We lost $12 trillion in funny money. The conventional explanations of the economic crisis that began in late 2008 are unsatisfying. A more compelling explanation is that the bull market of the late 1990s is the primary cause. The bull market caused stocks to be overvalued by $12 trillion and the inevitable return to fair-value prices has taken that amount of wealth out of the pockets of middle-class investors.
A) The Obvious Explanation Is Being Ignored
The economic crisis that began in late 2008 has transformed life in the United States. Millions have lost their jobs. Millions are experiencing a fading of their hopes of being able to finance good retirements. Millions of marriages are under stress. Much of the public responded negatively to President Obama’s health reform initiative largely because of a resentment that our political leaders are failing to address the more serious problem. The Tea Party Movement has flowered as a means for ordinary people to express their discontent with the economic and political leaders who have failed to find constructive answers to the nation’s most serious problems.
The claim that it was bankers who caused the economic crisis does not persuade, at least not in a complete way. The question “How precisely did the bankers do this to us?” has never been answered by those seeking to make the bankers the fall guys. Nor is the claim that it was a loosening of mortgage rules that did all the damage convincing. Could mortgage rules, no matter how misguided, really have played the primary role in bringing the global economy to its knees? The two conventional explanations of the economic crisis can fairly be dismissed as exercises in political opportunism (with those coming from one side of the spectrum of political opinion favoring the former explanation and those coming from the other side of the spectrum of political opinion favoring the latter explanation).
There is a simple and compelling explanation for our troubles that is rarely discussed. The bull market of the late 1990s pushed stock prices to three times fair value. That translates into $12 trillion of funny money. Presuming that stock prices are always fated to revert to the mean (Vanguard Founder John Bogle describes Reversion to the Mean as an “Iron Law” of stock investing), we set ourselves up for the loss of $12 trillion in spending power once the bull market came to an end. It’s not hard to understand why that would bring on an economic crisis. So why not pay heed to Occam’s Razor and accept the simplest explanation as the most likely one?
B) All Earlier Out-of-Control Bull Markets Caused Economic Crises
A strong case gets stronger when you take into account the message of the historical stock-return data. Yale Professor Robert Shiller reports in his book Irrational Exuberance that there have been four times in the history of the U.S. market when stocks reached insanely dangerous price levels: (1) the early 1900s; (2) the late 1920s; (3) the mid-1960s; and (4) the late 1990s. On each of those occasions, we experienced a stock crash. We have never experienced a stock crash of lasting significance starting from a time when stock prices had not gone to insanely dangerous levels. And on each of those occasions (and not on any other occasion) we also experienced an economic crisis. The correlation is perfect.
It would appear that bull markets cause stock crashes and that stock crashes cause economic crises. It is not even a tiny bit difficult to understand why this would be so. Price affects the value proposition of every single thing on Planet Earth that can be bought or sold. Why should anyone think it would be any different with stocks? If the price of stocks affects the value proposition obtained by buying them, it logically follows that the risk of price crashes must be much higher when stocks are selling at insanely high prices. Should it come as any surprise whatsoever to learn that the entire historical record shows this indeed to be the case?
And of course stock crashes are strongly correlated to economic crises. When stock prices crash, trillions of dollars disappear from the economy. Businesses obviously cannot afford to employ as many workers when so much less money is available to the consumers of their products. Mass unemployment of course causes consumers to cut back on spending even more. The puzzle would be if bull markets did not cause price crashes or if price crashes did not cause economic crises.
It is easy in an intellectual sense to explain why we are today enduring an economic crisis. A big question remains, however. Why have we not acknowledged the obvious cause of the crash? Coming to know the true cause of the economic crisis would be an important step to overcoming it. Why do we pretend to ourselves that it is these other relatively inconsequential matters that are the causes? The remaining words of this Knol are aimed at clicking this last piece of the puzzle into place.
C) Discussion of the Flaws of Buy-and-Hold Is Prohibited
There was recently a discussion of the question of what happened to the trillions of lost money at the www.Bogleheads.org discussion board. The thread-starter there refers to $7 trillion in lost money because the poster is trying to understand only what happened to the money lost in the recent stock crash. The full amount of overvaluation that applied at the top of the bubble was roughly $12 trillion but we are today only a little more than halfway through the process of paying back the debt we incurred to future investors (Today’s investors! Us!) when we permitted stock prices to go to the insanely dangerous levels they went to in the bull market of the late 1990s.
Please note that this thread generated a good number of intelligent comments and zero abusive posting and yet was shut down by the owners of the board. The question of what happened to all the money lost in the crash is clearly an exceedingly sensitive one for the owners of the www.Bogleheads.org board.
The trouble is that the leaders of the www.Bogleheads.org forum often push Buy-and-Hold investing strategies. The thread does indeed raise troubling questions about Buy-and-Hold. Please note that Alex Frakt, one of the site owners, answers the question posed in the thread-starter in the post in which he announces the shutdown of the thread. He explains that the $7,000,000,000,000 that middle-class people were thinking could be used to finance their retirements only existed “on paper.” Frakt is of course correct. There was no conspiracy (as was suggested in some of the comments). No one took the money. It disappeared. It went “Poof!” But it didn’t have to go anywhere to disappear. It never existed in the first place except in a paper sense!
This is the risk of stock investing. It is the only substantial risk. When you own a share of a U.S. index fund, you own a share of an economy that has been reliably generating profits sufficient to provide 6.5 percent annual real returns for as far back as we have records (1870). What the heck could be risky about owning a share of that? The risky part is that from time to time large numbers of people come to believe that it is not necessary to take price into consideration when buying stocks. That removes all price discipline from the market. That causes price levels to rise so high that the inevitable return to fair value (stocks must in the long run be priced properly or the entire market would collapse — it is the purpose of a market to price the things being sold within it properly) crushes us. So long as most of us hold on to our common sense stocks are a wonderful asset class. They become dangerous only when large numbers of us come to believe that Buy-and-Hold (ignoring price when setting your stock allocation) can work.
Stock risk is concentrated. There are times (times of moderate valuations) when the risk of investing in stocks is minimal. And there are times when stocks are extremely risky.
This is very good news for investors. It means that we can obtain the wonderful returns associated with stock investing without having to take on the high levels of risk that most today believe apply for stocks at all times; all we need to do is to opt out of participation once out-of-control bull markets develop. But it is perceived as very bad news by most of those who have long advocated Buy-and-Hold. It means that they have been advocating the opposite of what works for many years now. The “experts” have been telling us to stick with the same stock allocation at all times when they should have been telling us to be certain never to give in to the emotional impulse that makes us want to deceive ourselves into thinking that that could work.
The confusion over whether the gains resulting from price increases greater than those justified by the economic realities are real or not has been with us since the first stock market opened for business. Because human investors possess the power to push stock prices up to whatever they want them to be in the short term, we have always found emotional appeal in “strategies” that assure us that those price increases represent something real. If only bull-market price increases were real, we could all vote ourselves raises simply by bidding stock prices up higher and higher. The problem with following the emotionally appealing approach to investing is of course that the economic realities always triumph in the end.
Frakt shut down the thread because he was concerned that, if the middle-class investors seeking to learn about investing by reading the www.Bogleheads.org board were to put two and two together, they would figure out that Buy-and-Hold can never work. Stocks sooner or later are going to be selling at wildly inflated prices and so those following a Buy-and-Hold strategy sooner or later are going to be going with wildly inappropriate stock allocations. That’s obviously not a smart strategy.
Buy-and-Hold Investing is Get Rich Quick Investing. It is the universal human desire for “money for nothing” that makes us want to believe that there might somewhere be an alternate universe where failing to take the price of stocks into consideration before buying them would work. It’s hard for us to believe that because we all possess a capacity for human reason as well as an inclination to let our emotions cancel it out. Every now and again, though, there comes along a new means of rationalizing the emotional approach. When a compelling one comes along (the idea that has been promoted in recent decades, that there is academic research that supports Buy-and-Hold, is the most compelling case for emotional investing ever and indeed it produced the most insane stock prices ever seen in U.S. history), we are on our way to an out-of-control bull market and the economic crisis that inevitably will follow.
D) The Conventional Investing Wisdom of Today Is Rooted in “Myth and Urban Legend”
Buy-and-Hold is the problem. Buy-and-Hold produced the bull market and the bull market caused the economic crisis. But Buy-and-Hold was endorsed by very smart people who are not in it for the money — this model is rooted in a wealth of academic research of high quality. If Buy-and-Hold Investing is emotional investing, how is it that people who engage in research for a living became convinced that it was the best and the most rational and the most scientific way to go?
Our knowledge of how investing works is today primitive. In earlier days most of us did not have enough money to need to worry about funding our retirement plans; we worked until we died or became so old and sick that we could not do so and had to rely on our families for support. So we didn’t concern ourselves much with learning the realities of stock investing. It is only from the 1960s forward that we have engaged in systematic efforts to rationalize the investing project. Buy-and-Hold is not a finished masterwork, the final summation of all that we have learned about investing from hundreds of years of study. It is a first-draft effort, helpful in important ways, a huge step forward from where we were before, but a gravely flawed model in need of correction as weaknesses are discovered and new insights taking us to better places are developed.
There are many elements of the Buy-and-Hold package of ideas that have stood the test of time. The idea that investors should be focused on the long-term is pure gold. The idea that short-term timing (changing your stock allocation with the expectation that you will see a benefit for doing so within a year or so) doesn’t work checks out. The idea that transaction costs should be limited makes all the sense in the world. The idea that stocks are generally the best asset class for the middle-class investor stands up to informed scrutiny. But the idea that investors do not need to change their stock allocations in response to big price changes is wrong (or at least so the academic research of the past 30 years indicates). And this error is so fundamental that it poisons all the rest. The idea of researching the historical stock-return data to learn what really works was a masterstroke. The idea of pretending that we learned so much in the beginning days of that effort that we never again would need to question ourselves or reconsider seemingly settled matters has revealed itself to be The Greatest Mistake in the History of Personal Finance.
The analytical error that caused the economic crisis goes by the name of “The Efficient Market Theory.” The idea that investors do not need to change their stock allocations when stocks become insanely overpriced is obviously a counter-intuitive one. How did so many smart and good people come to view Buy-and-Hold as a prudent way to invest? They fell in love with a theory that promised to rationalize stock investing for the first time in history. They fell sufficiently in love with the theory to be willing to abandon common sense in deference to it and to cling stubbornly to their belief in it even in the wake of a mountain of evidence showing them to be wrong to do so.
The Efficient Market Theory posits that the community of investors rationally considers all factors bearing on stock prices and thereby insures that the market price is never too far from fair value. If the Efficient Market Theory were valid, Buy-and-Hold really would work. If the market price is always roughly right, it is not possible to time the market, it is not possible to beat the market. If it is not possible to time the market (to know when stocks offer a good value proposition and when they do not), the only thing left to the investor trying to decide on a stock allocation is to consider the average long-term return and set his allocation accordingly. The average long-term return for U.S. stocks is 6.5 percent real. That beats the return offered by just about any other asset class. If the Efficient Market Theory were valid, investors would be doing the right thing in going with a high stock allocation and then just sticking with it.
The Efficient Market Theory has been entirely discredited since the days when it was employed as the foundation for the Buy-and-Hold approach and all the strategies that have been advocated under its name. Yale Professor Robert Shiller published research in 1981 showing that valuations affect long-term returns. If the market were efficient, overvaluation would be a nonsense concept (because the market price could never be far from fair value). Shiller’s research has been confirmed by a mountain of research published in the past 30 years.
It is of course common knowledge today among those who follow the academic literature that the Efficient Market Theory has been discredited and that Buy-and-Hold can never work:
1) “Myth and Urban Legend”
Rob Arnott, the former editor of the Financial Analysts Journal, has said that: “The conventional wisdom of modern investing is largely myth and urban legend.”
2) “Stocks Do Not Follow a Random Walk”
John Cochrane, a professor of Finance at the University of Chicago, said in the Wall Street Journal that: “30 years of research… [shows that] stocks do not follow a random walk.”
Famed Investor Warren Buffett has said: “There’s so much that’s false and nutty in modern investing practice.”
4) “It Is Therefore Possible…To Know Whether Markets Are Overvalued”
Andrew Smithers, co-author of Valuing Wall Street, wrote: “”When tested, however, the Efficient Market Theory failed, as real equity returns do not follow a “random walk with drift” but exhibit negative serial correlation. This meant that sustained periods of real returns, which were above the very long-term average, were followed by below average returns and vice versa…. It is therefore possible, contrary to the Efficient Market Theory, to know whether markets are overvalued.”
5) “A Debate Won by the Side Whose Theories Turned Out To Be Wrong”
Anatole Kaletsky wrote in The Times that: “In the search for the ‘guilty men’ responsible for the collapse of the global economy, one obvious group has escaped blame: the economists…. It may be true that all bankers are greedy, all politicians venal, all regulators blind and all accountants stupid. But such personal failings do not explain their behavior in the past few years. After all, bankers do not like losing power. All these ‘guilty men’ behaved as they did because they thought it made sense. And why did these greedy bankers and stupid politicians hold beliefs that, in hindsight, seem so ludicrous and self-destructive?…. What the ‘madmen in authority’ were hearing this time was the echo of a debate that consumed academic economists in the 1960s and 1970s — a debate won by the side whose theories turned out to be wrong. This debate was about the ‘efficiency’ of markets and the ‘rationality’ of the investors, consumers and businesses who inhabit them…. So economics is on the brink of a paradigm shift. We are where astronomy was when Copernicus realized that the Earth revolves around the Sun. The academic economics of the past 20 years is comparable to pre-Copernican astronomy, with its mysterious heavenly cogs, epicycles and wheels within wheels or maybe even astrology, with its faith in star signs.”
E) We Have Not Yet Come to Emotional Acceptance of What We Intellectually Know to Be So
We “know” that Buy-and-Hold doesn’t work. But we also “know” that it does. We “know” two opposite things.
If we really “knew” that Buy-and-Hold didn’t work, the sorts of comments quoted above would have been front-page news when they were made. Arnott is saying that the investment advice that millions of middle-class workers are using to finance their retirements is rooted in “myth and urban legend.” And the New York Times has a more important story to run at the top of the front page on the morning after he advances that assessment? Huh?
The right way to say it is that intellectually we know that Buy-and-Hold cannot work. Emotionally, we have not yet permitted ourselves to process that knowledge. Shiller’s finding is the most far-reaching and the most exciting finding in the history of investment research. Now that we know that the market is not efficient and that overvaluation is both possible and detectable, we know how to greatly diminish the risk of stock investing. Buy lots of stocks when the risk is minimal and avoid buying lots of stocks when the risk is sky-high and you are obviously going to be able to retire years sooner than the investor going with the same stock allocation at all times. The logic chain here is rock-solid. The subtitle of Shiller’s book — “The National Bestseller That Revolutionized the Way We Think About the Stock Market” — is not hyperbole.
There’s an obstacle that blocks the path forward. The leap forward represented by Shiller’s research is so big that we have as a society not yet been able to take it in. We are suffering the most widespread case of cognitive dissonance yet on record.
F) “Valuation-Informed Indexing Is Everywhere Superior to Buy-and-Hold Over 10-Year Periods”
I have been the lead figure bringing about a series of discussions that have been held at scores of internet discussion boards and blogs over the past eight years (the discussions are collectively referred to as “The Great Safe Withdrawal Rate Debate”). Set forth below is a sample of the comments made by the hundreds of people who appreciate the powerful investing insights (all rooted in Shiller’s revolutionary research) that we have developed during these discussions:
1) “The Evidence Is Pretty Incontrovertible”
Norbert Schlenkler, a financial planner and part owner of The Financial WebRing Forum, performed an analysis comparing Buy-and-Hold with Valuation-Informed Indexing (an investing strategy that combines Bogle’s indexing concept [perfect for the middle-class investor because of its simplicity] with Shiller’s valuation-matters finding [a required addition for those middle-class investors who do not want to suffer the fate that always awaits investors going with a purely emotional approach] — I argue that Bogle and Shiller go together like chocolate and peanut butter!) and concluded that: “The evidence is pretty incontrovertible. Valuation-Informed Indexing…is everywhere superior to Buy-and-Hold over 10-year periods.”
2) “Holy Toledo! This Is Great Stuff!”
Bill Schultheis, author of The New Coffeehouse Portfolio, exclaimed upon discovery of my web site: “Holy Toledo! This is great stuff!
3) “I Feel Like I’ve Found a Kindred Spirit”
Tom Behlmer, a Nevada City, CA financial planner wrote me that: “I have counseled my clients to allocate a percentage to equities based upon market valuations… I feel like I’ve found a kindred spirit. Fascinating web site.”
4) “It Is Consistent With Shiller’s Analysis and I Can See How It Could Be True”
Rajiv Sethie, a professor of economics at Columbia University, wrote at his blog that: “Rob Bennett makes the claim that market timing based on aggregate P/E ratios can be a far more effective strategy than passive investing over long horizons (ten years or more). I am not in a position to evaluate this claim empirically but it is consistent with Shiller’s analysis and I can see how it could be true.”
5) “What You Are Doing Has Huge Value”
Carl Richards, owner of Clearwater Asset Management, told me: “I have read everything I can about Valuation-Informed Indexing, and I agree with you that Buy-and-Hold Passive Investing is extremely problematic… I value and respect the passion, hard work and research that you have put into this very important issue…. I think what you are doing has huge value.”
G) “The Most Infamous Troll in the History of Investing Forums”
Not everyone applauds my efforts to share with my fellow middle-class investors what the academic research of the past 30 years says about how to invest effectively, however. Here are some comments made by a group that has insisted that the discussions be shut down on grounds that it would be “dangerous” for middle-class investors to learn that Buy-and-Hold can never work:
1) “You Want To Be Very, Very Wary of Anything Connected With Rob Bennett”
Alex Frakt, owner of the www.Bogleheads.org forum, warned those who visit his site that: “You want to be very, very wary of anything connected with Rob Bennett, the most infamous troll in the history of investing forums on the internet.”
2) “Distortions, Unsubstantiated Claims, Misquotes, and Comments Taken Out of Context”
Mel Lindauer, co-author of The Bogleheads Guide to Investing, announced at the Vanguard Diehards board that: “I’ve had my fill of those long-winded posts that include distortions, unsubstantiated claims, misquotes and comments taken out of context.”
3) “A Dedicated Team of Scholars and Researchers Collects and Analyzes Bennett’s Lies and Misstatements”
John Greaney, author of the retirement study offered at the www.RetireEarlyHomePage.com site, stated: “Rob Bennett has posted…on about a half-dozen internet discussion groups devoted to the subject of early retirement over the past five or six years. He’s been banned from most of them for posting in a demonstrably false and misleading manner. Indeed one of the most popular forums hosts a “Best of Hocomania” board where a dedicated team of scholars and researchers collects and analyzes Bennett’s lies and misstatements and sets the record straight.”
4) “He Irritates Me to No End!”
A poster at the Financial WebRing Forum offered the observation that: “What I don’t understand is how Rob can correspond in such a sweet and polite way — Yet he irritates me to no end!”
5) “The Best Thing for the Get Rich Slowly Forum At This Point Is To Simply Ignore Rob Bennett”
J.D. Roth, owner of the Get Rich Slowly forum, had his site moderators send e-mails to all community members who participated in a thread that I started entitled “The Future of Investing.” The e-mails asked the community members not to put forward further posts to that thread. It explained: “The best thing for the Get Rich Slowly Forums at this point is to simply ignore Rob Bennett. Moderators will spread the word through Private Messages, and hopefully he will just quit posting if nobody responds to his posts. Your cooperation in this effort would be much appreciated.”
Yowsa! There are differences of opinion and then there are differences of opinion. The differences being expressed here are not the sorts of differences you see when two groups of people favor different interpretations of factual realities that they all at least generally accept as the factual realities or when two groups of people adopt different perspectives on a question because they come to it from different sets of life experiences. The two groups here are speaking different languages. They are responding to entirely different perceived realities. The differences we see in these two sets of comments are so big that we must conclude that they are emotional, not intellectual, in nature. Those in the second group show with their choice of words that they feel threatened by arguments that Buy-and-Hold has failed. With them, claims that investors must change their stock allocations in response to big price swings elicit personal animus. The voicing of the claim that Buy-and-Hold has failed provokes in them not civil and reasoned and warm and friendly disagreement but overt and persistent and intense and sub-human hostility.
H) “They Feel a Threat to Their Perceived Elite Status”
A number of community members have attempted explanations of this perplexing state of affairs:
1) “Some on This Board Feel Threatened By the Arrival of Rob and His Ideas”
A poster at the Motley Fool board observed: “It seems to me that some on this board feel threatened by the arrival of Rob and his ideas. They feel a threat to their perceived elite status.”
2) “If Rob Improves on the Safe Withdrawal Rate Methodology…You Are All, Metaphorically, Out of Business”
A poster at the Vanguard Diehards board noted that: “It is obvious that Rob, in attempting to identify new safe withdrawal rate strategies…is going your ox. If Rob improves on the safe withdrawal rate methodology [used in retirement studies], the implication is clear; you are all, metaphorically, out of business.”
3) “You’re Sitting on a Winning Lottery Ticket… I’d Do Anything to Have What You’ve Got”
Norbert Schlenkler, a financial planner and part owner of the Financial WebRing Forum, told me that: “You’re sitting on a winning lottery ticket… I’d do anything to have what you’ve got.” Yet he approved of the ban on posting re the flaws of the Buy-and-Hold model that was adopted at the site he owns. If he agrees that the ideas are breakthrough ideas, why would he not want his community to learn about them? These are not breakthrough ideas that Norbert Schlenkler developed or that Norbert Schlenkler has long advocated. Norbert Schlenkler has advocated the opposite approach for years. Norbert Schlenkler wants me to enjoy my “winning lottery ticket” but somewhere where his readers will not find out about it.
4) “It Doesn’t Even Look Like Rob is Running an Underhanded Smear Campaign Against Mel, Taylor, and the Other So-Called Big Shots, Right?”
A Vanguard Diehards poster asserted that: “Reading so many Rob-riddled threads is like being cyberstalked by a cult leader on a perpetual mission to recruit his following…. At this point it doesn’t even look like Rob is running an underhanded smear campaign against Mel, Taylor, and the other so-called big shots, right?” The objection here is that letting middle-class investors learn the realities of stock investing will diminish the influence of those who have long advocated Buy-and-Hold. The references are to Mel Lindauer and Taylor Larimore, co-authors of The Bogleheads Guide to Investing. Lindauer and Larimore regularly promote Buy-and-Hold Investing in their comments at the board.
5) “You Go About It In a Way That Is Catastrophically Unproductive By Adding Missionary Zeal That Inflates Your Importance and Demeans Others.”
Dallas Morning News Columnist Scott Burns wrote a column at my urging about our safe withdrawal rate findings, saying that “a newer school of thought believes that the safe withdrawal rate depends on how stocks are priced at the time you begin making withdrawals.” But he failed to link to the calculator at my site that gives the accurate numbers! And he continued citing the discredited studies in subsequent columns! When I pressed him on these strange doings, he complained that: “You go about it in a way that is catastrophically unproductive by adding missionary zeal that inflates your importance and demeans others. The whole idea that there is a New School of safe withdrawal rates [the “New School” terminology was taken from Burns’ column!] reeks of personal aggrandizement.” I think it would be fair to say that Burns’ take is that it is fine to provide accurate numbers so long as no suggestion is made that the studies containing inaccurate numbers (studies that Burns has been citing at his column for years) need to be corrected. To point out that the old studies get the numbers wrong and that studies that get the numbers right are superior is an act of “self-aggrandizement,” in Burns’ assessment.
Nicolo Machiavelli, author of The Prince, has never posted at our boards or blogs. But he understood well the aspects of human nature that are responsible for today’s economic crisis. He observed that: “It must be remembered that there is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than a new system. For the initiator has the enmity of all who would profit by the preservation of the old institution and merely lukewarm defenders in those who gain by the new ones.” The Shiller Revolution threatens those who made their fame or fortune advancing the Bogle Revolution.
I) What If Everything You Thought You Knew About Stock Investing Turned Out to Be Wrong?
The error responsible for the Buy-and-Hold concept (that the market always prices stocks properly) was not a small error. The mistake is so fundamental that acknowledging it throws into doubt every strategic recommendation made under the Buy-and-Hold Model. If Shiller is right and Bogle is wrong, most of the retirement planning advice we have been hearing for 30 years is misguided. If valuations affect long-term returns, most of the asset allocation advice we have been hearing for three decades is dangerous. If a belief in the Efficient Market Theory set the first effort at making stock investing knowledge scientific on the wrong track, most of what we have come to believe about risk tolerance and risk premiums and risk management is gibberish. What if everything you thought you knew about stock investing turned out to be wrong?
Discovering that we have gotten the ABCs of stock investing all wrong is not a bad thing. It is a wonderful thing. If you think about it, all advances in human knowledge begin with an acceptance that we don’t know it all yet; when we start thinking that we do, we close our minds to new ideas. Our finding in May 2002 that Buy-and-Hold is the investing model of the past and that Rational Investing (the premise of the Rational Investing Model is that investors must consider price when buying stocks) is the investing model of the future has led those of us in the Retire Early and Indexing discussion-board communities seeking to advance our understanding of how investing works to develop many exciting tentative insights in the first eight years of our discussions. We have learned that:
1) Timing Works
Timing works. It always works. Timing is in fact required for those seeking to have a realistic hope of long-term success. The confusion on this point stems from a failure on the part of those who developed the Buy-and-Hold Model to distinguish short-term timing and long-term timing. The historical stock-return data does indeed indicate that short-term timing (changing your stock allocation with the expectation of seeing a benefit for doing so within a year or so) never works. What the Buy-and-Hold advocates missed is that the same historical data that shows that short-term timing never works also shows that long-term timing (changing your stock allocation in response to big price changes with the understanding that you may not see a benefit for doing so for five or even ten years) always works. That’s exciting stuff because timing the market effectively permits investors to obtain far higher returns at greatly reduced risk. Investor heaven!
2) The Safe Withdrawal Rate Is Not a Constant Number
The safe withdrawal rate (the percentage that retirees may remove from their portfolios each year with virtual certainty that their plans will survive 30 years) is not a constant number but a number that varies with changes in valuations. The Buy-and-Hold retirement studies report that this number is always 4 percent. The new research shows that, at times of low valuations, it can rise to as high as 9 percent and, at times of high valuations, it can drop to as low as 2 percent. The implications are far-reaching. The bad news is that the millions of today’s retirees who relied on the old studies to plan their retirements are likely going to experience horrible life setbacks in days to come. The good news is that our ability to identify the tradeoffs that come into play in building successful retirement plans is now greatly enhanced from what it is was just a few years ago.
3) Stocks Are Safe for Retirees
There is no need for investors close to retirement or in retirement to pass up the benefits of stocks so long as valuations are not out of hand. Buy-and-Holders typically tell those near retirement to move to safer asset classes. But stocks are not risky so long as they are selling at reasonable prices, according to the post-Buy-and-Hold research. What we should be telling retirees to avoid is Buy-and-Hold Investing, the approach that posits that there is no need to look at valuations when setting one’s stock allocations. All investors (not only retirees) need to lower their stock allocations when prices get out of hand.
4) Valuation-Informed Investors Can Retire Five Years Sooner
Investors willing to take valuations into consideration can expect to be able to retire roughly five years sooner as a result of doing so. Valuation-Informed Indexing beats rebalancing in nine out of ten of the return sequences that conform to the patterns we have seen throughout the historical record. Valuation-Informed Indexers often do not go ahead quickly, but they almost always end up ahead in the long run. Once they go ahead, the magic of compounding returns kicks in to make the edge they enjoy over Buy-and-Holders grow larger and larger over the years.
5) Young Investors Need to Avoid Stocks When Prices Are Insanely High
It is not necessarily a good idea for young investors to invest heavily in stocks. Buy-and-Holders argue that young investors can afford the risk of stocks because they have time to recover from price crashes. No! Investors who endure price crashes lose the benefit of compounding returns on the amounts lost and this loss is greater for young investors than it is for any others (because young investors have more time ahead of them in which the compounding returns phenomenon can work its magic). Young investors should be avoiding stocks at times when they are priced to crash.
It is to every investor’s benefit to learn the realities of stock investing. It is to the economy’s benefit as well. When millions of investors follow discredited and dangerous strategies, trillions of dollars of capital are misallocated; money is taken from economic sectors where it would do the most good and placed in economic sectors where it does less good (for example, the sellers of luxury goods were put at a competitive advantage over companies that sold reasonably priced goods during the years in which millions of middle-class investors were persuaded to take the big numbers on the bottom line of the last page of their portfolio statements as accurate indicators of their accumulated wealth). Permitting investors to learn the new realities is a rare win/win/win for our free market economy and even for our political system (which has been placed under stress as we have begun paying the price for permitting the bull market of the late 1990s) with no possible downside.
J) Bogle Has Been Unresponsive
Unfortunately, it does not follow that the many institutions that have advocated Buy-and-Hold for many years now perceive it as a good thing for middle-class investors to learn what they very much need to learn. Buy-and-Hold was developed by smart people who are not accustomed to acknowledging that they have miscalculated important numbers. Many are of the “INTJ” personality type under the Myers-Briggs personality assessment system — this is the “Mastermind” personality type, a type that possesses impressive analytical powers combined with an incapacity to admit mistakes or to appreciate the human misery caused by its mistakes. I have found a strong interest among middle-class investors in learning the realities at just about every board and blog at which I have posted. I have also been met with brutally abusive posting (including threats of physical violence) by individuals who feel that they have a vested interest in blocking investors from learning the realities. Those who want to learn appear to greatly outnumber those who want to block the learning experience. But those who want to block the learning experience are 50 times more intense and determined. Those who want to block the learning experience have long since given up trying to offer an intellectual defense of Buy-and-Hold. Yet they have “won” battle after battle through the use of trash posting tactics.
Most site owners have been unwilling to honor their promises to protect those of us using their boards and blogs for the purposes for which they were created from those with destructive intent posting in “defense” of Buy-and-Hold.
1) Motley Fool Says That Permitting Honest Posting Would Be “Ideal”
I built the Motley Fool board on early retirement into the most successful board in the site’s history. It was burned to the ground in the space of about a year by John Greaney, the author of one of the discredited retirement studies and by posters putting up abusive posts in “support” of Greaney. When I asked the site administrator for help, I was told that it was Motley Fool’s view that “it would be ideal” if Greaney would permit honest posting on retirement planning at its retirement planning board.
2) Morningstar.com Bans Popular Posters If Mel Lindauer Demands It
The Vanguard Diehards board at www.Morningstar.com was a few years ago the most popular investing board on the internet. Surveys were taken on several occasions to identify the most popular posters and several posters who posted regularly on what the academic research has taught us in recent years about the effect of valuations on long-term returns ranked near the top in the community’s estimation. These posters have since been banned from further participation both at the Vanguard Diehards board and at the forum at www. Bogleheads.org, which was formed when the “leaders” of the Vanguard Diehards board became enraged that the www.Morningstar.com site administrators would not obey their demands that I be banned (Morningstar did ban me after the Vanguard Diehards board was destroyed). Numerous efforts by many different parties to have the Vanguard Diehards board and the www.Boglelead.org forum opened to honest posting on valuations and on the flaws in the Buy-and-Hold Model have been unsuccessful.
3) Bogle Acknowledges That Valuation-Informed Indexing Can Work
Vanguard Founder John Bogle said in an interview in the Summer of 2009 that he believes that Valuation-Informed Indexing can work. I saw this as a potential breakthrough. It obviously is absurd that there is a ban on posting on Valuation-Informed Indexing on grounds that it is “dangerous” at boards named after Bogle and his company given that Bogle himself acknowledges that the strategy makes sense. But Bogle was unresponsive to my e-mailed plea for help in my effort to open the indexing communities meeting at www.Morningstar.com and at www.Bogleheads.com to honest posting on the new strategy and on the flaws in the Buy-and-Hold Model.
4) Personal Finance Bloggers Live in Fear of the Lindauer and Greaney Goons
Greaney has formed a discussion board at which Buy-and-Hold “defenders” meet each day to develop strategies for attacking boards and blogs at which community members post honestly about the errors in the Old School retirement studies or about the flaws in the Buy-and-Hold Model. I have had several blog owners reject Guest Blog Entries or shut down discussions in which community members demonstrated interest on grounds that they are afraid of what will be done to their sites if they “cross” the Lindauer and Greaney Goons. I posted a thread at the Money Blog Network, a forum for blog owners, asking for help with the problem. The thread was deleted by one of the owners.
5) Money Magazine Endorsed the www.Bogleheads.org Forum Without Letting Its Readers Know of the Ban on Honest Posting on the Flaws of Buy-and-Hold That Applies There
Numerous personal finance blogs have banned honest posting on these questions. This group includes: (1) the Monevator blog; (2) the Oblivious Investor blog; (3) the Free Money Finance blog; (4) the Behavior Gap blog; and (5) the Four Pillars blog. As noted above, J.D. Roth, the owner of the Get Rich Slowly blog (possibly the most popular personal finance blog on the internet today) has gotten personally involved in efforts to discourage posting about the Big Fail of Buy-and-Hold at his blog and forum. Many other blog owners have expressed a great reluctance to tolerate posting on the issues discussed in this Knol. Not one blog has reported on the abusive posting problem and about what it says about Buy-and-Hold that big names associated with Buy-and-Hold (including John Bogle himself!) have permitted such tactics to continue for years at boards at which they participate. An e-mail that I wrote to an editor at Money magazine describing the history of the www.Bogleheads.org forum when the magazine endorsed it as “the best on the internet” was ignored.
K) We Are All Ashamed of Our Complicity in Permitting the Bull Market to Get Out of Control
We know on some level of consciousness that Buy-and-Hold caused the bull market and that the bull market caused the economic crisis. But we don’t talk about it. It pains us to do so. We are ashamed of the role that we played in causing the problem.
The Stock-Selling Industry (which profited to the tune of hundreds of millions of dollars during the Buy-and-Hold Era) played the dominant role in blocking the spread of information about the new investing realities. But where were the newspapers while this conspiracy of silence was being perpetrated? Where were the economists? Where were the politicians? Where were the ordinary investors, who despite their lack of familiarity with the academic research certainly should have had doubts about Buy-and-Hold from a commonsense standpoint and who should have come forward with some hard questions when it was being promoted so heavily?
We were compromised. We were all on it. We didn’t object to being kept in the dark because we liked the idea of being kept in the dark. Buy-and-Hold has remained popular for a long time for the same reason Bernie Madoff’s fund remained popular for a long time — it appeals to the Get Rich Quick impulse within all of us.
Madoff engaged in deliberate fraud. Bogle made a mistake also made by lots of other smart and good people. That’s obviously a distinction of great significance. Still, does Bogle (and all the others who continue to this day to promote Buy-and-Hold without even making their clients or readers or listeners aware that there is another side to the story) not owe some responsibility to those who turn to him for realistic, accurate, prudent, research-supported investment advice? The disquieting truth is that Bogle’s unwillingness to acknowledge his error (or even to acknowledge that he is capable of error — even that much would be enough to open the boards with his name or his company’s name on them to honest posting) has done greater financial harm than Madoff’s deliberate fraud. More people trust Bogle, largely because he is perceived as promoting an investing strategy in accord with the academic research. The painful reality is that Bogle’s stubborn and prideful unwillingness to admit a mistake has caused financial losses that make the losses suffered by Madoff investors appear as a drop of water in the Atlantic ocean in comparison.
I know from long experience that there will be many people reading these words who will react with shock and disapproval to my statements about Bogle, a much beloved figure. There was a day when I would have reacted that way myself. That was eight years ago, or perhaps even four years ago or to a lesser extent even two years ago. Not today. Today I have eight years of experience under my belt of seeing what harm can be done to a wonderful man’s reputation when his “friends” become so awed by him that they hold back from taking him aside and explaining to him the facts of life in response to a decision on his part to engage in behavior that I think can fairly be described as reckless in the extreme.
I love John Bogle. Valuation-Informed Indexing obviously would not exist but for the work Bogle did developing and promoting the first approach to investing simple enough for use by the typical middle-class investor. The work that I have done in this field began with a reading of Bogle’s book Common Sense on Mutual Funds. It was from Bogle that Rob Bennett learned about Reversion to the Mean. Thanks, man!
When you love someone, you respect that someone. Those who cannot bring themselves to ask Bogle to knock off the funny business show a disrespect for the man and for the important work he has done by doing so. Implicit in the failure to act is a suggestion that perhaps Bogle is so caught up in the fame and the money that he is beyond caring about the human misery that Buy-and-Hold has brought to millions. The reason why I press the point that Bogle (and all other Buy-and-Hold advocates, to be sure — I focus on Bogle only because his name is the one most think of as most closely associated with the Buy-and-Hold concept) needs to come clean about his responsibility for the pain caused by The Greatest Mistake Ever Made in the History of Personal Finance is that I don’t believe for two seconds that that’s the case. Bogle did not start out with an intent to destroy the U.S. economic and political systems. He started out with a desire to help middle-class investors tap into the wealth that comes with learning how to invest in stocks effectively. Bogle is a wonderful man who has made wonderful contributions and it is those contributions that I and all his true friends want him to be known for for many, many years to come.
That’s true for all the others, of course. It’s true for Scott Burns and William Bernstein and Jonathan Clements and Larry Swedroe and Mel Lindauer and John Greaney and the people at Morningstar.com and the people at Fool.com and the people at www.IndexUniverse.com and J.D. Roth and Mike Piper (the owner of the Oblivious Investor blog) and the owner of the Monevator blog and all the others. We’re all humans. We’re all doing the best that we can. We all want to know how to invest effectively. We all make mistakes from time to time. We all made one doozy of a mistake when we bought into the Buy-and-Hold “idea.” We all need to find our way back to where we once belonged.
We cannot acknowledge the true cause of the economic crisis because the shame we feel when we consider doing so is so intense that we cannot bear to open the door. We think of the human suffering that we caused ourselves and others and we think of the insights that we might have developed had we not chosen the path of pigheadedness and we freeze up. The blindness of cognitive dissonance kicks in. We ban discussion of the realities that we need to learn to get out of the giant mess we have created for ourselves.
It’s all a terrible mistake. As with Watergate, it’s not the initial mistake that is the real problem but the long and involved coverup. We need to take it the other way. Once we admit the mistake, it can no longer have power over us. Saying the horrible truth out loud frees us to follow the better path, the path that we can use to recover the losses we suffered on the bad path and then some. Humans are goof-ups. We also are heroes. We are transformed from one into the other when the pain caused by the goofiness becomes so intense that we feel no choice but to let it go and move to the better path.
We need to hurt. We need to hurt enough to want to change. That’s why God (or Evolution, if you prefer!) created economic crises in the first place. We need to feel this pain so that we can move forward together, rebuilding rather than covering up. We will never be comfortable with ourselves again for so long as we remain in cover-up mode. It is a degrading mode for the humans. It is beneath us.
The road out is through a combination of honestly and charity. I am the world’s expert on the emotional aspects of this economic crisis (I didn’t apply for the position! I was volunteered!), so you can take my word for it re this one. A combination of honesty and charity is what will get the job done. I’m sure of it!
We need to open the internet to honest posting on the flaws of the Buy-and-Hold Model. It is by talking these things over that we begin the healing process. The price we end up paying for our goofiness can get bigger. In the event that stocks perform in the next few years somewhat along the lines of how they have performed in the wake of all of our earlier experiences with emotional investing, we will be seeing another price drop of 60 percent in coming years (these words were written in March 2010). A price drop of that size on top of those we have already experienced could bring on the Second Great Depression. The further loss in confidence in our political leaders could cause the collapse of our government and the end of a way of life that has brought us all great personal fulfillment for many years now.
Or we could take it the other way. We could say The Three Magic Words (“I” and “Was” and “Wrong”) and thereby open the door to learning what we need to know to usher in The Golden Age of Middle-Class Investing. Have you ever been in an argument with a loved one in which things appeared to be careening out of control until it hit you that you love that goof-up on the other side of the table and you said that out loud even though you knew it was entirely against the rules and it all got a lot better real fast? That’s where we stand today. We have almost killed ourselves by coming to believe that we had it all figured out when that wasn’t the truth. And we are this close to saving ourselves by putting what we really did get right to work for constructive and positive and life-affirming purposes by taking the simple (but difficult!) act of working up the courage to give voice to the three hardest words to pronounce in the entire English language.
L) Political Bloggers Can Turn This Around
The internet is the place where this national learning experience should be taking place. We should be working every day to inform our fellow middle-class investors of the realities of stock investing and thereby working to rebuild our economic and political systems. But for that important work to begin, we must first demand recognition of our right to hold the conversations that we need to engage in at all of the boards and blogs that were set up just for that purpose but that have been denied us for eight years now by those trying to maintain public confidence in Buy-and-Hold for just a little while longer.
I ask the help of political bloggers from both the right and the left sides of the political spectrum to publicize this matter and thereby to loosen the grip of the Buy-and-Hold dogmatics on the personal finance boards and blogs. If you are one of the bloggers whom I have contacted by e-mail, I ask that you do what you can to get answers to the many troubling questions raised in the words above. If you are not a blogger but might be able to get involved in another way, I invite you to contact me with any questions that you have regarding help that you might be able to offer.
This economic crisis is not something that was done to us. It is something that we caused by giving in to that dark voice within us all that says that this time it is going to be different, that this will be the first time in history when investing in stocks without regard to price will work out. We all know in a foggy way what caused the economic crisis. We focus on other causes because we don’t want to acknowledge what we all in our hearts know in at least some vague sense to be the reality.
It’s a big black mountain standing in the way of our realization of our financial dreams. It’s when we collectively say The Three Magic Words that we find the way to the other side of the mountain and the real fireworks (the good kind!) begin!
There’s life after Buy-and-Hold!