Juicy Excerpt: Think of Rob as a buy-and-hold kinda guy with very infrequent reallocations, just like most sensible financial advisers. But Rob’s reallocations are really infrequent: only once a decade or so…. This plan isn’t really about market timing: it would have had you underweight equities for pretty much all of the big 1990s boom…. I think Rob’s approach has a lot to be said for it, but I do have a few problems with it.
Set forth below are my responses to several of Felix’s comments re the Predictor (Felix’s words are in italic):
I just don’t think that many investors have anything like the requisite amount of patience needed – where you can happily sit back for a decade or two waiting for the P/E10 to come down to the mid-teens before going overweight equities.
There is no question whatsoever that this is so today. Most investors have had the Passive Investing model drilled into their heads for so long that the idea of taking the price at which stocks are being offered into account when making allocation decisions sounds exceedingly strange. Given what we have heard from most investing “experts” over the past two or three decades, our finding (see The Scenario Surfer) that long-term timing has throughout history always beat rebalancing strikes many as counter-intutive.
The reality, however, is that it is Passive Investing that is strange, it is Passive Investing that is counter-intutive. We take prices into account when buying houses, cars, comic books and bananas. How could it be possible that stocks are the only asset class on the face of Planet Earth that operate according to an entirely opposite set of rules? Passive Investing simply does not make sense.
That’s a problem for those who try to practice Passive Investing during a secular bear. People need to possess deep confidence in an investing strategy to stick with it during hard times. It’s not possible to possess deep confidence in Passive Investing; the idea that prices don’t matter can never ring true to middle-class investors who have found that prices matter a great deal when making all of the hundreds of other types of purchases they routinely make.
Rational Investing (investing with an acceptance of the obvious reality that stock prices matter) is something new (speaking more precisely, it is something old than has been rediscovered after having been “forgotten” for the length of the most out-of-control bull market in U.S. history). It is going to take people some time to get used to the idea. This process cannot be rushed because long-term timing will not work any better than Passive Investing for those who do not possess deep confidence in it. The difference is that it is possible over time to develop a deep confidence in Rational Investing while this is not so with Passive Investing (investing as if stock prices did not matter).
I don’t believe that the stock-market asset class has rules which govern its long-term behavior
I like this statement because it is a clear and plain and direct and bold expression of a view that is held by many investors. We need to get these things out in the open and this statement does a good job of putting a topic that is too often evaded face-out on the table for discussion.
I do not share this view. I believe that there are indeed rules that govern how stocks perform and that it is very important that we do all that we can to discover these rules and to share what we learn with our fellow investors. My sense is that progress on this front has been held up for a long time because of the popularity won by Passive Investing during the huge bull and that we need to put confidence in this discredited model behind us to get about the business of learning the realities.
Rob Arnott has said that be believes we are on the threshold of a “revolution” in our understanding of how stock investing works in the real world. That’s my take as well.
I can easily believe that we will never again see the S&P 500 trading on a P/E10 of less than 15. (It’s already been 20 years…)
Again, this view is widely shared. Again, I take the minority viewpoint.
It’s not at all uncommon for secular bulls to last 20 years. So it shouldn’t be so surprising that it has been a long time since stocks have been undervalued. The big benefit I see in using the historical data as a guide to how stocks may perform in the future is that it gets us beyond the subjective impressions that we cannot help but adopt from watching stocks perform in one way for so long. For most humans, the way in which something works for 20 years is the way it works, period. For stocks, that rule does not hold. Stocks have been going through wild up and down cycles sometimes lasting for decades ever since the first stock market opened for business.
for people who like to take a 30,000-foot view of investing, this is a very handy little tool.
It cheers me to hear the Predictor described as a tool for use by those seeking “a 30,000-foot view of investing.” That’s a perfect way of describing it. Anyone who uses only the Predictor to inform her investing decisions is a fool. Anyone who does not use either the Predictor or some tool like it is also a fool, in my opinion. The Predictor obviously does not answer every question and obviously does not aim to. What it does, though, is to provide an historical perspective on how stock investing works that it is very hard to tap into though any means other than a review of the historical data.
The Predictor grounds you in an understanding of how stocks have always performed in the past not for the purpose of persuading you to accept that there can never be changes in how stocks perform, but to develop in you a healthy skepticism of the commonly voiced truisms that just happened to have become accepted as true during the most out-of-control bull market in the history of the United States.
I have seen many people react to the Predictor as if the only possible responses were 100 percent acceptance or 100 percent rejection. There are all others sorts of far more moderate and generally more interesting possibilities. It could be that the calculator gets some things right and some things wrong. There’s value in that if you possess the insight needed to distinguish what things it gets right from what things it gets wrong.
That sort of insight comes only from exploring the implications of the findings generated by the tool with both a healthy desire to learn and a healthy skepticism. The “it’s all good” and “it’s all bad” reactions tend to be conversation stoppers. We need to avoid dead ends and find ways to encourage lots of smart people to talk more about the questions brought to the table by the Predictor.
it gives me pause, too: I’ve worried for a while that stocks aren’t an attractive asset class any more.
That sounds real. And encouraging. I take these words as a sign that there are people opening up to the idea of looking at stocks in a new light. I view that as being good news indeed (stock investors could use some right about now, eh?).
The problem, of course, is that there’s not very much in the way of alternatives.
This is a very widespread belief that I do not share. The alternative to investing in overpriced stocks is — investing in fairly priced stocks! Fair prices always return. The returns earned on stocks purchased at fair prices are so great that they are well worth waiting for. It bugs me when people call me a bear because the primary reason why I avoid investing in stocks when they are selling at sky-high prices is that I love stocks and like the idea of being able to own so much more of them just by taking a little something off the table for a few years.
I don’t invest in TIPS at times of high stock prices because I love TIPS. I invest in TIPS at times of high stock prices because I love stocks and owning TIPS for a time permits me to come into ownership of more stocks down the road a stretch.
in any case, according to Rob, if I put all my money in stocks today, I can expect a real return of 5.65% over the next 30 years; 4.65% would be unlucky. I’d be happy with that, I think.
Stocks are a good deal even when purchased at today’s prices for those who hold for 30 years. I wish, though, that we saw more discussion of what is involved in holding stocks purchased at today’s prices for 30 years. My guess is that it is going to be a big bunch tougher to pull off than most of the investors who think of themselves as buy-and-holders realize today.
I am grateful for Felix’s blog entry. He made a good number of helpful observations on a good number of important points. I think he has pushed our debate over how stocks work in the real world forward in a significant way. Thanks, Felix!
Note: The statistical research that drives the Predictor was done by John Walter Russell, owner of the www.Early-Retirement-Planning-Insights.com site. Those interested in knowing more about where the numbers come from should check out John’s site.
Today’s Passion: I outlined some of the uses to which the Predictor can be put in an article entitled Benefits of Using the Historical Return Data for Predicting Stock Returns.