We don’t know the meanings of the words. This one kills me. When people offer you investing advice, the odds are good that they don’t know the meanings of the most basic terms at issue.
If a baseball manager didn’t know what a bunt was or what a squeeze play was or what the infield fly rule was, you would fire him. I’ll bet 50 cents that whoever it is you turn to most often for investing advice doesn’t possess a strong grasp of the meaning of most basic investing concepts. I can say that because just about no one does today. Our understanding of how investing works is not yet sufficiently advanced for us to have reached agreement on even the most fundamental points.
Risk is fundamental, right? If you don’t understand risk, you don’t understand investing. Still, the reality is that there is not yet a general consensus on what risk is.
Lots of people say that risk is volatility. Stocks are risky because prices go up and down a lot. Buffett laughs at that idea. He points out that, if risk is volatility, then a stock that goes up in price is more risky than one that remains always at the same price. He’s got a point. But the others just keep insisting that volatility is risk, as if they knew what they were talking about and as if they had not heard what Buffett said. That’s reassuring — not!
The Great Safe Withdrawal Rate (SWR) Debate is the product of a failure of investing “experts” to distinguish between the concepts of “surviving” and “safe.” Say that you drove drunk two times and got in horrible accidents, but lived. You would not conclude that driving drunk is a safe thing to do. That’s what the Old School SWR studies do. They look for what withdrawal rate barely survived for the two times in history when we got to the price levels that apply today and declare that withdrawal rate “100 percent safe.” Um, that makes sense. If the authors of the studies understood the difference between these two simple concepts, they wouldn’t do that. And they probably do understand the difference when talking about other subjects. When it comes to investing, though, they “forget” the meaning of the words and offer highly dangerous retirement advice.
Greaney has a study that says that a 74 percent stock allocation is always “optimal.” John Walter Russell checked the historical data and found that that allocation is indeed optimal except for just about all of the other possibilities that can be imagined by the rational human mind. People don’t use the word “optimal” in the investing realm to mean the same thing that it means when used in any other context any more than they use the word “safe” to mean the same thing that it means when used in any other context.
Investing experts do not know what the word “indexing” means. There are big battles going on about it. Rob Arnott came up with something called “Fundamental Indexing” and John Bogle is saying that it is only Bogle’s idea of indexing that is really indexing and that no other understandings of the term are permitted. As Church Lady has been known to observe from time to time, how convenient!
People use the phrase “Passive Investing” to refer to indexing all the time. Are they the same thing? It sure doesn’t seem so to me. I love indexing (owning tiny interests in a large number of stocks so that you enjoy great diversification at low cost). Love it, love it, love it. I hate Passive Investing (sticking with the same stock allocation despite wild price swings). Hate it, hate it, hate it. If they are the same thing, how can one guy love one and hate the other? I’m thinking that it just might be possible to index without investing passively, you know?
Long-term. We’re all investing for the long-term today. So we need to know what it means. But we do not.
The promise that investing in stocks will always work out well in the long term works only for those willing to hold for 30 years. Few of the investors who say that they are investing for the long-term know that. Many think that the long-term is 5 years or 10 years. Guess what happens when those people learn that the results they were expecting to see in the “long-term” ain’t gonna show up when they were expected to show up?
Buy-and-hold. We don’t know what it means.
Buy-and-hold is effortless during a huge bull, like the one that ended in 2000. We’re now in the huge bear that inevitably follows a huge bull (during a bull, we borrow huge amounts from the returns of future investors to push current-day returns far above those justified by the economic realities). Ball-and-hold is now a very difficult thing, especially for those who were led to believe that it was always easy. The reality is that no one knows what is required to be a buy-and-hold investor yet because the strategy has never yet been tested in a bear market.
We don’t know what a high valuation level is. Most “experts” use P/E1 to tell us whether stocks are overvalued or not. P/E1 gives many false reads. Those who know what they are talking about use P/E10 or perhaps Tobin’s Q or some other legitimate valuation assessment tool. The majority of people who call themselves “experts” don’t know that they are using a tool that does not work. So they do not really know what valuation level applies at any given time or what its significance is (you cannot make meaningful comparisons of how stocks perform from various valuation levels if your valuation assessment tool is gravely flawed).
It’s not my intent here to put people down. My intent is to let people off the hook. If the experts would stop pretending that they know things they do not know, investors would know to check things out more carefully for themselves. People got proud and careless during the huge bull. Giving investing advice that “worked” during the huge bull was not too difficult a task. Most of us are not up to the job in this new environment.
We need to go back to school. We need to learn the basics. We need to be more cautious in how we state things. We need to learn how to say “I don’t know” and “I was wrong.”
Most of all, we need to develop the intellectual curiosity needed to begin an effort to nail down some of the most basic concepts.
Today’s Passion: The article entitled Investing Basics that Even the Pros Don’t Understand notes that the return you will obtain on your stock investment can be known in advance. Why don’t the big boys they tell us these things?