so why should we believe that it’s even possible. It’s not, by the way. Think I’m wrong?

Try the following exercise for yourself: Start with a hypothetical balance of $1 million. Pick a starting year… say 2000, or 1990, or whenever you’d like. Then pretend that you invested the entire amount in the S&P 500 and see what happens when you withdraw 5% a year (or $50,000) from that account. It’s easy. You can find the annual return figures for the S&P 500 online. Just deduct $50,000 each year, and add whatever the S&P 500 returned each year. See how long (or short) your money lasts. If you start in 2000 and go to today, you’ll have about $365,000 left. Then imagine doing this at 65 years old and living until age 90.

I’m no genius, but I’m positive that running out of money at 83, and living until 93, would be… let’s just say “less than ideal” and leave it at that.

So, why don’t we do something about our situation? Change our ridiculous behavior. Start saving more, spending less? Why that’s an easy question to answer: We can’t… not now… maybe when the market comes back. Don’t want to miss the “bounce” don’t you know!

Well, alrighty then… all I can say is: “Hit me. And bring me another cocktail. Viva Lasfriggen’ Vegas!”

If you’re old enough to remember the 1980s, you’ve undoubtedly heard the conventional wisdom about retirement investing from one financial advisor or another. Here’s how it goes:

Invest in stocks through quality mutual funds, diversify properly relative to your risk tolerance, hang in there for the long-term… and everything will work out fine… you’ll achieve your financial goals and enjoy a comfortable retirement. Or something very close to that, right?

Basically, ever since Oliver Stone’s movie Wall Street, we’ve all been told that the stock market will go up and it’ll go down, but over the “long-term” we’ll do better than investing anywhere else.

Today, something like 75% of all Americans are invested in the stock market in one form or another, and they do so believing that this is the path to accumulating the amounts they need to retire comfortably. Americans invest in the stock market through their employer-sponsored retirement plans, their IRAs, their pensions, insurance policies, and more. It’s become the accepted conventional wisdom: If you want to invest for the future, you need to have most of your savings in stocks.

Consider that in August of 1982, the Dow Jones Industrial Average hit 772, but by that year’s end, an interest rate fed Bull Market was born and it would last for an astounding twenty-five years. On October 9, 2007, the Dow Jones Industrial Average closed at a record 14,164.53.

So, what is the definition of a bull market anyway? That’s easy: It’s a temporary condition that makes investors feel like geniuses.

Well, the proverbial jury is in and I’m sorry to say that the news is not good: We’ve been lied to. Deceived. Misled. Manipulated. And, as a result, our ability to save the amounts we need to retire comfortably is… well, shall we say… lacking. We’ve been confused by charts. Stunned by statistics. And buffaloed by B.S.

Avoiding Future Financial Shock

If you’re under forty years old, chances are there’s no talking to you about investing for your future. If you’re over forty, you’re looking at 65 as being just around the corner, and it’s really important that you take a moment to take stock. Not buy stock, take stock.

Your retirement years are approaching fast. If you don’t start to examine your views on investing for your future years, then what’s in store may come as quite a shock. To avoid that future shock, we need to better understand how we all got here, so we can change things going forward.

Understanding Bubbles…

We seem to have a love-hate relationship with bubbles. It all started in mid-1980s, when “greed was good,” corporate raiders were modern day cowboys, and junk bonds meant that money was flowing through Wall Street like lava from Mt. Vesuvius.

Of course, much like what happened when Vesuvius erupted above the town of Pompeii, it all soon came to a standstill. The “Black Monday” market crash of October 1987 signaled the end of an era. Drexel Burnham Lambert, Mike Milliken, Charlie Keating, Ivan Boseky, and the other names that had permeated our lexicon as being leaders of American business, all ended up to be major disappointments, to say the least. The bubble popped, S&Ls went under, and suffice it to say… it was a real mess that would trigger a bad recession. All of a sudden, having a new BMW wasn’t cool, but a mini-van and a new savings account was.

Then, after weathering the recessionary storm of the early 1990s, we saw little company named Netscape go public, and soon the three initials on everyone’s mind were I, P and O… and everyone was “doing it”. We heard stories of business plans written on napkins raising millions, our neighbors all seemed to have bought Cisco Systems at $6 a share, and relatively tiny AOL would soon buyout media giant Time Warner.

It didn’t make a lot of sense to many people, but the stock market was flying high, a “new economy” had supposedly arrived, and early retirement became the buzzword of the day. Cab drivers were day trading, and just about everyone over the age of 18 had a stockbroker on speed dial. Never mind that Alan Greenspan was warning of irrational exuberance and Warren Buffet was sitting on the sidelines. Never mind that the companies we were investing in didn’t make any money. Other people appeared to be getting rich, so we jumped in with both feet.

Then, on April 10th, 2000, the bubble popped… again. American consumers lost $7.3 trillion as a result, and prayers rang out promising God that we would only buy bonds for the rest of our lives, if Cisco would just come back to $84 a share, even for a moment. IPO, as it turned out, actually stood for: It’s Probably Overpriced.

When the dot-com bubble popped in 2000, the United States was plunged into a recession that many feared could become quite serious, as the prospect of “deflation” came into view. But, the Federal Reserve under Greenspan, determined to avoid a replay of the 1970′s economic malaise, lowered rates and opened the floodgates of capital. Real estate became our savior-du-jour, and soon it would be our homes that would save us from ourselves. Someone that lost his or her bet that Amazon.com would reach $400 a share, could still be assured a comfortable retirement simply by owning a home and perhaps investing in a duplex. Or, what the heck… why not buy two.

“Real estate is by far the safest investment you can make. Housing prices will never fall like share prices.” That was the thinking way back then, remember? “Pets.com may go to zero, but a house can’t do that.”

People ignored anyone suggesting that yet another bubble was in the making. The fact that housing prices had fallen after previous booms, such as in 1990, didn’t seem to matter. “This time is different”, was the order of the day. Of course, that was exactly what the stock market analysts had said in the latter half of 1990s, but we didn’t seem to remember that for some inexplicable reason.

Here’s what The Economist printed in May of 2002:

IF THERE is one single factor that has saved the world economy from a deep recession it is the housing market. Despite the sharp fall in share prices and a worldwide plunge in industrial production, business investment and profits, consumer spending has held up relatively well in America, supported by low interest rates and the wealth-boosting effects of rising house prices. Over the 12 months to February average house prices in America rose by 9%, the biggest real increase on record in America.

Yes, we were all blowing hot air into another yet another bubble and by 2005 that bubble was approaching the size of planet earth. Here’s what The Economist wrote in June of 2005:

PERHAPS the best evidence that America’s house prices have reached dangerous levels is the fact that house-buying mania has been plastered on the front of virtually every American newspaper and magazine over the past month. Such bubble-talk hardly comes as a surprise to our readers. We have been warning for some time that the price of housing was rising at an alarming rate all around the globe, including in America. Now that others have noticed as well, the day of reckoning is closer at hand. It is not going to be pretty. How the current housing boom ends could decide the course of the entire world economy over the next few years.

Never before in history of the world had housing values gone up so fast, so much, and for such a long period of time. The rising property prices that had helped prop up our economy after the dot-com bubble burst in 2000, but it was about to get ugly.

According to estimates published by The Economist in the second half of 2005:

The total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, which is an increase equivalent to 100% of those countries’ combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stock market bubble in the late 1990s (an increase over five years of 80% of GDP) or America’s stock market bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.

Of course, by the time 2007 appeared on our calendars, the real estate bubble had popped over a year before and many of us, for THE THIRD TIME, are still trying to get the gum out of our collective hair. And the economic crisis we now face, as a result of the giant real estate bubble having popped, has only just begun to affect our wallets and national psyche.

So, three bubbles, and we’re three for three. What’s next? Are we waiting for yet another BIG GET RICH OPPORTUNITY, through which we can finally catch up and retire in style? Or will we finally learn that we can’t afford any more of those opportunities?

It is the view of many “experts” that it is we investors that are the culprits. We, as the thinking goes, are our own worst enemy. It is simply human greed that creates the bubbles that cause us such financial harm. And therefore, since greed is here to stay, we are doomed to repeat our past behaviors. But is this easily reached assumption really true? Are we really just greedy opportunists receiving our just desserts as the bubbles we create inevitably pop?

The answer is unequivocally “let’s hope not”.

There’s no question that greed is an inherently human trait that we are all capable of exhibiting under the right circumstances. But, to assume that greed is what fuels our collective investor psyche is simply too cynical, and a conclusion too easily reached.

Consider, for example, that most of the people that saw their 401(k) balances decimated as a result of the dot-com bubble’s demise weren’t being greedy when they jumped on the technology bandwagon. Greedy people, one would think, would be more careful… more crafty. Greedy people don’t leave 75% of their retirement investments in company stock, and then sink the rest into a technology growth fund. People jump on bandwagons because they don’t want to be “left out” of what everyone else is doing, and from which many appear to be benefiting.

Being left out sucks… big time. We hated being left out in elementary school and high school, and we don’t like it any more as adults. No one wants to be the one still looking for an empty chair when the music comes to a stop. The feeling of being left out, like greed, is a basic human trait, but it’s much more commonly shared than greed. Some among us are greedy, but none of us relishes the idea of being “left out”.

So, while it is us that provide the air that inflates our market’s bubbles, it’s not being driven by all-too-human greed. We are simply trying to ensure that we are not left out of a party to which so many of our peers appear to have been invited.

Human traits, such as greed are not things we can change… they can only be controlled. However, human beings will never like the feeling of being left out… not even for a moment.

With all of this in mind, it shouldn’t be difficult to imagine how investment bubbles keep happening. “Honey, we should buy more technology stocks… Joe and Mary bought more technology stocks… why can’t we buy technology stocks?

Or, more recently: “Honey, we should buy another house… Joe and Mary just bought another house… Tom just bought a place in the desert… everyone but us has at least two houses… shouldn’t we buy another house? We don’t want to be left out!!”

Left Out of a Financially Secure Future

During the technology bubble of the last half of the 1990s many of us were contemplating an early retirement as a result of our newfound investor prowess. Today, we’re not entirely sure that we will be able to retire at all, and few of us can remember the name of the stockbroker we used in the late 90s. Just try mentioning that you received a “tip” from a broker at an upcoming social gathering and you’ll quickly see how risk averse we’ve actually become.

Oh sure, we haven’t appeared to be all that gun shy these last few years, but that’s only because we jumped into the real estate bubble. But make no mistake about it… those that jumped into real estate were driven by a need for the assumed relative safety of the real estate market. No one thought investing in real estate could be overly risky because everyone was doing it, and because houses, regardless of their purchase price, cannot end up being worth nothing, as was the case for shares of Pets.com.

Those that got into real estate later in the game, however, did so NOT out of greed… but to ensure that they would not be left out. Numerous studies conducted after the dot-com collapse support this hypothesis. For example, many people reported feeling much less embarrassed about losing money on a popular stock that half the world owns – like AOL or Yahoo – than about losing on an unknown or unpopular stock. As long as everyone’s losing… or winning… we’re okay.

This is another example of why we’re terrible at investing: We buy what’s “hot”. All data shows that money flows into high profile mutual funds much faster than the money that flows out of underperforming ones. As a result we continually buy high, and sell low.

There are many other aspects of human behavior that impact our ability to invest effectively. Some studies show that we’re more scared of losses, than we are happy about gains. Anchoring is the concept that shows that people tend to place too much credence in recent market events and opinions, and ignore historical, long-term averages and probabilities. And most of us are overconfident. Countless studies show that people generally rate themselves as being above average in their abilities. We often overestimate the precision of our knowledge and our knowledge relative to others.

We’re human, and therefore… we’re doomed?

It would be easy to reach the conclusion that as flawed human beings we are doomed to failure as far as investing or preparing for our future goes, but I don’t believe it’s true. I believe that, by understanding our inadequacies, we can overcome our proven tendencies.

The Solution: Change your view of what you don’t want to be left out of…

It’s time to take hold of the law of nature that dictates that we, as human beings, don’t want to feel left out, and harness its power to our advantage. We can learn from the past.

Consider this: What’s the one thing, more than anything else, that you don’t want to be left out of: A comfortable retirement, right? Imagine being left out of that. Imagine watching your friends and relatives vacationing together, while you remain at home constrained by a budget far less than you lived with throughout your working life. Perfect. Now that you have the time to travel, you can’t afford to. Imagine what it would be like to run out of money at age 83, and then live to age 93… your last ten years spent below the poverty line.

Are you imagining the horror of that situation? Good. Now, compare that with feeling of being left out of buying Cisco Systems at $6 a share, or not buying real estate when everyone else was. If the latter is a pinprick, the former is amputation of your arms and legs… right?

Once you realize that the most important thing not to be left out of is your own comfortable retirement, you can begin to change your perspective on what you should do to make sure that you’re not.

Savings and Returns on Investments

Of course, the first step is to save as much as you can, but for the purposes of this article, that’s the given. The next step, as any investment advisor will tell you, is to invest those savings, within a certain tolerance for risk, in order to maximize your returns on investment or ROI.

That’s what we’re told, isn’t it? If we are to reach our financial goals, it’s the long-term performance of our investments that reigns supreme? And it makes sense, on the surface anyway. Of course you should take steps to maximize your ROI, right? If you see one fund doing better than another, it stands to reason that you should put your money where the returns are higher, assuming the risk of doing so is not significantly greater. Doesn’t it?

I’m not at all sure it does, how about that? In fact, I’m pretty darn sure it’s all a pile of crap. ROI is investment advisor horsepucky, nothing more.

I’m going to tell you something you may not have considered before: Chasing ROI is a fool’s errand… waste of time… entirely pointless.

Why? Why would it not matter what your ROI, or return on investment was? How can that be? Is that what you’re thinking? Because that is what you should be thinking… that’s certainly what I would have been thinking before embarking on a year long intensive study of the markets and retirement investing. Now, I’m thinking something very different.

ROI doesn’t matter for several reasons the most important of which is that it’s the down years that kill you. If you could invest to earn just a 5% annual return every year and never a penny more, but you could skip the down years… you’d be a lot better off in the long run.

The other reason that attempting to maximize ROI isn’t so important is that we are terrible at it. According to John Bogle at Vanguard, between 1980 and 2005, the average annual return was 12.3%, but the average investor earned just 7.3%. That’s us… we buy high and sell a few weeks ago.

Consider what Warren Buffet had to say about the last century and the century ahead:

“Over the last century the Dow went from 66 to 11,497. While this may seem like enormous growth on the surface, compounded annually, it’s just 5.3% per year. In this century, if investors matched that return, the Dow would close at 2,000,000 by year end 2099.”

Two million? The Dow Jones Industrial Average at 2,000,000? I know that’s ninety years from now, but still. Right now, the DOW’s hovering around 7,000.

Warren went on to say this:

“And anyone who expects to earn 10% annually from equities during this century is implicitly forecasting the Dow to reach 24,000,000 by the year 2100. If your advisor talks to you about such double digit returns from equities going forward, explain this math to him… not that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland who said: Why, sometimes I’ve believed as many as six impossible things before breakfast.”

Here are the facts about the markets:

1. The return on the S&P 500 Index over the last decade was zero… zip… nada.

2. Let’s say you had retired at the beginning of 2000 when you were 65, and you invested $1,000,000 in the S&P 500 Index on January 1, 2000, and taken withdrawals of just 5% a year, or $50,000, to cover your retirement living expenses. As of July 30, 2008… that’s last July… you’d have $482,930… half of what you started with… and you’d be 73 years old.

3. Although we enjoyed a bull market that lasted almost 25 years, from 1982-2005, prior to that we languished in a 16 year bear market from 1966 to 1982, during which the stock market’s average annual return was -6%… that’s negative 6%. And that’s according to Art Laffer, the man who’s never seen a tax cut with which he didn’t fall in love.

4. Diversification… Modern Portfolio Theory… Diversify your investment holdings, that way if one investment goes south, the others will reduce the impact of the loss. These ideas also appear to make complete sense, but perhaps there’s more to the equation than has been explained to us in the past. Maybe conventional wisdom should be questioned. Why should we accept losses at all?

5. The biggest threats to your comfortable retirement can be thought of as tax risk, longevity risk, and sequence risk. Tax risk is the risk that taxes will be higher in the future, which will eat into your available income during retirement. Longevity risk is the risk that you’ll outlive your money. And sequence risk is the risk of market downturns in the years preceding or immediately following retirement. Taxes… life expectancy… market downturns.

The Real Question to Answer…

When it comes to planning for your comfortable retirement, there’s really only one question to answer: How much money do you know that you will be able to receive each year after you stop getting a paycheck from work? That’s it. When discussing your retirement years, no other calculation matters. Period.

What percentage withdrawal rate can my portfolio sustain this year? What if the market is down next year, will I have to reduce my income? Will I have enough money? Can I run out of money in retirement? These aren’t the questions you want to answer after you’ve retired.

What percentage did a given fund return last year? Are the markets forecasted to go up or down? Who knows, and why should you care? The question you have to focus on, if you don’t want to be left out of your comfortable retirement, is about the cash flow your accumulated savings will provide during those years. And not just “maybe” but “for sure”.

It’s been a rocky ride, these past 25 years. We’ve had some good years and some terrible ones. But only the people who brought us the economic meltdown in which we find ourselves today could have invented the idea that our stock market is where we should all be investing our retirement savings. It’s nonsense. The stock market is gambling, pure and simple. Except you don’t get free drinks as you would in Las Vegas, when you’re gambling on the stock market.

We all need to come to terms with the fact that we’re nothing special when it come to investing and that even though we may have a financial advisor we like… it’s our money and our job to make sure we reach our goals.

We need to stop listening to the historical averages, and start listening to the phrase “past performance is no assurance of future results”.

A recent study showed that in the U.S. alone there are more than 3.5 gazillion books on “how to become a better investor” published each year. That’s more than the number published on the subjects of “diet and exercise,” and roughly the same number written about Hillary Clinton.

Haven’t we learned enough by now? Are we simply doomed to continually give back gains every few years until our portfolios would have performed better if left in a money market account or even a mattress? Are we greedy? Short-term memory loss? A learning disability? Restless leg syndrome… what’s the deal?

Oh… the “light bulb” is on alright… but even with market meltdowns, and unemployment both going in the wrong directions, and dollars now being used overseas as toilet paper, too many of us are still sitting at home using the light from that light bulb to read the “Hot Stocks for 2009,” list in Rich & Richer Magazine.

Oy vey…

Coming Soon… An analysis of investment vehicles… the best return for the lowest risk… Or, how to skip the market’s down years without having to be in the bond market.