What do you know? How do you know it?
You need to know certain things to get from the place where you are when you pull yourself out of your bed in the morning to the place where you are will be when you throw yourself back into it at night. For example, you need to know about gravity. If not for gravity, you would need to dress differently. You might need to wear heavy boots to keep from floating off into space. Gravity matters. Since you know that gravity exists, you keep this reality in mind as you make all of the various life decisions put before you during the course of another day spent journeying through this Valley of Tears.
You do know that gravity exists, right?
No. The truth is, you really don’t.
Have you ever explored the gravity question in depth? Have you ever checked out the claims that teachers and friends and experts have made about gravity? You haven’t. You have taken them on faith.
That’s what humans do. There are thousands of things we need to do to keep body and soul joined. We couldn’t possibly check out each and every little detail of each and every little claim that we elect to take on faith for the purpose of freeing up some time to devote to the things in our lives that we care about most.
I think you made the right choice re the gravity thing. I personally am confident that there really is such a force and that it really does work at least largely as lots of people tell us it does. The conventional understanding of how gravity works is cool.
The conventional understanding of how stocks work is not cool.
Taking things on faith makes sense. It save us an awful lot of time to just assume that, when lots of people say the same thing, they must all be right or at least close enough to being right that we don’t need to worry about it much. There are times, though, when taking things on faith can get you in a whole bunch of trouble. One of those times is when you are deciding how to invest your money.
Here are some words from a community member named “Janey”:
“What Rob said sounds reasonable enough, so I wouldn’t be able to judge his advice without additional input. I must rely on the fact that I don’t hear the authors I trust saying the same thing. The authors I trust seem to agree that returns may be lower in the years to come, but none of them suggest that we should drastically reduce our stock allocations in light of this information….I don’t have time to join the search for ‘the Grail of Investing.’ Besides, I have other priorities in life. So, I have to rely on the judgment of people who make the most sense.”
Janey is telling it straight. She is acknowledging that she is not able to identify any reasons why the Valuation-Informed Indexing approach to investing is not superior to the conventional indexing approach. It sounds fishy to her, though. There are lots of smart and well-informed and well-respected people who say things that are at odds with what I say. So she can’t help but conclude that there is probably something wrong with what I am saying. Given the practical reality that she cannot afford to spend years of her life researching my claims and the counters to my claims advanced by my critics, she has decided to place her confidence in what a lot of smart and well-informed and well-respected people have told her.
Janey believes in gravity. Is that so wrong?
I think it makes a lot of sense. I think Janey is a smart cookie and a nice person too (I am going by what I have read in a few posts she has put forward at the Vanguard Diehards board). I think she is making a mistake to place her confidence in the smart and well-informed and well-respected people in whom she has elected to place her confidence. But I understand why she has done so and I am grateful to her for sharing with us a look into the thought-process by which she made a decision to do so.
Janey makes investing decisions in the way that most smart and nice people make investment decisions. We humans are not computers with legs. We are social animals. We often decide what we think by asking others what they think.
The dominant investing paradigm assumes that we are computers with legs. The dominant investing paradigm says that the stock market is efficient because prices are set by millions of investors acting rationally in their self-interest.
In reality, prices are set by people. People make their investing decisions not rationally (reason comes into it, of course, but reason is not the dominant influence on our investing choices), but by talking with other people. Each time that another human becomes convinced that stocks are “good,” two things happen: (1) stocks become a little less “good” (because that human’s purchases cause the price of stocks to go up and the long-term return obtained by those who purchase stocks in future days to go down); and (2) those who retain doubts about how good stocks are become less sure of themselves as the result of hearing from yet one more fellow human how good they are. In time, just about all the humans that can be reached by telephone or e-mail or radio broadcasts own stocks and prices have been driven so high that we are in one of those rare time-periods when stocks are not so “good.”
Janey has been misled by the smart and well-informed and well-respected people in whom she has placed her trust. Not because they are bad or dumb or uncaring people (athough human failings do indeed play a role in making transparently silly ideas popular for a time). Because they are just as human as Janey is. Being smart and well-informed and well-respected doesnt make you any better at understanding how stocks work than all of your fellow humans who are a bit less smart and a bit less well-informed and a bit less well-respected than you. Janey would be better off listening to her common sense than listening to the people she has come to view as investing experts.
You cannot learn about stocks in the way that you learn about gravity. Why? Because the very fact that so many people have come to like stocks so much is what makes them unappealing. It is because so few question the value proposition of stocks today that stocks have today become such a dubious investment choice for the middle-class investor.