A Rich Life

The Old Ideas on Saving & Investing Don't Work -- Here's What Does

Cash Is A Strategic Asset Class (Take One)

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I recently posted a Guest Blog Entry at the Out Of Your Rut blog. It’s called Cash Is a Strategic Asset Class.

Juicy Excerpt: Nobody makes much money promoting TIPS or other cash-like investment classes. The “experts” in the investing advice field HATE cash. No commissions. No acceptance into the “Experts” Club. No appeal to the Get Rich Quick impulse lurking within each and every one of us that tempts us into ignoring price when choosing our investment classes.

Keith Mercadante, the blog owner, put forward some kind words in the introduction to the Guest Blog Entry.

Juicy Excerpt: Rob offers a…refreshing approach that offers a counter to the prevailing financial culture that recommends heavy and permanent positions in stocks—an investment class which is more risky than most people commonly understand.

Comments

  1. Aforemention blog owner here…As rule I prefer not to host investment related posts, largely because of the passions people bring to the subject. But Rob’s post struck me as required reading in a world full of people who have what I consider to be a dangerous level of “certainty” in regard to how they believe the financial markets will perform.

    It’s my opinion that too many middle- and working class people are over committed in the stock market, and largely because of the financial media, they’re also unaware of the true degree of risk they’re taking on.

    Like Rob, I’m a supporter of stock market investing, and believe it can be done intelligently and at lower risk than the usual sources advise us to take on. Rob’s advice offers balance, which is a benefit to anyone investing in the financial markets.

  2. Thanks for the kind words, Kevin. And thanks for hosting the Guest Blog Entry. I believe that you have performed a service for your readers.

    Your phrase “a dangerous level of certainty” resonates strongly with me. The fact that there are differences of opinion re the best way to invest is not a problem. That’s a natural thing and a wonderful thing — it is by hashing out differences that we all learn. The big problem today is the “certainty” of the Passive Investing Dogmatists — the idea that they have discovered the One True Path and that any who question them are too stupid to be worth listening to. Pride comes before a fall. We need to move to a less dogmatic model. Models that cannot be questioned are dangerous.

    I look forward to a day when honest posting on investing questions is both permitted and encouraged everywhere on the internet.

    Rob

  6. the advantage is over 4% per year (real, annualized, total return) over 30 years.

    I’m thinking that aspiring early retirees might want to find a few minutes to look that one over.

    If they can bear the “controversy” of it all.

    Rob

  7. Here’s the conclusion from John’s article above:

    “The advantages of Valuation Informed Indexing are tremendous. They are already 4%+ based on a simple TIPS versus stocks comparison at Year 10. They will be a fantastic 7.6% per year (real, annualized, total return) at Year 20. They will still offer an advantage of 4.2% per year at Year 30 assuming that the correct decision is to remain in stocks.”

    If I were able to, I would link to this article in the thread from the Bogleheads board linked to at the “Today’s Passion” feature. It’s hard for me to imagine that a good number of the people reading that thread would not want to know that the benefits of Valuation-Informed Indexing can in some circumstances be far greater than 1 percent real of added return per year. I would be grateful if some kind and brave person would add the link.

    I think it is worth nothing that the return that John is showing for those following a Passive strategy assumes that they will not sell any stocks even after suffering huge portfolio losses. I understand that assuming otherwise requires some subjectivity in the analysis and presume that John is trying to avoid that. However, the reality is that many Passives (including Taylor Larimore and Bill Bengen) have already sold stocks after price drops or have announced plans to do so. Most other Passives have expressed enough shock at seeing stocks perform as they always have in the past from the price levels that applied when Passive was most popular that they are almost certain to sell if we see another big crash. So the gains being attributed to Passive in John’s analysis are speculative.

    In contrast, the returns being attributed to VII are far more likely to show up in real life. By taking valuations into account, the VII investor not only increases his returns dramatically — he also reduces risk dramatically. So the VII investor is far more likely to be able to walk the buy-and-hold walk than is the Passive investor.

    To be sure, there is also a speculative element in John’s analysis that favors the VII investor. He assumes that we will be seeing a drop in the P/E10 value to 8. That is what we saw on the three earlier times when stock prices went to the insanely dangerous levels that applied from 1996 through 2008. But it is possible that we will not see a repeat this time. Stocks are already at fair value and thus there is no economic need for a further price drop. Any further price drop would be emotional in nature (the result of investors learning that many of the claims made for Passive have virtually no chance of working out in the real world).

    That’s an extremely helpful article, John.

    Rob

  8. I think it is worth noting that the return that John is showing for those following a Passive strategy assumes that they will not sell any stocks even after suffering huge portfolio losses.

    Do you remember my Current Research series on Price Drops? I had several articles in which I assumed that an investor would shift to 20% equities after a drop.

    http://www.early-retirement-planning-insights.com/current-research-l.html

    Look at Reacting to Price Drops..and Locking in Failure.

    This was one of the benefits of building the Scenario Surfer.

    Have fun.

    John Walter Russell

  9. From the link at John’s site. “Here are some numbers based on the most likely values of P/E10 from Year 2000 to Year 2030. ”

    Do you have any numbers for actual investment returns in the past? Assuming a 4% out performance based on estimating returns 20 years into the future might not be as convincing showing how 4% out performance could have been achieved with the real returns that we have already seen.

  10. Do you have any numbers for actual investment returns in the past?

    That’s what The Investment Strategy Tester is for, Evidence.

    Assuming a 4% out performance based on estimating returns 20 years into the future might not be as convincing showing how 4% out performance could have been achieved with the real returns that we have already seen.

    I haven’t run a test with the calculator. But I think it make sense to believe that the outperformance that John is finding from 2000 forward would be exceptionally big. That is the worst case of overvaluation on record.

    Still, it’s something we are living through today. So it makes all the sense in the world to look at it.

    You can’t look at any one analysis to get the answer to every possible question. The 4-percent out-performance finding is shocking. And it is illuminating so long as the finding is kept in perspective. I don’t think that 4 percent out-performance can be said to be typical. But this is what was possible in recent history. So I certainly think it is valuable for us to learn this.

    Rob

  11. I wish that Passive Investing advocates would not be defensive about this sort of thing. Is there some reason why this has to be a battle? Do we not all benefit when we learn new things about investing?

    The Passives have mined hundreds (or perhaps thousands) of insights over the past 30 years. They didn’t get it all right. They need to make some changes in the advice they give. Must this be such a big deal?

    Is there some reason why we should not all just be grateful for the things we have learned from the Passives and also excited about the new things we have learned during the early development of the Rational model? This bickering and quibbling is such a drag.

    Rob

  12. I do think that the point you are making is a valid one, Evidence.

    I don’t feel that it is being offered in the most constructive spirit possible. But I am grateful to you for taking time out of your day to make a point that otherwise might not have been put forward.

    Rob

  14. John:

    You’re fantastic. Thanks a million.

    I think these new results are worth a separate article. I have a set of links at the bottom left side of the home page of the blog where I link to “Favorites/John’s Site” because I want to have quick access to the material at your site that does the best job of summarizing for newcomers why making the shift to Valuation-Informed Indexing is so important. I added a link yesterday to your new article because I think it makes the point in a compelling way. I think the new numbers do the same.

    Personally, I would love to see an article that provided numbers like this for all the years from 1921 forward. We make the same point with the calculators. But different people are persuaded by different types of evidence. These numbers might help make it click for some. My belief is that the reason why Passive became popular is that there were so many different people recommending it from so many different angles. We need to do the same with Rational. People need to hear the same basic message (that long-term timing is REQUIRED for those wanting to have some realistic hope of long-term investing success) lots of different ways at lots of different times from lots of different people.

    Thanks again for all you have done for our communities.

    Rob

  15. Rob,

    I have looked at the entire time frame from 1871. The average advantage of Valuation Informed Indexing was 0.2% per year, 0.4% per year and 0.6% per year for time frames of 10, 20 and 30 years.

    However, the numbers are all dragged down by the build up years just before 2000.

    Exclude the years just before a bubble and VII wins consistently.

    Have fun.

    John Walter Russell

  16. Thanks for the feedback John.

    Also from your article.
    Using Valuation Informed Indexing over the 30 years, the TIPS-stocks combination lifts the original balance by (1.03^10)*(1.12^20)=12.96=(1.089^30). That is, the TIPS-stock combination using Valuation Informed Indexing lifts the most likely 30 year return from 4.7% to 8.9% per year real, annualized, total return.

    Am I right in assuming that these figures are based on 100% TIPS for the first 10 years and then 100% stocks for the next 20 years?

  17. The average advantage of Valuation Informed Indexing was 0.2% per year, 0.4% per year and 0.6% per year for time frames of 10, 20 and 30 years.

    I find this fascinating.

    Please don’t think that I am trying to suggest jobs for other people to do. But I think there is a lot to be learned by seeing how the number changes by starting things from different starting points, by ending things at different ending points. and by using different assumptions to set things up. There are all sorts of insights that I believe could be mined from this sort of exercise.

    Is it possible to translate the percentage figures into dollar figures by using assumptions? It would be nice to be able to give people some idea of what a 1 percentage point difference in annual return means.

    Thanks again for all your work, John. Amazing stuff.

    Rob

  19. Rob,

    The 1921-1980 advantage over 10 years was 1.2% per year.

    The 1990-2000 run up gave an advantage to an all-stock portfolio of 3.4%.

    This is why the long term 10-year average is dragged down to 0.2%. They Year 2000 peak was far outside the historical range.

    Have fun.

    John Walter Russell

  20. The 1990-2000 run up gave an advantage to an all-stock portfolio of 3.4%.

    Thanks for that explanation, John. It helps me. I understand what is going on in a vague way but not in a terribly clear way.

    I have two questions:

    1) Is it reasonable to say that the best number we have for the 10-year advantage in ordinary sorts of circumstances is the 1.2% that applies from 1921-1980?; and

    2) Is it reasonable to say that the advantage became much greater at the top of the bubble and that this is interesting information because it is recent history but that the numbers from the top of the bubble are not representative of the typical experience?

    My view is that both numbers have significance (presuming that what I suggest above is so). I am inclined to think that the more important number is the 1.2 number. I personally find that number extremely impressive. If it can be said that following Valuation-Informed Indexing strategies permits an investor to increase her annual percentage return by 1.2 percent, I see that as being huge.

    Rob

  21. Rob,

    Yes and yes.

    If you can spot a bubble’s peak, you can do fantastic. This is what we see from the Year 2000 projection of 4% per year in favor of Valuation Informed Indexing.

    But 1.2% per year is what everyone can count on.

    Have fun.

    John Walter Russell

  23. Rob,

    I found an error. My previous comparison was simply with Idiot Switching. I have now corrected my work, keeping the accumulator out of stocks after a run up until P/E10 falls below 10.

    The new 10-year advantage is 2.4% per year.

    Have fun.

    John Walter Russell

  26. It has some pictures.

    Thanks also for setting up the special section. The graphics are extremely helpful.

    Loudon Wainwright taught us that “Baby, It’s An AM World.” And I have generally found this to be so. Graphics are the internet equivalent of hit songs (in comparison to articles comprised of words and logic and all that other boring stuff).

    Rob

  27. Rob,

    I just ran some Idiot Switching with the new calculator.

    With TIPS-only when P/E10 exceeds 20 until it drops below 10 and 100% stocks otherwise, the Historical Surviving Withdrawal Rates range from 5.1% in 1962 to 16.1% in 1924.

    Compare this with the traditional 3.9% to 11%.

    Avoiding price crashes and secular (long lasting) Bear Markets pays off big time.

    Have fun.

    John Walter Russell

  28. We need to have tens of thousands of people discussing this, including all of the big-name “experts.” The Ban on Honest Posting on the Flaws of the Passive Investing Model is irresponsible in the extreme.

    Rob

  30. Super.

    I love the charts.

    I am thinking that somewhere down the road I am going to create a section of this site that just contains charts (either ones that I create or links to charts created by others or most likely both). I believe that they help people grasp this stuff better than anything words written or spoken.

    Rob