An earlier blog entry described the background of my recent correspondence with Michael Kitces on safe withdrawal rates (SWRs). Set forth below is the text of an e-mail that Michael sent to me on November 25:
Rob,
Thanks for your patience with me on the podcast title. This sounds like a fine solution. And I didn’t mean to undermine your point about experts and expertise – you’ve posed an interesting theory that would be a good discussion (a conversation for another time), but it’s certainly a reasonable premise to explore.
And indeed, I think some of the planning community is starting to open up to acknowledge more of the flaws of Passive Investing. In the “traditional” planner’s view, the greatest risk is to be out of the markets and miss the upside potential (an attitude clearly born of a profession that found much of its early growth right in the middle of the 1982-1999 era). I and some others are trying to change that dialogue, to acknowledge at a basic level that owning a market with incredibly high P/E ratios is ALSO a risky thing to do (arguably, more risky than being out of the markets). Not that this has to be done all-or-none (you’re in the markets or out), but that at a minimum we can make adjustments to better manage risk at the margins and it’s constructive to long-term wealth accumulation and preservation. Of course, the irony is that we may find ourselves back in an ultra-low valuation environment where buy and hold really DOES work pretty well before this is all over; in that case, we’ll just have to see if we can learn our lesson better in advance of the end of the next secular bull market. 🙂
With warm regards,
– Michael
John Walter Russell says
Of course, the irony is that we may find ourselves back in an ultra-low valuation environment where buy and hold really DOES work pretty well before this is all over; in that case, we’ll just have to see if we can learn our lesson better in advance of the end of the next secular bull market.
A high stock allocation makes sense. P/E10 is just below 15. Stocks will make a bundle over the next decade.
That having been said, it makes sense to hold some cash right now–about 40% or so–to buy at even more attractive levels. A further fall is not guaranteed, but it is likely for those with a longer time frame.
This could take place over several years. I would be happier if we could just get it over.
This is a great time for those who were able to sidestep the October 2008 meltdown.
Have fun.
John Walter Russell
Not Sold says
For a guy who used to claim he did not endorse short term timing, your eagerness to look back at what “moves” would have been ideal over the last year or so, and what completely different “moves” might optimize returns (let’s leave risk aside for a moment) sure smacks of short-term-market-timing to this grizzled old veteran.
No one will ever be able to take you two lone guys seriously unless and until you come out with some parameters and specifics for “VII” that can be tested on a going forward basis, not just looking back and saying what could have been.
Rob says
No one will ever be able to take you two lone guys seriously
We know this to be false as a result of the first seven years of discussions, Not Sold. There have been thousands of community members who have expressed a desire that honest posting be permitted.
sure smacks of short-term-market-timing
Your claim here is that advocacy of long-term timing combined with a rejection of short-term timing “smacks” of advocacy of short-term timing. That’s emotion talking, Not Sold.
You’ve been led to believe by Passive Investing advocates that market timing does not work. The reality is that market timing is required for those who want to have some realistic hope of long-term investing success. You need to give up the old ideas to permit the new ideas in.
I understand that you are in pain. I understand that there was a time when you truly believed in Passive Investing. That doesn’t change the realities. The academic research showing that valuations affect long-term returns dates back to the early 1980s. There are serious people saying that the Passive Investing Crash may cause our economy to go into a depression. It’s time to give up the dogmatism. It’s well past time.
until you come out with some parameters and specifics for “VII” that can be tested on a going forward basis,
There is no need to “test” whether it is a good idea to invest rationally or not, Not Sold. It is obviously a good idea to invest rationally. We permit the use of human reason in deciding on strategies for winning baseball games, do we not? We permit the use of human reason in deciding on strategies for building spaceships, do we not? We permit the use of human reason in deciding what to eat for breakfast, do we not? Why should we not do the same when deciding on our stock allocations?
If you insist on “testing” before being willing to consider Rational Investing ideas, why do you not also insist on “testing” before being willing to consider Passive Investing ideas? Are you aware of any studies showing that long-term timing does not work?
Our common sense tells us that long-term timing works and there are no studies showing otherwise. Why, then, the hostility to the idea of investing rationally? That’s what you need to be “testing.” When you come to understand the source of your hostility to rational investing ideas, you will have turned the corner. I can assure you that everything falls nicely into place once you get over that hurdle.
I aim to keep an open mind on these questions. If anyone ever comes up with a rational argument suggesting some reason to believe that there might be circumstances in which long-term timing does not work, I certainly will take a look at what they have to say. In seven years of discussions on multiple discussion boards (at which a good number of recognized “experts” participated), no one has yet ever even attempted to make a case for the claim that long-term timing does not work. That in itself is telling. In any event, until someone at least makes an effort to put forward a case, there is nothing for Rational Investors to respond to.
I can’t debate air, Not Sold. Every sliver of evidence that we have looked at for seven years now points in the same direction. People made a mistake in thinking that studies that showed that short-term timing does not work can be interpreted as showing that long-term timing also does not work. The mistake needs to be corrected before it does even more harm to even more middle-class investors.
That’s my sincere take, in any event.
Rob
Rob says
your eagerness to look back at what “moves” would have been ideal over the last year or so,
Valuation-Informed Indexing didn’t just start working over the last year or so, Not Sold. The historical data available to us dates back to 1870.
Rob
Rob says
The historical data available to us dates back to 1870.
On reading this back, the thought hit that I should add a comment noting that I put a post to the Motley Fool board pointing out the analytical errors in the Old School SWR studies on May 13, 2002.
The events of the past year have highlighted for many the dangers of the Passive Investing model. But the dangers have been known to many for close to three decades now. What’s changing is that larger numbers of middle-class investors are becoming more concerned about the financial consequences that follow from advocacy of a failed investing model.
The model failed when the academic studies were published showing that valuations affect long-term returns. What happened in the past year is that we saw what happens to real live investors when Passive Investing becomes popular in a world in which valuations affect long-term returns.
The intellectual work showing that Passive Investing cannot work was done a long time ago. The job before us today is dealing with the emotional issues being experienced by the “experts”who have long advocated this model and who remain reluctant to acknowledge mistakes made in earlier days.
Rob
JCL says
There is no need to test? OMG!
Just because you call your method rational doesn’t mean that it is or that it actual works better than a diversified portfolio
Rob says
There is no need to test? OMG!
Your expression of shock shocks me, JCL. What a confusing situation!
Anyway, yes, that is indeed my view — there is no need to “test” whether it is a good idea to invest rationally. Making use of human reason works so well in so many other areas of life endeavor that I think it makes all the sense in the world to presume that it will work with investing as well. So Passive Investing (staying at the same allocation despite wild price changes) is out.
Once you make the decision to go rational, all kinds of testing come into play. That’s why I provide the calculators. Rationals are testing different strategies all the time. It’s the rational thing to do!
Passives like to “test” only a small number of things — whatever it is that they need to “test” to persuade themselves that it might work out okay this time to stick with a high stock allocation at a time when stock prices are insanely dangerous. It’s not really quite right to think of this work as “testing.” It looks like testing. They use charts and tables and data and stuff like that — they include the trappings of science in their “tests.” But they know up front what they want the “tests” to prove. They want the tests to support their emotional desire to overinvest in stocks. So they set things up in ways sure to cause the “tests” to generate their preferred “findings.” It’s pretend science, pretend testing.
Rational Investors test things to identify what works, not to provide support for their emotional allocation decisions. That’s the big difference. Rationals are big on testing. But their approach to testing is very different from the approach followed by the Passive Investing Dogmatics.
Rob
Rob says
Just because you call your method rational doesn’t mean that it is or that it actual works better than a diversified portfolio
I think you make a good point here, JCL.
You are certainly correct that calling something “rational” does not make it so. People need to check out the stuff I say. They need to do Google searches to see what others say about these ideas. They need to check the historical data on their own. That sort of thing.
Anyone who follows these ideas because some guy on the internet puts them forward is a fool and not even a tiny bit rational.
My sincere take.
Rob
Rob says
better than a diversified portfolio
Diversification by itself is a very good thing.
You can get good results with a diversified portfolio by setting your stock allocation rationally or you can get poor results with a diversified portfolio by setting your stock allocation passively. I strongly favor diversification but I also strongly oppose Passive Investing.
It’s good to know that we at least agree on some important points, eh?
Rob
JCL says
So what is your plan? To put forward untested ideas and hope that others will test them for you and let you know if they work?
Rob says
I wouldn’t use the words you use to describe my “plan,” JCL. But what you are saying is not 100 percent off the mark.
My “plan” is to learn and teach about stock investing using the same procedures that I use to learn and teach about all other subjects. I read. I ask questions about things I don’t understand. I check things out on my own when I have doubts about the accuracy of what I am reading. I incorporate insights from a variety of sources in formation of my own take on a topic. I reject things that don’t make sense for the purpose of making my own particular take better than the take of a source that got some things right and some things wrong.
Isn’t that how you learn about every subject other than stock investing? What is it about stock investing that makes you so darn sure that the learning processes that work in every other area of life endeavor cannot work with stock investing? That I do not get.
Look into things and you can learn. That’s the secret to Rational Investing. Absolutely anyone can do it. My view is that absolutely everyone should do it.
The key to successful long-term investing is coming to possess confidence in your strategies. I think it would be fair to say that the Passive Investing Dogmatists lack confidence. That’s because they bought into ideas that they do not really understand. They “know” with absolute certainty that timing doesn’t work but they have no idea why they believe this, they just know that some “expert” somewhere said it. And most of the “experts” aren’t all that much better informed on the fundamental questions. Most of them too “know” that timing doesn’t work because they read it in a book that they needed to read in preparation for a class.
What if the book was published before the research came out showing that valuations affect long-term returns? What if the “expert” has been reluctant to incorporate what the new research says because he spent a lot of time telling people that timing doesn’t work and he feels uncomfortable incorporating this new reality into his investing advice?
Our understanding of how stock investing works improves over time, JCL. We are always learning new things. That’s a good thing, not a bad thing. There was a time when there was a good bit of evidence that valuations did not affect long-term returns, that the market really was efficient. Those days are long past. The rational thing to do is to accept these new realities just as we at an earlier time accepted the old ones, to acknowledge that we got some things wrong, and to move forward.
Do you know of a reasonable alternative? I sure am not able to imagine one. Acknowledging mistakes does not have to be a bad thing. It’s by acknowledging mistakes that we learn. Learning that you have made a mistake can be the first step down a truly wonderful path. Have you never had a life experience in which that turned out to be so?
Rob
John Walter Russell says
There is no need to test? OMG!
Just because you call your method rational doesn’t mean that it is or that it actual works better than a diversified portfolio
We have tested rational investing thoroughly.
The big holes were in the Passive Investing tests. I am talking about HUGE holes. They did not even consider the power of their tests (type 2 errors). They saw nothing unless a portfolio manager exceeded an index by 5% per year for more than a decade. That is, Warren Buffett qualifies, but very few others.
[Professor Shiller proved his point, but he did not follow up (in terms of retirement issues). We have. The evidence is overwhelming.]
Have fun.
John Walter Russell