Retirement Catch-Up, IPO Heat Check, and the Market Effects of Index Funds
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It's a very special listener question episode. I know what you're saying.

What's special about it? How is this listener question episode different from all the others? And you know what? You got me. It's not special at all. But that doesn't mean it's not good, right? I'm Jack Howe. This is the Barron Streetwise Podcast.

With me, our audio producer, Alexis Moore. Hi, Alexis. Hi, Jack. What are some of the topics? Give us a sprinkling of the topics we're going to hear about coming up. Yeah, we have a few really good ones. We're going to talk about passive investing and its effects on markets.

We're going to talk about playing catch up with your retirement funds. You know, maybe you started a little later. Starting late. And we're going to hear from our pal, Elizabeth O'Brien from Barron's, our in-house retirement expert. Yes.

Always happy to hear from Elizabeth. And what else? FICO, our favorite topic. FICO. Oh, right. I'm going to be getting in the confessional booth. Yeah, you're going to have to answer for what happened not too long after we published the episode, which was that the stock dropped by kind of a lot. Because I talked about FICO and then attacked. Okay, we'll get to it. Okay, let's start with our question on passive investing.

Hi, Jack. My name is Julian. I'm calling in from Vienna, Austria. I have a question regarding the contrast between passive and active investing.

Passive investing seems to have been on the rise. It's gained popularity, and apparently the share of money that is passively invested has skyrocketed over the past years. And I wonder whether that has any effect on how the capital markets function, especially if there's any negative effects to it as well. Thank you, Julian from Austria. I like this question a lot.

All this money flowing into passive funds. And here in the U.S., they've done so much better than active funds. If you're a large cap stock fund manager here in the U.S., you have had a tough time of it, I think, over the past couple of decades. I think the S&P 500 has been difficult to beat. And that's reflected in the numbers. The vast majority of fund managers there have underperformed.

And I take your point, Julian, what happens if so much money flows into passive investing that we no longer have active traders to discover prices? Keep in mind, the whole theory that the stock market efficiently prices in information, that depends on the existence of people out there looking to scoop up deals. They buy or sell shares based on that new incoming information.

There's a paradox here named for a couple of researchers who introduced the idea back in 1980. It's called the Grossman-Stiglitz Paradox. It says that perfectly efficient markets are impossible. If markets fully reflected all available information, there'd be no profit motive in trading on new information. So how could you have efficient markets to begin with?

That's a deep thinker, but I'm most interested in the real-world practical consequences of all this indexing. It seems a little bit, as the kids say, "sus" or "suspect." Stock market valuations here in the U.S. have been above average for so long that I'm starting to wonder, "What's average?" For a while we said that's because interest rates were so low. They're not that low anymore. Yes, I know that in the U.S. we have an abundance of fast-growing technology companies.

So that explains part of it, but I just wonder if indexing also plays a role. The market is so concentrated at the top with these tech companies. Could it be that all that money just flowing blindly into S&P 500 funds is making those companies at the top more expensive? I do not have a definitive answer on that for you.

But I would like to tell you about an award-winning academic paper on the subject. This is a 2024 paper titled Passive Investing and the Rise of Mega Firms. And it won the Outstanding Paper Award from the Swiss Financial Institute. The paper is written by Liu Zhang at the University of California, Irvine, and two of her colleagues.

The paper points out that between 1993 and 2021, passive funds went from $23 billion of assets to $8.4 trillion. That means they went from less than half a percent of the U.S. stock market to 16%. That's massive growth. According to Morningstar, passive funds ended 2023 with more assets than active funds.

I'm going to read you a one paragraph abstract that sums up the paper.

We study how passive investing affects asset prices. Flows into passive funds raise disproportionately the stock prices of the economy's largest firms, and especially those large firms that the market overvalues. These effects are sufficiently strong to cause the aggregate market to rise even when flows are entirely due to investors switching from active to passive.

Our results arise because flows create idiosyncratic volatility for large firms, which discourages investors from correcting the flow's effects on prices. Consistent with our theory, the largest firms in the S&P 500 experience the highest returns and increases in volatility following flows into that index.

If you want to read that paper for yourself, it's free to pull up online. Just search for passive investing and the rise of mega firms. Academic papers are written in a way that's not always super approachable for all investors. If you want to find a more newsy article on that paper and its findings, there's one on the UC Irvine website. It's titled The Dominance of Passive Investing and Its Effect on Financial Markets.

This is, as you might imagine, a complicated thing to study. There are a lot of factors affecting company valuations at any one time. Flows into index funds are just one of them. What we can say for now is that there is some evidence out there, academic evidence at least, that all this money flowing into index funds is leading to some overvaluation of stocks and to some higher volatility.

I would not call it an open and shut case. We don't know how big indexing can get, and we don't know if there's some moment down the road where some of these higher valuations revert back to normal for good. This is definitely a subject I want to come back to on a future episode. Noted.

What's next, Alexis? Give me something saucy, something jazzy. Let's spice things up a little bit here. What have we got? Okay, yeah. Let's do Jeremy from Washington State. He has a question about IPOs. Okay. The IPOs are spicy or Jeremy's spicy? He's spicy. He has something to say about you. He's calling you out. Okay, let's hear it.

Hey, love the show. Had to correct your pronunciation on your last cheese episode. Up here in the Pacific Northwest, it is Tillamook, not Tillamook. Jack, my question is about the recent IPO market, Newsmax and Coreweave. Is this a good sign for the economy or do these things just happen when they happen? Jeremy, you really threw the book at me on my cheesy pronunciation. I had it coming.

Not the book. Yeah, the whole book. The IPO market. It was good until it wasn't as good. I'm getting ahead of myself. Let me answer the question you asked before I get to a question you didn't ask.

If the IPO market is hot, if there are a lot of deals coming, is that a good sign for the economy? Definitely. IPOs do not just happen when they happen. If you're bringing a company public, you're a seller. When do you want to sell? You want to sell when the buyers are eager. You want to sell for as much as possible. You'd love to sell into a rising market where investors are embracing risk.

So when we see a high volume of IPOs, I think, yeah, it is a pretty good sign for the economy. There's a fine line, of course, between a strong market and a frothy market that could be worrisomely expensive. But that aside, more deals is generally better.

Okay, now the question you didn't ask. That's how we started this year. In the first quarter of 2025, there were 15 traditional IPOs raising over $7.9 billion. This is according to the accounting firm PwC. And that made the first quarter the strongest start to the year since 2021.

It was significantly better than last year, way better than 2023 and 2022. Okay, so what's the problem? The problem is that deal activity began to taper in the middle of the quarter. We had some companies that had to cut their valuations before pricing. And of course, we had a quick but steep market sell-off and then a rebound. I think investors are anxious. I don't have an angstometer to measure it with.

But I hear a lot of people wondering, is this a sell-in-may-go-away type thing, or should we just hang tight and see what happens next? The economy seems to be holding up well. If the stock market stabilizes or perks up through the rest of the year, we might get back to that hot IPO market.

Right now, if you have a company that you're looking to sell to the public, you're probably just waiting on the sidelines for a little while longer to see if investor enthusiasm picks up so that you can get the best possible price. Thank you, Jeremy, and hi to listeners in Washington State. I remember that Tillamook is in Oregon. Just kidding. Just kidding. I know it's Oregon. I'm not looking for any other pronunciation trouble.

Let's take a quick break. When we come back, we'll talk about retirement savings after 50 and FICO's big flop. That's next after this quick break. Isn't home where we all want to be? Reba here for Realtor.com, the pro's number one most trusted app. Finding a home is like dating. You're searching for the one. With over 500,000 new listings every month, you can find the one today.

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We have Beth, who is reaching out on behalf of her husband. Okay. Does she, do we know the husband's name? We don't. He's just. Just Mr. Beth. Mr. Beth, correct. Okay. Let's hear it. Hi, Jack. Long time listener. First time writing in.

My husband is age 50 and has no IRA and wants to start one now. What advice do you have for starting an IRA later in life that could help him play catch up? He makes about $55,000 take home and spends $2,500 a month if this is helpful. Thank you.

Thank you, Beth. I'm calling in the big guns for this one. Elizabeth O'Brien is a Barron Senior Writer and a Personal Finance and Retirement Specialist. I spoke recently with Elizabeth. Let's listen to part of that conversation now. Elizabeth O'Brien, how are you? Good, thanks. How are you doing, Jack? Doing well. Thank you so much for joining me. I want to talk to you about what's the best thing that this family can do.

So, yeah, IRAs come in two flavors, traditional and Roth. The difference is when do you pay your taxes. With traditional IRAs, you might be eligible for a deduction on your contributions.

It's going to depend on your income and whether you have access to a 401k at work. But say if you don't have access to a 401k, you can deduct that money up front, but you pay taxes when you withdraw it in retirement. Roth, it's the reverse. You contribute with after-tax money, but in retirement, your withdrawals are tax-free. You and I were talking about this recently on the Barron's TV show. We were talking about whether or not to convert a retirement account to a Roth. What do you think about that decision, traditional versus Roth?

Honestly, at that income level, I don't think you can go wrong either way. So I'd say, you know, start it off. It's probably good to have one of both. But if you're just getting started, go with the traditional, get that going, fund it for a few years. And then down the road, maybe you open a Roth and you split your contributions. But I don't think there's a wrong answer for this one because I think it's good to have one of each. I

I like taking the money. You know me. If there's money up front to be had, I want to get that money. You don't want to pay taxes until you have to. That's right. And that's what we're talking about here because you can get a deduction. I'm looking up the limits here. If they're married and they're filing jointly and we don't know, but...

I see a limit here, $126,000 or less for a modified adjusted gross income, and it phases out after that. So it sounds like they might be able to get a full deduction on an IRA contribution. That's what we mean when we say take the money now versus with a Roth, they're not going to get a deduction on the contribution now. But later on when the money comes out, it'll come out tax-free. Exactly. That's the basic trade-off. What else is there to know about

advantages if they go Roth versus traditional. I think that's the big one. It's when do you want to pay your taxes? You can't avoid them. So you pay them now or pay them later. And it involves sort of peering into the crystal ball. Do you think your income is going to be the same in retirement? Is it going to be less? But the wild card is also tax rates.

You know, this deficit chickens are going to come home to roost. The federal government is probably going to raise rates eventually. I've heard of deficit hawks. There are deficit chickens, too. And they're coming home to roost. They're coming home to roost eventually. So 20 years down the line, they could very well rise, in which case there's an argument to be made for paying your taxes now. Do required minimum distributions come into play here on this or no?

Yes. So once you are 73 and older, the IRS requires you to start withdrawing money from your IRA and paying tax on it. This is your traditional IRA. So you can't defer your taxes forever. Uncle Sam wants his peace. That starts at 73.

And, you know, you're not going to be able to control the amount. It's set by a formula. If you have a Roth, those are not subject to annual RMD requirements. Putting aside Beth's situation, thinking about someone who they've been contributing for many years to a 401k and now they have a choice. You can take some of that money and convert it.

it into a Roth using different means. But should you, you have to pay taxes now, which sounds like a total drag. But you were making the point that you're going to have to pay them eventually anyhow, because with a traditional 401k or IRA, you're going to get hit with those distributions. Right. If you do decide to convert your traditional IRA to a Roth, you don't have to do it in one fell swoop. You can convert a little bit each year to keep those taxes relatively under control, like stagger it over a number of years. Right.

Yeah, that's an important point. I tend to think all or nothing. What's the best choice? I'm going with choice A or choice B. But you had made the case to me that there's something to be said for having diversification in the types of retirement money that you hold. Exactly. Tax diversification is a thing. Now, if you're getting started in midlife, I think it's fantastic. Your RMDs are probably not going to be ginormous when you get to be 73. So it's a little less of a concern for people who are just starting to build their next eggs.

You know, if you've got a million plus in your traditional IRA, then you're looking at heftier RMDs. There's some folks out there who are going to be 55, 60 and say, hey, look at this spring chicken. Look at this go-getter getting an early start. So, you know, it's never too late to get going. What else should Beth know about this situation? Well, first of all, kudos for getting started. That's great. And like you said, it's never too late to start saving for retirement.

In 2025, the IRA contribution limit is $7,000 for people 49 and younger. If you are 50 plus, you get an extra $1,000. So that's for a total of $8,000. That extra $1,000 is the catch-up contribution. Yes. So if you're 50 and over, you can put $8,000 into your IRA for 2025. Now, one thing to remember is that is across all

all your accounts. So you can't open up two IRAs and get $16,000, even if you have multiple accounts, that 8,000 counts for all. But if you weren't sure whether to do traditional or Roth, or you see some benefit in having both, you could make contributions to both accounts, a little bit in a traditional IRA, a little bit in a Roth, as long as you don't go over the limit for all of them. Exactly.

There is something out there called the Savers Credit, and I'm not a super duper expert on it. It starts to phase out for adjusted gross incomes of $47,500. Sounds like these folks are above that. It's done phasing out at $79,000. So they may be able to catch a portion of it. If you do your taxes on filing software, your software will probably alert you if you're eligible for that credit.

So it might be some extra. A little extra sweetener. Right. And that credit is going to change in a couple of years. Beginning in 2027, it'll be replaced with a matching federal retirement plan contribution. Savers match. Now, what should they put this money in that will double by August guaranteed? Come on. Don't get me in trouble here. This is the most important part, Elizabeth. Yeah.

You raise a good point. You've got to invest it in something. You need to take an extra step after the money is deposited to invest it. I don't have any get-rich-quick ideas. I don't know. You know, you need a healthy allocation to stock. You know, low-cost index funds.

Get your basics covered. Yeah. Don't spend a lot in fees. Yes. Get yourself a stock index fund and a bond index fund. And probably at that age, I would say put a little more in the stock index fund if you're planning on saving for at least a couple of decades. Yeah. Maybe 70% stock roughly at that age at 50%.

Depending on where they're doing this investing, they might have a target date fund or something like that that does an asset allocation for you. It's kind of like one-stop shopping. They can check that out, but don't spend too much on fees. Yeah, like really like 0.03%. You know, these index funds have very, very low fees. There should be a zero after the decimal place. So 0.0 whatever. You shouldn't be paying more than that for your low-cost index funds. The first number after the decimal point ideally should be a zero. I like that.

Elizabeth, thank you so much. And I'll see you on the Barron's TV show. Sounds good. Thanks. Alexis, last one we have is about FICO. Who's our questioner? Yes, we have a question from Greg. Thank you, Greg. And he asks about FICO. Just wondering when a stock gets hit so hard within days of your discussion, what your reaction is? Greg, I'm detecting a bit of a tone there. What are you trying to say? No, I'm just kidding. Okay.

Greg, I write about or talk about particular stocks for all sorts of reasons. Maybe there's a company out there that looks cheap and it seems to be in the right place at the right time. There's a catalyst that I think might take that stock price higher. Or maybe there's an outside analyst or money manager who feels that way and I find their case convincing or at least informative.

Sometimes it's just the opposite. Sometimes it's a stock where I find it to be preposterously priced. I'm not particularly prescient on any of those things. I have not detected an extraordinary ability on my part to beat the market. And I think at my age, I would probably have detected a thing like that by now.

Sometimes I write about stocks just because they're in the news a lot. A lot of people are talking about them or wondering about them. And sometimes, like in the case of FICO, it's just because there has been some type of extraordinary market move and I want to figure out what's behind it. It's not the first time I've written about FICO. I've done so here and there over the years.

I just find it extraordinary that a company known for the humble credit score has returned so much for investors over so many years. Even now, after the big recent sell-off, that's a stock that has returned almost 5,000% if you've held it over the past 20 years. To me, that raises the question of why has the stock done so well over time?

And that's what I wrote about. Five reasons. There are business trends like the rise of credit card spending and the fact that the FICO scores become an industry standard. There's the fact that lenders request the scores, but it's borrowers who ultimately pay for them through application fees. That's important. If the customers aren't the payers, it gives the company a lot of pricing power.

It gives FICO what one Wall Street firm recently called "perfectly inelastic demand." Hold that thought for a moment. Other reasons include that Fair Isaac or FICO is very scalable. In other words, it can raise its sales and expand its services much faster than its costs.

also management has been buying back a lot of stock and a lot of it has to do with a rising valuation as i wrote in barons in the middle of may shares go for more than 60 times forward earnings projections up from closer to 30 times at the start of last year fair isaac has become an artificial intelligence stock whether the business can grow into this valuation or the stock is due for a drop

Depends on the mood of fickle growth investors. Well, those fickle investors have made their mood known. The stock was around $2,200 in the middle of May. It was recently trading around $1,750.

So why the big drop? Mackenzie Tattanani has been writing for Barron's about the stock's decline. She writes, "You can blame it on five simple words: still not happy with FICO." That's from Bill Pulte. He's the director of the Federal Housing Finance Agency. He said his agency would take a closer look at FICO's practices. He wrote on X, formerly Twitter, "American consumers must be respected.

Mackenzie reached out to Farrah Isaac for a response and they directed her to a November blog post. It reads, the royalty FICO collects for the FICO score is the lowest among all other components commonly included in mortgage closing costs. FICO's saying, hold on here, the credit score, that's one of the cheaper things on that list of closing costs when you buy a house. Well, yeah, I mean, but there's some pretty expensive things on that list. Title insurance? I mean...

Who listening to this who has bought a house and who is not in the business of selling title insurance feels like title insurance is a good deal? It's a lot of money. I don't know whether a credit score is cheap enough or too expensive, and I'm not the person whose opinion matters.

So, Greg, your question was, what's my thought after something like this happens? In this case, my thought is, I wonder how FICO steers its way around this one, if it does. Will this sudden burst of interest from regulators pass? Or will there be more policymakers who will speak out and say credit scores have gotten too expensive? And will a viable alternative emerge that will force industry pricing lower?

We will keep an eye on it. I don't know whether the stock's going higher or lower from here. Unless, of course, if it goes much higher, in which case I saw it coming all along. I want to thank Beth and Greg and Jeremy and Julian and, of course, our pal Elizabeth. If you have a question you'd like played and answered on the podcast, just send it in. It could be in a future episode. You can use the voice memo app on your phone and send it to jack.howe at barons.com.

Thank you all for listening. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, wherever you listen to podcasts. If you listen on Apple, you can write us a review. See you next. Viking, committed to exploring the world in comfort. Journey through the heart of Europe on an elegant Viking longship with thoughtful service, cultural enrichment, and all-inclusive fares. Discover more at viking.com.