Vanguard Founder John Bogle in a recent video interview with the IndexUniverse.com site offered an almost-but-not-quite endorsement of the Valuation-Informed Indexing strategy, the investing strategy explored at this site. Bogle’s comments come in the wake of a growing wave of opinion that the Passive Buy-and-Hold strategy long advocated by Bogle has been proven a failure by last year’s stock crash.
“Big moves out of stocks should not be done at all,” Bogle told interviewer Jim Wiandt, publisher of the www.IndexUniverse.com site. But “tactical asset allocation — I should say strategic asset allocation rather than tactical — can be done at very rare times, so rare and so difficult to observe, maybe six times in an investor’s lifetime, three times when the market is stupidly high and three times when stupidly low.”
Valuation-Informed Indexing rejects the idea that Passive Investing (sticking with the same stock allocation even when stock valuations change dramatically) can ever work in the real world for the long-term investor. This strategy is rooted in the Rational Investing model (the alternative to the now-dominant Passive Investing model), a model that accepts the academic research of the past 28 years showing that valuations always affect long-term returns. Valuation-Informed Indexers adjust their stock allocations as needed to keep their risk levels roughly constant rather than keeping their allocation levels constant and thereby permitting their risk levels to get wildly out of whack from what they had determined was right for them when they set them. Thus, Valuation-Informed Indexers lost far less in the crash and will be benefitting from greatly enhanced compounding returns for decades to come. The historical stock-return data shows that there has never yet been a time in U.S. history when Passive Indexers have done better than Valuation-Informed Indexers although there have been many cases in which the valuation-informed strategy soundly beat the passive strategy.
Bogle distanced himself from the position advanced by Mel Lindauer (author of The Bogleheads Guide to Investing) during his Campaign of Terror against the Vanguard Diehards discussion-board community (which expressed great interest in learning more about Valuation-Informed Indexing); Lindauer said that those who follow valuation-informed strategies are not properly thought of as “Bogleheads” and that it is “dangerous” for indexing boards to permit civil and honest discussion of the academic research of the past three decades showing that valuations affect long-term returns. In contrast, Bogle invited those who find appeal in valuation-informed strategies to “be my guest” in following them (and presumably in discussing them amongst themselves and with any of their friends who happen to be Passive investors).
However, it cannot be said that Bogle gave a full and clear endorsement to the new indexing strategy, a strategy developed by the thousands of members of the Retire Early and Indexing discussion-board communities participating in the controversial series of discussions collectively known as “The Great Safe Withdrawal Rate Debate.” He expressed skepticism as to investors’ ability to take advantage of the message of the historical data, saying that Valuation-Informed Indexing works only “if you can pick the times” to make the necessary allocation shifts. “I don’t do it myself — I’m not smart enough to,” the Vanguard Founder (and father of the Indexing Revolution) added. Bogle did not offer any explanation of why he does not view himself as “smart enough” to follow this exceedingly simple strategy (but his expression of concern over picking the right times to make allocation shifts suggests that he may not yet possess a clear understanding of the key distinction between short-term timing and long-term timing — that picking market high and lows is not necessary for success as a long-term timer).
Still, Bogle made two major concessions that no big-name Passion Investing advocate has made before.
First, he conceded (in the words quoted above) that Valuation-Informed Indexing is a strategy, not a tactic. Passive dogmatists have often played word games in which they pretended (perhaps to themselves as well as to others) to acknowledge the academic research of the past three decades while ignoring a key finding of that research — that changing one’s stock allocation in response to price changes works only when applied strategically (to obtain long-term benefits) and not when employed tactically (to obtain short-term benefits). The historical data shows both that tactical (short-term) timing never works and that strategic (long-term) timing always works. Bogle’s acknowledgment that the benefits of long-term timing are strategic rather than tactical is potentially a highly significant development; Passive Investing dogmatists have long taken advantage of the general public’s confusion over what the academic research says about timing (that short-term timing is a bad idea and that long-term timing is required for long-term success) to thwart efforts of investors to learn the realities of stock investing by planting the suggestion that advocates of Valuation-Informed Indexing are promoting a doomed tactical change rather than a common-sense strategic one.
Second, he noted that knowing when to lower or increase one’s stock allocation “might not be quite as difficult as it seems.” This statement suggests that Bogle has been educating himself about the message of the historical data in the months since the crash. There have been numerous good discussions of the merits of Valuation-Informed Indexing at the Bogleheads.org board since September 2008, when the ban on discussion of the academic research of the last 28 years was eased but not entirely lifted.
Wiandt imposed a partial ban on discussion of the investing realities at the www.IndexUniverse.com site after first expressing excitement about publishing articles on the Valuation-Informed Indexing strategy and then learning from his senior editor (who has ties to Mel Lindauer and other “leaders” of the Bogleheads.org board community) of Lindauer’s position. However, Wiandt too has evidenced a softening in recent months. His site recently published an article by Rob Arnott, former editor of the Financial Analysts Journal, arguing that most of the conventional investing wisdom of today (insights developed under the Passive Investing model) is the product of “myth and urban legend.” Arnott has said that we are today living in the early days of a “revolution’ in our understanding of how stock investing works.
Rob,
We are seeing the foundations of the old theory fall apart one piece at a time. Everything is still slow, but things are getting faster. Eventually, the old structure will come crumbling down with great speed.
Have fun.
John Walter Russell
the old structure will come crumbling down with great speed.
That’s encouraging.
I think.
Rob
My friend Drip Guy today started a thread at the Bogleheads.org forum entitled “Bogle’s Real Message”:
http://www.bogleheads.org/forum/viewtopic.php?t=40901&mrr=1248816306
Rob
I am an index investor and have studied indexing for over 20 years. Do you have any data to support your assertion that valuation indexing is a better way to go? How many years have you tracked the performance against traditional index benchmarks? I am open to the idea but your site does not appear to offer concrete comparisons or hard data to support your views.
Thanks for joining in the discussion, Larry.
Valuation-Informed Indexing has beaten Passive Indexing on a risk-adjusted basis throughout the entire historical record. If you think about it a bit, I think you will see that this mustbe so. How could it ever make sense to ignore price when buying something? Paying attention to price must be a plus, right? Well, that same rule applies to stocks as well as to everything else. That’s common sense.
The data of course confirms what common sense tells us must be so. Here are some things to look at:
1)Here’s a thread from the Financial WebRing Forum
http://www.financialwebring.org/forum/viewtopic.php?t=106998
at which Norbert Schenkler (a big Passive Investing advocate) says: “The evidence is pretty incontrovertible. Valuation-Informed Indexing…is everywhere superior to Buy-and-Hold.” He notes one exception, the 1990s. But this post was written before the crash and the claim about the 1990s no longer holds;
2) Take some time playing with the four calculators. Start with The Stock-Return Predictor. The Predictor merely reports,; what the historical data says about how stocks are likely to perform starting from various valuation levels. At a P/E10 level of 8, the most likely long-term return is about 15 percent real per year. At 44, it’s a negative number. What one allocation makes sense both when stocks are providing a negative long-term return and when they are providing a return of 15 percent real per year? There is just no way to make Passive Indexing work in the real world;
3) If you scroll down the Return Predictor page a bit, you will see a link to research by Robert Shiller. Follow that link for more background on what the data says, according to the academic research of the past 30 years (but please don’t let anyone from The Stock-Selling Industry know that I filled you in on this!); and
4) Go to John Walter Russell’s site, http://www.Early-Retirement-Planning-Insights.com. John has hundreds of reearch articles offering the most up-to-date take on what we know today about the effect of valuations on long-term returns.
http://www.early-retirement-planning-insights.com/index.html
Rob
Rob,
Thanks for entering my web site address twice. The first time, you misspelled insights.
Have fun.
John Walter Russell
Thanks, John.
I fixed that.
Rob
Your quote “The evidence is pretty incontrovertible. Valuation-Informed Indexing…is everywhere superior to Buy-and-Hold.”
The context.
Finally 10 year annualized returns.
Now this is an interesting picture. If you ignore the right hand side and imagine you are in 1996, just as Shiller was when he began to think and argue and publish about this, the evidence is pretty incontrovertible. VII, i.e. market timing, is everywhere superior to B&H over ten year periods.
I mentioned above that the one exception noted by Schenkler is the 1990s but that no longer applies in the wake of the crash. Schenkler wrote those words prior to the crash, Evidence.
Rob
Thanks Rob. I’ll review the information you suggested so I can contribute to the discussion.
Rob,
I am not yet convinced. I reviewed your information and I’m still skeptical. Take a look at the IFA.com site and see how your data stacks up against the data of several Nobel Laureates. I’m not being smart. I’m just asking you to take a look at their studies on market timing and other strategies versus time tested tradtional index investing.
In addition, accurate statistical analysis requires at least 20 years of evidenced based data to successfully predict the value of an investment strategy (versus the appropriate benchmark for the asset class).
Looking forward to hearing from you after you have checked out the data at IFA.com
Take a look at the IFA.com site and see how your data stacks up against the data of several Nobel Laureates. I’m not being smart. I’m just asking you to take a look at their studies on market timing and other strategies versus time tested tradtional index investing.
Is there something particular that you could point me to that persuades you, Larry? I took a look at the home page of the site and there is a mass of material there. I don’t have time to look at it all. But if you have one study that you find persuasive, I would be happy to take a look at it.
I have had people point me to studies in the past. In every caseit turned out that the study showed that short-term timing (changing one’s allocation and expecting to see a benefit from doing so within a year or two) doesn’t work. I am convinced re that point. What would impress me is if you could point me to a study that shows that long-term timing (changing your allocation with an understanding that you may not see a benefit for 10 years or so) doesn’t work. I have never seen one and I have never been able to find any Passive Investing advocate who could identify one (I have spoken to thousands of people who strongly believe in Passive Investing). I have seen scores of studies showing that long-term timing always works.
Given that I am aware of a mountain of evidence showing that timing always works and of zero evidence that there has ever been a time when timing did not work, I feel compelled to continue to tell people that long-term timing is the way to go and that Passive Investing is the strategy to avoid. But if there is some evidence going the other way, I would very much like to know about it. If I am wrong about the Rational model, I am wasting my time pursuing it. So you would be doing me a huge favor if you could point me to anything pointing in the direction of showing that there might be circumstances where timing doesn’t work.
I will tell you what I think is going on. I think the experts made a mistake. The mistake is a very basic one and it embarrasses them to acknowledge it. Thus, cognitive dissonance has kicked in and they simply cannot bear to acknowledge what has happened. We all make mistakes, even the Nobel Laureates among us.
I believe strongly that, when we discover a mistake that we have made, the best thing to do is to acknowledge it promptly and put it behind us. I believe that the friends of the Nobel Laureates should be taking them aside and trying to explain to them that the best thing at this point is to acknowledge the mistake or at the very least to acknowledge the possibility that they got something wrong so that the rest of us can get about the business of sorting out the realities.
I can assure you that when this started out I had no intention of taking on any Nobel Laureates. I discovered an error in the studies that we use to plan our retirements and I told my fellow community members about it and a lot of them were excited to learn about it and then some abusive posters showed up pointing to what the Nobel Laureates said. So I was forced to show that the Nobel Laureates were wrong to protect my discussion-board community from the abusive posters. After years of study, I found that, yes, the Novel Laureates are indeed wrong.
That doesn’t mean that they are bad people or dumb people. Good and smart people make mistakes all the time. But, yes, I do believe that the Nobel Laureates who defend Passive Investing got all the numbers wrong in their studies. To get the numbers right, they need to take into account the effect of valuations on long-term returns. To show that valuations have no effect, they would have to show not only that short-term timing doesn’t work but also that long-term timing doesn’t work. I am not aware of any study that shows this. If anyone ever finds one, that person will be my friend for life for the favor he or she has done me.
I am grateful for the time you have put into this and for the constructive manner in which you have approached it. You’re helping everyone here (including Rob Bennett, to be sure) by challenging me. Please do be sure to let us know if you see something that you believe indicates that long-term timing might not work. If you do not find anything, I hope that you will give more serious consideration to the idea that the conventional investing wisdom of the past 30 years might be entirely off the mark and that getting the word out about what really works in stock investing might be the key to getting us all out of this economic crisis.
Welcome to the monkey house — er, Financial Freedom Community, my new friend!
Rob
Rob,
You have several good points. First of all, I believe we all make mistakes as well. No argument there. “Experts” are just as fallable as the rest of us. I agree 100% and don’t worship at the altar of experts either.
Second, I should have sent you to a specific study about long term timing in the first place. I apologize for not taking the time to do so. I’ll work on this issue later this afternoon and on Wednesday.
My only goal is to find the truth about investing success as it pertains to the average person. One of my life goals is to find out what works best for the individual investor not just the financial advisor or large financial institutional investors. Few people look out for the little guy when it comes to investing success. I try to help in this area.
I spent 16 years in the public pension industry before leaving 10 years ago to help the individual investor learn more about successful investing. I work on a volunteer basis and don’t accept a dime for what I do. I just want to find the very best financial strategies that help families meet their life goals,reduce stress, and build stronger families. World class investing and savings strategies are essential to these goals.
I’ll do my homework this time so we can continue to debate this topic in a postive manner.
God Bless,
Larry Weber
That all sounds wonderful, Larry. I very much look forward to continued explorations with you.
Rob
Rob,
Attached is a link to some of the best studies on market timing strategies. Mark Hulbert and many other researchers have looked at all kinds of timing strategies during different time periods.
http://www.ifa.com/12steps/step4/
Look at Bob Brinker’s results as one example. He is suppose to be one of the best timers in the world yet he consistently underperforms the S&P 500. Not one of the timing newsletters in the study mentioned in the link beat the market average.
Here is a quote from one study:
“Jeffrey Lauderman wrote a BusinessWeek article titled Market Timing: A Perilous Ploy, dispelling the myth of market timing, which he called a guessing game. His 1998 analysis included an interview with Mark Hulbert, who monitors the time pickers recommendations. Hulbert’s conclusion provided a knockout blow to all 25 newsletters he tracked. None of the newsletter timers beat the market. For the 10 year period ending 1988 to 1997, the time pickers’ average return was 11.06% annually, while the S&P 500 stock index earned 18.06% annually and the Wilshire 5000 earned 17.57% annually. The figure below tells the story”.
Take a look at the chart in the link that I provided as well. Some “big names” in the investment industry are adding no value for their clients.
Here is one other quote from the research:
“The landmark and definitive study of time pickers was conducted by John Graham at the University of Utah and Campbell Harvey at Duke University. The professors painstakingly tracked and analyzed over 15,000 predictions by 237 market timing investment newsletters from June, 1980 through December, 1992. By the end of the 12.5 year period, 94.5% of the newsletters had gone out of business, with an average length of operations of about four years!
The conclusion of this 51 page (see page 25) analysis could not have been stated more clearly. “There is no evidence that newsletters can time the market. Consistent with mutual fund studies, ‘winners’ rarely win again and ‘losers’ often lose again.” This clearly indicates that the market’s signals are inaudible to the thousands of time pickers claiming to clearly hear them. Any investment professional who speculates on the market’s future should be relegated to the fortune telling parlor”.
The majority of gains in the stock market in any given year occur on a small fraction of days during the year i.e., 26 days out of 365 days. It is virtually impossible to pick those 26 days. The statistical probability is near 0. If valuation timing or any other timing works, then the creators of the strategy will have a niche in the “market” and make billions by promoting their strategy. If you can prove it to me, I’m in. I’ll create a marketing plan and sell the strategy to the local private equity firm or venture capitalist.
The acid test: What investing strategies would you recommend to your kids? I would not recommend the valuation strategy to my kids or parents and risk their capital based on what I know about valuation indexing. In addition, I would not bet the farm or my retirement on this method without fully understanding the long term success or failure rate of this or any other strategy. I want to believe what you are saying but I’m not convinced.
It’s your turn. Please take a careful look at the link I sent you,let me know your thoughts, and why you think these studies are wrong.
Thanks Rob and have an awesome day.
Larry:
You are failing to distinguish short-term timing (changing your allocation with the expectation that you will see a benefit from doing so within a year or so) with long-term timing (changing your allocation with the understanding that it may take up to 10 years to see a benefit from doing so). All of the studies you point to show that short-term timing does not work.
I am persuaded of this and I have been persuaded of this for many years now. There is no need for anyone to do further studies since the point has been long proven. But there has never been a study showing that long-term timing does not work. Does that not seem odd to you? If there had ever been such a study, wouldn’t the people who argue that “timing doesn’t work” be willing to produce it? I believe that the reason why we have never seen such a study is that it is impossible to produce one. The idea that timing doesn’t work is a logical impossibility.
Think what it would mean for it to be true that timing doesn’t work. Timing is taking price into account when setting your stock allocation. To say that “timing doesn’t work” is to say that “price doesn’t matter.” Does that seem possible to you? If The Car Selling Industry told you that you should always pay whatever price the salesman asked because “studies” show that negotiating price never works, would you fall for it? Why should we fall for it when its The Stock Selling Industry telling us essentially the same thing? Would you not agree that the claim that timing never works is equivalent to a suggestion that we should stay with the same stock allocation regardless of the valuation level that applies, that we should ignore price?
There has never been a reasonable argument made that there might be some alternative planetary system in which timing doesn’t work. There has never been a sliver of historical data produced showing that timing doessn’t work. So, yes, of course I would tell my children to educate themselves enough about the realities of stock investing not to fall for the marketing pitches of The Stock Selling Industry. The historical data shows that those open to the idea of investing rationally can thereby finance a safe retirement five years sooner. Why would I not want that for my children?
It’s no mystery why timing always works. Timing is taking price into consideration when making buying decisions. OF COURSE timing always works. But the data shows that short-term timing never works. Why? Why does short-term timing not also always work? That’s the true puzzle.
To understand that, you need to understand how stock prices are determined. In the long term, index-fund shares are shares in the productivity of the U.S. economy. Since prices are set by economic forces in the long term, long-term prices must be rational. That’s what makes long-term price predictable and thus timeable. But is this so in the short term? It is not.
The economic realities do not determine the prices that apply in the short term. Short-term prices are set by investor emotion. Investor emotion is entirely unpredictable and irrational. Thus, short-term prices can be just about anything. Short-term timing cannot work. But timing (the word “timing” encompasses both the short-term and long-term varieties) ALWAYS works (so long as the right variety is chosen, to be sure).
It was a breakthrough insight when the “experts” discovered that short-term timing doesn’t work. Our state of knowledge of how investing works would not be where it is today if these good and smart people had not done the important work they did. That said, it was a MISTAKE for these people to jump to the hasty conclusion that, because short-term timing does not work, long-term timing also does not work. That mistake has already caused more human misery than any other mistake ever made in the history of personal finance. It should be corrected. The many “experts” who have argued in recent decades that timing doesn’t work should acknowledge the error and engage in efforts to make it up to the millions of people who have been done irreparable harm by this terrible and foolish mistake.
There has never been a study showing that long-term timing doesn’t work, Larry. Our common sense tells us that long-term timing must work. There have been hundreds of studies confirming what our common sense tells us must be so. Our collective unwillingness to acknowledge this basic reality of stock investing has done huge harm to millions of middle-class investors, has brought our economy to its knees and in recent months has even been shown to be shaking the foundations of our political system. It’s time for the “experts” to work up the courage to give voice to the three hardest works to pronounce in the English language — “I” and “Was” and “Wrong.”
We help people when we tell them the realities of stock investing. That’ my sincere take re this matter. I apologize if I engaged in small bits of sarcasm here and there in my response. I believe that you are asking sincere questions and you are entitled to sincere responses. Still, I have been arguing for a long time that we should be straight with people about stock investing and I have seen this shell game tactic (pointing to studies showing that short-term timing does not work and pretending that this shows that timing in general does not work) employed thousandsof times. I am weary of it.
My plea to you is that you ask yourself a question — If these smart people have been able to produce so many studies showing that short-term timing does not work, why is it that they have never been able to produce one showing that long-term timing does not work? A second good question to ask yourself is — Why have none of these people ever been able to offer an effective response to the hundreds of studies showing that long-term timing always works, research dating back 28 years (Shiller did his work showing that valuations affect long-term returns in 1981)?
The continued viability of our economic system is at stake here. There are some signs that the continued viability of our political system may be at stake as well. My take is that it is long past time for serious people to begin taking serious steps. I am going to continue to report the realities as I understand them until I see evidence that my current understanding is flawed in some way. For me to be persuaded that timing does not work, I would need to see something other than studies showing that short-term timing does not work as I have been aware of these for decades now. I would need to see a study showing that long-term timing doesn’t work. I am confident after spending seven years asking many thousands of the most ardent Passive Investing enthusiasts in the world to produce such a study and having zero success with the effort that the reason is that no such study exists or ever can exist.
Rob
Rob
You said
“You are failing to distinguish short-term timing (changing your allocation with the expectation that you will see a benefit from doing so within a year or so) with long-term timing (changing your allocation with the understanding that it may take up to 10 years to see a benefit from doing so). All of the studies you point to show that short-term timing does not work”
yet the reference Larry provided 10 year periods of performance. Do you consider 10 years short-term?
JCL
yet the reference Larry provided 10 year periods of performance. Do you consider 10 years short-term?
It was 10 years of SHORT TERM timing.
It was not seeing what happens after 10 years based on valuations.
Have fun.
John Walter Russell
Rob,
Thanks for your response. I feel the passion of your position on this issue.
I get what you are saying about the distinction between short and long term timing. I read your entire explanation of valuation indexing this morning again.
I understand the distinction that you are making between short and long term timing. I have not seen a study that exactly matches the criteria that you described in your recent post.
Your concept is theory makes sense to me to a degree. However, think about this next point for a minute. How does your valuation indexing theory correlate with the sub prime meltdown, fraud in the market, derivative trading,credit default swaps, hedge fund trading, and all of the other investment mutations that Wall Street is creating? What impact do these issues have on your theory? How can your trade on valuations and not consider all of these issues?
Let me be totally open to what I did in 2006. I have not shared this with a forum like this because it was not data based it was primarily a intuition.
I move 92 percent of my portfolio our of the market because I saw what I call ‘Wild West” economics going on. I read state financial regulator reports and saw what was happening with the banks and the sub-prime problems. I also read Schillers work but I came to a different conculsions than you did. I moved my money to cash because I felt there was may too much risk in the market. It had nothing to do with a valuation number. It had everything to do with “Wild West” investment strategies i.e., derivatives that only computer programmers understood, greed from the sub prime lenders and all the other wacky investment product mutations.
I move my money out of all index products and avoided the crash based on the factors above. I did not listen to the experts and my family portfolio survived. Thank God. I don’t know if I was just lucky or if skill was involved. That is my own struggle. We did well and are know reaping the benefits of that decision. I made an educated guess and it worked out.
Could I do it again? I don’t know.
My point is that there is some validity to moving your portfolio in extreme circumstances. You are right, no one has really studied the long term strategy of moving your money based on some pretty extreme circumstances in the market. I had different reasons to move my money than you but it worked out. The bottom line: Is this just luck, skill or a combination of both???????
Sorry about all the spelling errors in the last post. I was in a hurry. I’ll watch it next time.
yet the reference Larry provided 10 year periods of performance. Do you consider 10 years short-term?
No. Ten years and anything beyond that is long-term in my assessment. My sense is that there are a good number of investors who think of five years as “long term.” Timing often does not work in five years. Anyone giving thought to engaging in market timing needs to be made aware of that.
Every study of the historical data shows that timing works in 10 years(for the not-too-hard-to-understand reason that that is what the historical data tells us). There are a few occasions on which it has taken a bit more than 10 years for the economic realities to fully assert themselves. For example, stocks went to insanely high price levels in 1996 but it was not until 2008 that we saw the crash. Still, stocks did not provide a positive return from January 2000 forward. Timing began to work in 2000, only four years after prices reached insane levels. But it took nearly 13 years to see the bigger payoff. And in all likelihood we will be seeing more of a payoff in years to come as valuations drop to levels far below fair value.
There is no hard and fast rule for how long it takes for timing to work. Someone who became convinced in August of 2008 that prices were too high saw a payoff within a month. But those who want to time effectively need to understand that it frequently takes at least five years for timing to pay off, that they need to be prepared to wait 10 years or else they should not be engaging in the timing in the first place (my view is that those not willing to wait 10 years should not be investing in stocks, period) and that there are even cases in which it has taken a bit longer than 10 years for timing to provide a significant financial payoff.
I once went through the entire historical record and identified cases in which there was not a significant financial payoff for timing in 10 years. In all of those cases, the payoff came shortly thereafter.
I think it is fair to say that timing always works. I don’t think it is fair to say that “timing always works within x amount of time,” at least not if you are speaking precisely. But if you are willing to wait 10 years for the payoff, the odds are very much with you.
Thank for participating in the discussion, JCL. I don’t share your take. But I think you are raising an important point that those reading these words need to think through carefully before giving serious thought to engaging in any long-term timing efforts of their own.
We can give people tools to help them become effective timers. But we cannot (certainly not at this time and perhaps never) give people precise rules to follow. We are dealing here with the effect of human emotion on stock prices. Human emotion does not perform in accord with precise guidelines in my experience (and I believe that the historical stock-return data backs up my experience re this point).
Rob
Sorry about all the spelling errors in the last post. I was in a hurry. I’ll watch it next time.
That’s not a problem. I sometimes have to rush things too. I prefer to get the spelling right and to fix typos and so on. But I think that people understand that this is an informal medium and that the most important thing is that we get the content out to people that they need to see to sort things out.
We are all grateful to you for your efforts to help us come to a better understanding of these matters.
Rob
How does your valuation indexing theory correlate with the sub prime meltdown, fraud in the market, derivative trading,credit default swaps, hedge fund trading, and all of the other investment mutations that Wall Street is creating? What impact do these issues have on your theory? How can your trade on valuations and not consider all of these issues?
This is a fantastic question, Larry.
The answer is — overvaluation IS fraud. And Passive Investing — which encourages us to overlook the fraud of overvaluation — is ALSO fraud.
We are talking about the same thing. All that P/E10 does is to tell you how much fraud is present in the market price at any given time.
In January 2000, stocks were priced at three times fair value. That means that each person who purchased $1,000 worth of stocks obtained in return $350 worth of stock and $650 worth of cotton-candy northingness.
That’s fraud, no?
Bernie Madoff was put in jail for selling people stocks that didn’t exist. But the fraud worked on us by those promoting Passive Investing was thousands of times bigger than the fraud worked by Bernie Madoff. It was unintentional and that’s an important distinction. But the financial pain caused by Bernie Madoff is a drop of water in the Atlantic ocean compared to the financial pain caused by the promotion of Passive Investing.
Bull markets are a huge act of fraud that we all work on ourselves. Bull markets destroy wealth. Bull markets take place when for a time we all agree to tell lies to ourselves about the values of our stock portfolios and thereby destroy our financial independence dreams for many years to come.
It’s fine if people want to do it the way you did it and watch for other signs of fraud and get out of stocks when the fraud becomes widespread. But there are lots of people that do not have the time to study these matters in great depth. What I suggest is that these people take the easy way of detecting fraud and just look at the P/E10 value. When we get to a P/E10 level of 26, we are dealing with an overwhelming amount of fraud and we are sure to see a price crash as a result (there is not one exception in the historical record). You obviously do not want to be going with the same stock allocation when a price crash is inevitable as you were going with when the stock market was on the up and up, right?
Passive Investing is fraud, Larry. To promote Passive Investing is an act of fraud. That’s what it comes to.
We would all recognize that a car dealer who told us to accept any price and told us that there were “studies” supporting such self-serving gibberish was practicing fraud. But when it comes to stocks, we say “oh, those people who sell stocks are so smart, I had better just do what they say.” I am saying that that’s a bad idea.
To tell people that price doesn’t matter when buying stocks is an act of fraud. The widespread promotion of this fraudulent model of understanding how stock investing works has caused the greatest loss of middle-class wealth in the history of the United States. There are going to be millions of busted retirements in days to come because of the demonstrably false claims put forward in the Old School safe-withdrawal-rate studies. It’s time to knock off the funny business.
I started writing about personal finance because I want to help people achieve financial freedom early in life. It was never my intent to engage in fraud. But for so long as the Passive Investing model remains dominant, it is impossible for anyone to engage in honest talk about how stock investing works without causing the Passive Investing “defenders” to go stark raving bonkers.
Why do they go bonkers? Because they are humans. Humans have a desire to achieve personal integrity. For so long as there are “experts” suggesting that there is some alternate universe where Passive Investing might work in the long run, it is impossible for anyone in this field to maintain their integrity while explaining stock investing to people. I think we should put an end to that. ALL investing “experts” should be able to start talking about stock investing HONESTLY again. That means giving up on Passive Investing and embracing the Rational Investing model.
That’s what it’s all about. That’s why I call the book I am working on “Investing for Humans.” We all have a Get Rich Quick impulse within us that attracts us to Passive Investing. We also all have within us a heart and a mind that causes us to feel revulsion for the huge amounts of human misery caused by promoting an investing model rooted in the darkest impulses of human nature. Passive Investing is the investing model of the past. Rational Investing is the investing model of the future. I’m sure of it!
I think.
Rob
It was 10 years of SHORT TERM timing.
It was not seeing what happens after 10 years based on valuations.
Thanks very much for pointing that out, John. That’s extremely helpful.
Rob
I feel the passion of your position on this issue.
I bill myself as the most severe critic of Passive Investing alive on Planet Earth today, Larry.
I hate Passive Investing in the way that I hate cancer and illiteracy and racism.
I understand that is is an idea that at one time was state of the art and that generated hundreds of wonderful insights in its day. But the time for taking Passive Investing seriously passed nearly three decades ago when Shiller published his research showing that valuations affect long-term returns. Since then, the human misery caused by this now-long-discredited investing model has grown greater and greater and greater.
I’ve seen enough. I’ll be happy when this investing model is buried ten feet in the ground.
Here’s Dylan in “Masters of War”:
And I hope that you die.
And that your death will come soon.
I’ll follow your casket
In the pale afternoon.
And I’ll watch as you’re lowered
Down into your deathbed.
And I’ll stand over your grave
Until I’m sure that you’re dead.
The continued promotion of the Passive Investing “idea” for 28 years after it was shown by the academic research to be pure gibberish is all that is wrong in The Stock-Selling Industry today, in my view. Yucko!
Rob
My point is that there is some validity to moving your portfolio in extreme circumstances….The bottom line: Is this just luck, skill or a combination of both???????
This is another fantastic question.
It’s not luck or skill or a combination of the two that is the secret to investing success. It’s emotional balance.
Most of us like to eat chocolate cake, right? Most of us know that it’s a bad idea to eat six pieces of chocolate cake every day. But a good number of us still eat too much chocolate cake. Fortunately, we have experts in the medical and nutritional fields that warn us of the dangers. That doesn’t make us totally rational. But it helps.
Compare what happens in the investing field. We all know on some level of consciousness that valuations affect long-term return and that therefore Passive Investing is 100 percent nonsense. But we all also have a Get Rich Quick Impulse that whispers in our ear that it might all turn out different this time from how it has ever turned out before. And what do the “experts” do? They spend hundreds of millions of dollars putting out magazines and studies and calculators and speeches telling us that, yes, it is certainly going to go entirely different this time from how it has ever gone before, that there are “studies” showing that Passive Investing might work in some alternative universe, that we are special and that the laws of mathematics do not apply to special us.
I don’t buy it. But I see that advertising has an effect. People have heard so many times that timing doesn’t work that a good number have come to believe that there must be something to it.
When an “expert” reports what the historical data says about safe withdrawal rates, he takes on a responsibility to report what the historical data says accurately. That’ my sincere take. My take is that, once you doctor the methodology of the studies so that the numbers that people are using to plan their retirements are wildly off from the numbers that they would be using if you used an analytically valid methodology, what you are doing is not science. Science is a quest for truth. True scientists correct their studies when they find errors in them.
What people need is emotional balance. The way they get that is by having the “experts” report the realities. When you look at how investing really works, it all makes sense. When you try to believe in Passive Investing, you find yourself caught in endless swirls of self-contradiction. One problem is that there has never been a stock market that performed in the real world in the way that the Passives say all markets must perform. Another is that it is not possible for the rational human mind to imagine how there ever could be such a market.
Investors are emotional today. That’s because they are scared. Their common sense tells them that Passive Investing can never work in the long run but they are intimidated by the “experts.” The Stock Selling Industry has hundreds of millions of dollars available to promote what doesn’t work and so most middle-class people feel that they had better go for that and hope for the best. But as they see their hopes for retirement dwindle, they naturally become concerned and wish that there were some source of information available to them other than The Stock Selling Industry through which they could obtain more realistic and sensible advice.
We can’t wait until the next time prices are at insane levels to warn people of the dangers of Passive Investing. Emotional investing is a habit. People didn’t come to believe this junk in a day or a week or a year. It is the steady promotion of it for decades that has done the trick. We should be telling people the realities of stock investing even when prices are low. If we do that, then when prices go insane people will know what to do.
The root question is — Are the short-term profits of The Stock Selling Industry a more important consideration than the future viability of the U.S. economic system? I say that the U.S. economic system is more important. We need to open up avenues for people to learn the realities. In the long run I believe that is best even for those in The Stock Selling Industry.
Millions of middle-class investors would love to learn what works. We have seen great interest in learning about effective investing strategies at all of our boards. The one big problem is that telling people that Passive Investing is the most dangerous Get Rich Quick scheme in history would require that a good number of “experts” learn how to pronounce the three magic words.
I feel a great amount of respect and affection for the “experts.” And I appreciate that they hate the idea of having to acknowledge that they are human and capable of making mistakes. Still, I don’t see how there is going to be any Stock Selling Industry in days to come unless we begin taking some steps to get out of this economic crisis. So I feel that the best thing for the “experts” to do at this point is to say the three magic words and then get down to the exciting work of building the Rational model.
We all should be working together on this. Just as the promotion of Passive Investing is ultimately a lose/lose/lose/lose/lose, the promotion of Rational Investing is ultimately a win/win/win/win/win.
Or so Rob Bennett says in any event.
Rob
Rob,
I think we have found some common ground.
There was absolutely no “main street/stream” investment type that agreed with my decision back in late 2006 when I opted out of the market (to be precise 92 percent out of the market). They thought I was crazy for leaving the market based on conventional investment wisdom at the time.
However, you and I have arrived at basically same investment destination with a slightly different road map. I based my decision on detailed data from state regulators, Schiller’s work, boomer demographics, and some other resources that I’ll discuss in minute.
The end result was that I strongly suspected fraud and severe market hype so I pulled the plugged on my stock market investments and went to cash.
By reviewing the detailed reports of state regulators, I was tipped off to the brewing sub-prime crisis and the impending financial tsunami (you had to read somewhat between the lines). In addition, I read a book called Stock Market Manias, Panics, and Crashes several years ago that gave me some clues as well. The book tracks stock market manias and panics all the way back to the 1600”s and highlights such stock market panics as the Tulip Bulb Mania and other stock market fraud.
Moreover, I read a book called Financial Shenanigans that helped me spot the accounting tricks and fraud of individual companies. The bottom line: I just saw too much risk for fraud in the market so I got out.
That’s also why I used the metaphor “Wild West Economics”. I was trying to find a way to point out the risk I saw in the market to friends, relatives, and anyone that would listen.
Financial companies and banks in general were living in the “Financial Wild West”. They could basically do anything they wanted because they were making up and playing by their own rules. In addition, there was no strong “investor sheriff” in town to keep financial institutions in line because Wall Street lobbyists neutralized the sheriff by influencing policy and limited the investing sheriffs (the Securities and Exchange Commission) authority. It was just like the Wild West in the 1800’s.The bad guys could do whatever they wanted because they made the rules and the sheriff had little authority to stop them.
In addition, I study demographics and knew the baby boomers were at the end of their home buying life cycle in about 2004. Home sales should have declined after 2004 because there were not enough “buyers“ left in the housing market to purchase all of the new homes that were being produced by the construction industry. In other words, home sales “ought” to have declined because there were not enough buyers for the new homes.
However, in a stroke of evil “genius” (really fraud), the unethical banks (not all banks played this game) and other financial organizations (some in the legislative branches as well) marketed sub-prime loans to buyers they knew could ever make their payments by any historical standard. The boomer market had dried “up” and the banks needed to do something to ensure growth and therefore profits. In one sense, some banks created a false short term market to sell homes at inflated prices. The housing market was declining because most boomers were done buying their homes and the inventory needed to be cleared. Enter the sub-prime loan fiasco.
There is another way of thinking about our discussion. You use a simple Price to Earnings ratio to help people see the fraud in the market. I use a much more detailed way of analyzing the reasons behind the inflated Price to Earnings ratio (not better, just different).
Your “timing” word also confused me initially. I am going to think about a different term that describes your process because it has merit. We are actually saying almost the same thing but in a different way.
In my view, most people think of timing in a very negative way especially those investors who are taught traditional investment theory. The “timing” word to me does not accurately reflect what you are trying to communicate.
It’s the “T” word that ruffled my feathers.I don’t think you’ll change mass investment thinking by using the timing word.
I will give my next suggestion a lot of thought because I think it has the power to change a lot of people’s minds about investment theory.
I think you need to scrap the timing tag line and come up with a new strategy to market( obviously,in a good and ethical way) this theory. You need to craft a “first” ever theme for the investing industry to give this theory more attention. I’ll ponder this potential strategy for a few days and offer suggestions.
It’s the “T” word that ruffled my feathers.I don’t think you’ll change mass investment thinking by using the timing word.
Thanks for sharing your thoughts, Larry. You’ve started a good discussion and put forward some helpful observations.
You are absolutely right about the word “timing.” People have come to view it as something dirty.
There’s one sense in which this is a good thing. There truly is a lot of evidence that short-term timing is a bad thing. I see it as a positive that people have come to think of short-term timing as a bad thing.
But I see it as a bad thing that people have come to think of even long-term timing as a bad thing. Long-term timing is price consciousness. We should want all investors to be price conscious. It’s a disaster for everyone when investors stop being price conscious.
You may be right that there is another way of saying it that would connect with people better. But I don’t know what it is. Some who share my views try to avoid use of the word “timing” for just the reasons you suggest. My inclination is to be up front about it, to point out that long-term timing is just being price conscious. I obviously don’t want to turn people off by doing that. My thought is that the best strategy is to be as clear as possible and that avoiding use of the word just adds another layer of confusion. It could be that I am wrong.
Is it “timing” to lower one’s stock allocation when prices are too high? I think it is. Long-term timing is certainly a very different thing than short-term timing. But it does seem to me that it is a form of timing that I am advocating. So I have felt it best to acknowledge that up front and to try to explain why this form of timing is so different from the form that has been so often disparaged.
Another way to make the point is to explain that long-term timing is strategic while short-term timing is tactical. That’s the point that I was making in the blog entry commenting on Bogle’s recent interview. But I am not sure that everyone sees the importance of the distinction between tactical moves and strategic moves either.
In any event, I am grateful for your feedback. I hope you will remain in touch from time to time. I look forward to hearing any suggestions for enhancing the pitch that you are able to come up with.
Rob
I find it very interesting to read the comments here from last year. Buy and hold is definitely a strategy that no longer works in today’s casino markets.
I’m curious to read more about what quick defensive plays people use for their portfolios when they feel a crash coming. Can you do the same with your 401k?