I mentioned on a thread at the Early Retirement Extreme forum that J.D. Roth at the Get Rich Quickly blog once sent an e-mail to all readers of his forum asking that they not respond to my posts. A community member named “Alex” said: “Rob — I have to ask…What do you say that’s so controversial?”
The response that I provided over there is set forth below:
You’re going to be sorry you asked, Alex! I want to answer your question. But I don’t want to hijack the thread. If anyone thinks it would be a good idea to pull this question and response off into a separate thread, that makes perfect sense to me.
I say that valuations affect long-term returns. It’s not even a tiny bit controversial from one way of looking at things and it is the most controversial thing ever said from another perspective.
The history is that the Buy-and-Hold Investing Model was developed at a time when people believed in the Efficient Market Theory, which posits that stocks are always priced properly. Thus, Buy-and-Hold does not tell people that they need to change their allocations when prices go to insanely dangerous levels. Shiller did research in 1981 showing that this is not so, that valuations matter. If Shiller is right (I strongly believe that he is), then the Buy-and-Holders are wrong. The two ideas (that valuations matter a great deal and that valuations matter not at all) are in conflict. Accepting one or the other of the root premises as true leads to the development of an opposite model for understanding how stock investing works from the model you would have if you went with the other option.
As a society, we have been working hard for 30 years to avoid dealing with the implications of Shiller’s findings. If Shiller is right, then 90 percent of the retirement planning advice we have been giving for 30 years is wrong. So is 90 percent of the asset allocation advice. So is 90 percent of the risk management advice. Most of the investment calculators on the internet today get the numbers wildly wrong. And on and on.
I don’t care what others believe. It is of course none of my business. But I do think that I have an obligation to state my own views sincerely. So, when I am in a group that is talking about retirement planning, I always point out that the numbers in the existing studies all get the numbers wildly wrong (they don’t account for the valuation level that applies on the day the retirement begins). I don’t do this to hurt anyone’s feelings. I just do it because it seems clear to me that it really is so and I have made many friends in all the communities in which I have participated and I think that it is important that people at least have access to accurate retirement planning guidance, whether they elect to follow it or not.
If you think Shiller is right, it follows that it was the promotion of Buy-and-Hold that caused the economic crisis. The intuitive thing would be for people to lower their stock allocations when prices go to insanely dangerous levels. Why wouldn’t they? But Buy-and-Hold says there is no need to do this (because it is rooted in the now-discredited Efficient Market Theory, which says overvaluation is a logical impossibility). So people kept buying even after prices went nuts. By 2000, stocks were overvalued by $12 trillion. Prices always revert to the mean after 10 years or so. So we put ourselves in circumstances in which an economic crisis was assured. The loss of that $12 trillion in Pretend Money is today killing us.
The Buy-and-Holders don’t want to deal with any of this. So, when I bring it up, people get excited. If there were a way to talk about the topics I write about (saving, investing) without bringing any of this up, I would do it. But it is impossible. How can you tell people how to save or invest effectively without ever talking about asset allocation strategies or retirement planning or the cause of the economic crisis or what we need to do to recover from it? This thing is so huge that it is unavoidable.
It’s a strange, strange story, Alex. It’s like I got myself involved in a nuclear explosion. What’s going on is that Buy-and-Hold was the first attempt to rationalize the investing project. Instead of giving their subjective take, Buy-and-Holders cite academic research and historical data. That part is wonderful. The problem is that, when you cite research and data, you need to update what you say when the old stuff is discredited. Numbers are objective, so when they are wrong they can be shown to be wrong. A lot of the big-name Buy-and-Holders don’t like the idea of acknowledging that they got important things wrong. They view it as bad from a marketing perspective. So this thing goes on and on.
Anyway, it drives a lot of people crazy. I get very strange reactions. I have had numerous people ban me from their sites and then write me e-mails apologizing and telling me that they read all my stuff and think my work has huge value. This hasn’t happened just one time, it has happened numerous times! I have three blurbs on the back of my saving book, people praising me to the sky. Two of the people who wrote those blurbs banned me from their sites after I started posting on investing even though numerous big-name experts have confirmed what I have said about investing. Can you beat that?
I believe that as a society we need to deal with this Efficient Market thing. We need to have a national debate in which everyone participates and decide once and for all whether valuations matter or not. If we get to a point where there is a consensus that they do (the evidence is overwhelming and there is no evidence on the other side — the Efficient Market thing was always just an hypothesis, there was never any study supporting it) , we can fix all the textbooks and the calculators and the studies and I believe that we can enter the greatest period of economic growth that we have ever seen. If we don’t fix this stuff, the numbers indicate that we are in a lot more trouble than nearly anybody recognizes today. By persuading millions to invest in precisely the opposite of the way that works (I don’t say this was done intentionally, but still…) we have placed ourselves in quite the little sticky fix.
My belief is that, as things get worse, more people will open up to consideration of new ideas, and we will eventually get to a point where we are able to turn everything around. I have already seen some signs that that is starting to happen. But I think it would be fair to say that it is a maddeningly slow process!
Please understand that I did not ask for this job of saving the world with my two bare hands, Alex. They were looking for volunteers and I wasn’t paying attention and everyone else stepped back and that make it look like I had stepped forward. Now this is my life!