“Vehement Denial is Common Among both Drunks and Passive Investors”

A community member named “James” wrote in an e-mail:

“I just listened to your podcast on Buy-and-Hold Cannot Work.  I was referred to it by a friend with whom I have recently been discussing the same concepts.

“What you don’t mention in this podcast is the primary basis for the Stay-the-Course concept.  As I understand it, the idea is that: The market is smarter than any one individual and automatically prices value effects into itself.  Ergo, it’s safe to be passive!

“Quite obviously, this is not correct, but I would be interested in how you refute it.”

Set forth below is my response:


Thanks for your note. You pose an interesting question.

The idea that the market gets the price right is called the Efficient Market Theory. As you note, this is the intellectual framework for the Passive Investing concept. The Efficient Market Theory was at one time believed to be true. However, there has been much evidence accumulating in recent decades that it does not accurately describe how markets work.

Please take a look at these three blog entries:




The Efficient Market Theory is rooted in a premise that investors are all rational actors seeking to maximize their returns. If this were so, the claim that is made — that the market price is close to being right — would indeed follow. The problem is that the premise does not stand up to scrutiny — we are NOT rational actors.

Humans have both a rational side and an emotional side. At times of massive overvaluation, human investors (that’s pretty much all of them!) are highly emotional. They WANT valuations not to matter and are inclined to ignore the wealth of evidence showing that they do. Those acting emotionally are NOT seeking to maximize their returns. They are more interested in being proven right in their investing beliefs than they are in accumulating wealth. The collective decisions of irrational investors do not work to set the market price properly.

Think of an alcoholic. An alcoholic is not rational. He sacrifices his family, his job and his health for the temporary pleasures of drink. At times of massive overvaluation, investors are essentially Stock Drunk. The drunk denies that he has a problem and Passive Investors deny that it is possible for the market price to be wrong. But these denials are themselves part of the problem — vehement denial is common among both drunks and passive investors.

The very fact that the Efficient Market Theory (and the Passive Investing model that goes with it) is so popular is evidence of the problem. Such theories always become popular at times of high valuations. The popularity of such theories fades as prices return to reasonable levels (as they must if the market is to continue to function). The aim of these theories is not to explain how markets work in the real world, but to rationalize an emotional desire to invest heavily in stocks at a time when the long-term value proposition attached to doing so is poor.

I hope that helps a bit. Welcome to the Financial Freedom Community!



  1. Evidence Based Investing says

    The idea that the market gets the price right is called the Efficient Market Theory.

    The Efficient Market Hypothesis makes no claim about the market price being “right”. I believe this is the main source of your misunderstanding of the Efficient Market Hypothesis.

  2. Rob says

    There are millions of middle-class investors who have been told that timing the market doesn’t work. If the market price can be wildly wrong, it is obviously possible to time the market. All that you need to do is to invest more heavily in stocks at times when the market price is wildly on the low side and less heavily when the market price is wildly on the high side.

    The idea that the market cannot be timed is the product of the Efficient Market Theory. That’s where this insane idea comes from.

    You are right that “defenders” of the Efficient Market Theory change the definition of this “theory” each time the flaws in it are brought to their attention. That’s not science. That’s word games. I am not impressed by the verbal gymnastics.

    The fundamental problem is that investing is a 70 percent emotional endeavor and only 30 percent an intellectual endeavor. Those who feel driven by a Get Rich Quick impulse to invest heavily in stocks at times of insanely dangerous prices need some rationalization for doing so. The Efficient Market Theory — because it is dressed up in the trappings of science — fits the bill.

    If the Efficient Market Theory were true science, there would be no need for its “defenders” to define it in so many different ways. True scientists can define things in one way and then stick with that definition.

    “Timing Doesn’t Work” is a marketing slogan, not a scientific theory. The Efficient Market Theory is like one of those “studies” they use to sell you toothpaste that “finds” that four out of five dentists recommend a particular brand. The people doing the “studies” knew what they were going to “find” before they started the study because they were determined for emotional reasons to continue changing the methodology as many times as needed to produce the “right” result.

    There is no Easter Bunny, Evidence. There is no Tooth Fairy. There is no Efficient Market. And Passive Investing can never work in the real world. Them’s the realities.

    Please don’t get angry at me for bringing these realities to your attention. I am a reporter. That’s what reporters do. If you want to get angry at someone, I suggest you take a look at the man in the mirror. You are the one who fell for this junk (and thereby encouraged even more such “theories” and even more such “studies”).

    I don’t say that to hurt your feelings. I say it because it is what you need to hear to become a more effective investor in the future than you have been in the past. There’s a whole big bunch of good stuff to learn once you stop believing in the Tooth Fairy and the Easter Bunny. My job is to say what needs to be said to help you on over to the other side, my old friend.

    I think you’re going to make it one of these days. I am not sure. But I do have hopes, and I see signs that they are not entirely ill-founded.


  3. Rob says

    I am grateful to you for putting forward that link, Evidence. You could have responded in lots of other ways. You chose the most constructive approach possible — sharing your sincere reasons for finding it hard to place much confidence in what I say above. That’s a kindness that benefits all of us.

    The material at the link is absolutely relevant. I am 100 percent convinced that Bernstein believes the points he makes in that article and I am also 100 percent convinced that you find the points he makes persuasive. Bernstein is smart as smart can be and so are you. So the article has a lot of things going for it.

    I ask that you consider the possibility that it does not tell us whether long-term timing works or not.

    Here is a quote from the article: “For any timing system to succeed, it must therefore supply correct calls 70 percent of the time.” That’s a powerful observation. I think Bernstein is right and I don’t think that most people (even most Passive Investing advocates) fully appreciate how important a point he is making here.

    He is not saying that timing indicators do not point to important signifiers. He is saying that many timing schemes are rooted in something of value. He is saying that [b]they do not work regardless of that reality.[/b] He is saying that the reason is that stocks usually go up by so much that even the edge gained by paying attention to the indicators used is not enough to pull timing schemes ahead of a passive approach. I am personally convinced that he is right.

    I am also convinced that it is his being right on this point that has persuaded millions that timing cannot work. When people get the point that Bernstein is making, it changes how they think about stock investing in a fundamental way. Bernstein’s observation (this is one of the key Passive Investing insights) helps people to make sense of investing in a way that they never could before. It’s powerfully important stuff. I certainly do not say different.

    What I say is that Bernstein’s observation is not the last thing we were ever fated to learn about how stock investing works. He (and all the others who have made the same point) did indeed advance the ball in a very important way. But he (and all the others) made a huge mistake in coming to believe that this observation was the last observation of importance that anyone was ever going to make. That’s the error that has brought on all our troubles.

    Bernstein’s argument is a probability-based argument. He is saying that gaining an edge is not good enough to make timing work because it’s hard for any edge to be big enough to make up for the fact that stocks go up 70 percent of the time. The odds are so much stacked against the timer that all of the insight in the world cannot get him up the hill he needs to climb to make timing work.

    Bernstein and you and all the others need to spend some time considering whether this rule applies to long-term timing as well as to short-term timing. If you think this question through with a desire to learn, you are going to come to a conclusion that it does not. Bernstein is right about short-term timing. He is wrong about long-term timing (to the extent that he says it does not work — Bernstein has actually made a good number of statements showing that on some level of consciousness he understands well why long-term timing always works).

    The difference with long-term timing is that the odds shift. Instead of the odds being against the timer, the odds are very much in favor of the timer.

    Stocks went to three times fair value at the top of the bull. For the market to continue to function, prices must return to fair value. That means that a price drop of at least two-thirds (and perhaps of more than that) was guaranteed. That puts the odds heavily against the investor not engaging in long-term timing. It makes it impossible for him to come out ahead of the long-term timer.

    In 1995, stocks went to an insane price level. The rule that stocks usually go up continued to apply. And they did indeed go up in 1996, 1997, 1998 and 1999. That’s the Bernstein rule in action. Short-term timing does not work for just the reason he says.

    The Shiller rule is an opposite rule. The Shiller rule does not conflict with the Bernstein rule, it does not say that stocks do not usually go up in the short-term. It says that, even though stocks usually go up in the short term, stocks ALWAYS go down in the long term when they are priced where they were priced in 1995. If you follow only the Bernstein rule, you are certain sooner or later to get crushed in a massive price crash. If millions come to believe only in the Bernstein rule, the entire economy is certain to be brought to its knees.

    Bernstein is right. Shiller is also right. Both rules are of critical importance. The Bernstein rule helps if you understand the circumstances to which it applies and the circumstances to which it does not apply. The Bernstein rule will crush you if it causes you to believe that, just because short-term timing does not work, long-term timing does not work either.

    The Shiller rule works for the same reason why the Bernstein rule works. It’s a matter of probabilities. All the intelligence in the world won’t help you win at short-term timing because the odds are just too much against you. Nor will all the intelligence in the world permit you to succeed at Passive Investing — again, the odds are just too much against you.

    It’s the same historical data that shows that short-term timing never works and that long-term timing always works. If you do not accept the value of looking at the historical data, you should not be a Passive Investor — the support for this approach is in the data. But if you accept the value of the data showing that short-term timing never works, you are also logically bound to accept the value of the data showing that long-term timing works. It is irrational to accept what the data says on one point and ignore what the data says on the other point.

    This entire crisis is the result of a MISTAKE. Some very smart people learned something important about stock investing — that short-term timing does not work. Then they jumped to a wrong conclusion that this means that ALL forms of timing do not work. Nothing could be further from the truth. Long-term timing is REQUIRED for long-term investing success. It cannot be done without long-term timing.

    We need Bill Bernstein and John Bogle and Jonathan Clements and Scott Burns and Evidence-Based Investor helping us all out. But we need them to become willing to acknowledge the horrible MISTAKE that they made in thinking that data showing that short-term timing does not work also somehow suggests that long-term timing does not work. The precise opposite is so. Long-term timing works for the same reason short-term timing does not — the probabilities always are working AGAINSY the short-term timer and always are working FOR the long-term timer.

    The probabilities always get you in the end, Evidence. Passive Investing provided good results from 1995 through 1999. But those who understand what the data says knew that the probabilities were going to catch up to the Passive Investors in the end. Just as the Passives know that the probabilities are always going to catch up to the short-term timers in the end.

    You want to get the probabilities on your side. To do that, you need to open your mind to the reality that Passive Investing is a MISTAKE. Short-term timing doesn’t work. Long-term timing does. Long-term timing is required for anyone who wants to have a realistic hope of engaging in successful long-term investing.

    We need to get the word out on this. We need to stop this economy from going over a cliff before all of us are cooked, Passives and Rationals alike.


  4. Rob says

    [i]Bill Bernstein once again shows that SHORT TERM timing is difficult, at best.[/i]

    13 words. Why couldn’t I have said it like that?

    I’m just joking around.


  5. Rob says

    Evidence-Based put forward a response that suggested that he does not understand the difference between short-term timing (changing one’s stock allocation with the hope of seeing a benefit within a few months or a few years) and long-term timing (changing one’s stock allocation with an understanding that one is virtually certain to see a benefit within 10 years).

    The difference has been explained to Evidence on hundreds of occasions. It seems possible to me that his belief in Passive Investing makes it impossible for him to take in the explanations that have been offered him — that the emotional pain of acknowledging that he has been following a doomed investing strategy for years now is just too much.

    I feel bad for the guy. I also feel bad for all the community members who are going to suffer busted retirements because of the hundreds of thousands of word-game posts that have been put forward by Passive Investing dogmatists in recent years. My job is to achieve a reasonable balance between our desire to help out Evidence and the other dogmatists and our desire to help the thousands of others who have expressed a greater willingness and ability to learn about the realities of stock investing.

    I am not able in good conscience to let Evidence or any of the other dogmatists waste the time of the community that congregates here to learn about the subject matter of the board by putting forward an endless series of word-game posts.

    Your post has been deleted, Evidence. But you will always be warmly welcomed here. I believe that there may come a day when you will be able to participate in a constructive way. I am grateful for the positive contributions you have made in the past and look forward to seeing more constructive contributions from you in coming days.


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