Yesterday’s blog entry reported on an e-mail that Academic Researcher Wade Pfau sent me on February 28, 2011. My two responses, sent on March 1, 2011, are set forth below.
I’ve said it before and I’ll say it again, my man. It’s the front page of the New York Times or bust for this important research.
You can say “it will never happen” just because it has never happened before. But I can assure you that on the morning of May 13, 2002, not one person (including me) who read my post asking questions about the safe withdrawal research of the time anticipated it leading (through an indirect and highly circuitous process) to a post of this nature nine years later.
But all of these issues are connected. You pull one thread and a lot of things begin unravelling. You are pulling at a lot of threads. I am confident that we are going to see enough unravelling to see this on the front page of the New York Times after some time passes and the speed of the unravelling continues to accelerate.
All big stories start with something small. It took years of investigations for the Watergate story to generate a “Nixon Resigns” headline. People make things happen by sticking their necks out and asking questions. The World Famous Portfolio Allocation Strategist Bruce Springsteen once observed: “From Small Things, Mama, Big Things One Day Come.”
I disagree with you about the “Dismal Science” comment. Economics has been a Dismal Science in the past because it has largely ignored the human aspect of the question. What we are learning is how terrible a mistake that is.
Buy-and-Hold is just Adam Smith economics (“the market is always right”) applied to investing. What we are seeing with today’s economic crisis is what follows when an excessively rationalistic economic theory is applied in the practical world. What follows is widespread human misery. When a new economics is developed that includes consideration of the human element, economists will be leading us to a new era of greater economic growth than we have ever seen before. No one will be calling them practitioners of a Dismal Science then.
Anyway, that was the single best post I have ever seen. And not by a little bit either. People will be thinking through the implications of that one for a long time.
Just don’t forget to consider taxes next time, you big dummy!
Your point about it being unfair to compare 100 percent stocks with 100/0 stocks (that the proper comparison is 100/0 with 50 percent stocks) is very important. I came to see the importance of this when doing runs with the Scenario Surfer and have struggled with finding a good way to get the point across. You did an amazing job with your use of the Sharpe ratio and the other statistical tools you cited.
The problem that I ran into with the Surfer is that I had two different goals: (1) to learn how to invest effectively; and (2) to demonstrate the benefits of long-term timing. When it comes to investing effectively, I would be disinclined to ever go with a stock allocation higher than 80 percent. The individual investor just cannot afford to have all his eggs in one basket. When it comes to showing that long-term timing works, it would be best to at times of very low prices to go with a
stock allocation of 100 percent or even SOMETHING WELL IN EXCESS OF THAT.
I am confident that, if you run tests on allocations of over 100 percent at times of low valuations, your showing that long-term timing works will be even stronger. My guess is that the optimal (according to the numbers) stock allocation is well in excess of 100 percent stocks at times of low valuations and is probably at least somewhat in excess of 100 percent stocks even at times of moderate valuations.
The reason why this is so is that long-term timers are not guessing. Valuations MUST revert to the mean or the market would collapse. So this is a sure thing (the amount of time that will pass before reversion to the mean takes place is of course NOT a sure thing). Since stocks pay such high returns at low valuations, an allocation in excess of 100 percent is locking in a big differential.
People have a hard time accepting this because it is irrational. There should not be such a big differential. What they are missing is that all overvaluation is irrational. There should not be any differential at all. But there is! And there always will be until the day arrives when we can all talk plainly about this topic and thereby as a society come to terms with it.
I don’t want to add to your projects list. You are making fantastic choices on your own. But someday in the future I would love to see a calculation of the optimal stock allocation at different price levels, with allocations of over 100 percent stocks among those considered as possibilities. That analysis is going to show a HUGE differential for VII. One of the reasons why the case has never been made strongly enough is that most of us shy away from even testing allocations in excess of 100 percent.
If I were creating the Surfer today, I would let people test allocations above 100 percent. I wouldn’t suggest anyone adopt such an allocation. But I think looking at what they have produced throughout history tells us something important about how stock investing really works. I see great theoretical value in showing this.