I have two reactions to this observation.
One, there is a sense in which I agree. I said in one of my e-mails to Wade that my 10-year experience of trying to bring an end to the Campaign of Terror against our board and blog communities while developing the Valuation-Informed Indexing concept has seemed more amazing to me than the moon landing. Yes, the words we have seen appear before us when we have turned on our computers have been implausible. Yes, the words we have seen appear before us when we have turned on our computers have been strange and unsettling at times.
There’s another way to look at it, however.
The Wright Brothers once entertained an idea that man could fly. That was an implausible vision too. But we are all a lot better off as a result of the Wright Brothers’ unwillingness to give up on the vision because it was widely viewed as implausible.
The idea that the earth is round was once viewed as implausible.
The idea that the earth revolves around the sun rather than it being the other way around was once viewed as implausible.
The idea that rock and roll would turn out to anything more than a fad was once viewed as implausible. The company that had the rights to release the Beatles’ first three singles in the United States didn’t do so. Why bother? Four moptops couldn’t produce music that would last. What an implausible notion!
The greatest advances in human history begin as implausible ideas. The idea that Yale Economics Professor Robert Shiller’s finding that valuations affect long-term returns will stand up to scrutiny is today an implausible idea to Buy-and-Holders. I believe that in days to come it will be the Valuation-Informed Indexing Model that will be the dominant model and that it is the idea that there is no need for investors to change their stock allocations in response to big price swings that will be recognized as implausible.
Valuation-Informed Indexing is a huge change from Buy-and-Hold. The change is so dramatic that it shocks people. The idea that we all really can obtain far higher returns while taking on greatly reduced risk really does strike many good and smart people as implausible on first impression. So I think it might be helpful for me to go through the history of how the good and smart people who came up with the Buy-and-Hold Model made the mistake that caused today’s economic crisis and that transformed an investing strategy that was intended to be the first research-based strategy into the purest and most dangerous Get Rich Quick scheme ever concocted by the human mind.
The story has ten chapters.
The first chapter, the first thing you need to understand to make sense of why all the academic research supports Valuation-Informed Indexing while most of the experts in this field continue to maintain that Buy-and-Hold must work, that it just must, is that today’s understanding of how stock investing works is primitive.
We didn’t begin studying how stock investing works as an academic discipline until the 1960s. I doubt that there is one academic discipline in which the good and smart people who performed the research got everything right starting on the first day and never once had to acknowledge a mistake in order to free themselves to get back on the right track and move forward again. People mess up. People make mistakes. That’s the way it is. We should stop thinking that the study of stock investing is going to go down as the first exception to the rule.
We are in the process of learning how to crawl. We need to stop talking as if we know it all. We need to chill. We need to take humility pills. We need to make more of an effort to tone down the dogmatism, listen to the other guy to the best of our ability and try to learn.
They didn’t know it all in the 1960s and early 1970s, when they developed Buy-and-Hold. They were taking guesses as to how stock investing might work. They got lucky with a few guesses and hit it on the head. They got unlucky on one big guess and caused an economic crisis some 40 years later. Oopsi! It happens. The Big Shots in this field need to take their Big Egos out for a walk and come to accept that they are humans too. They are capable of goofing up and that’s what they did. It would be no biggie if it weren’t for the 10-year cover-up.
Chapter Two of the story of how we got to the implausible place where we are today is that indexing didn’t exist at the time Buy-and-Hold was being developed.
Buy-and-Hold was developed in the late 1960s and early 1970s. John Bogle launched the Vanguard Group in 1976.
Valuation-Informed Indexing is a practical impossibility in the absence of index funds. We know today that Valuation-Informed Indexing always beats Buy-and-Hold by a very large margin in the long run. But there was zero chance that the people who developed the Buy-and-Hold Model were going to discover that given that the investing vehicle that makes this wonderful advance possible did not even exist at the time. Oh, those horrible Buy-and-Hold creators! Why didn’t they get into their time machine, travel to 1976, and come back and tell the researchers of that day about the wonders of Valuation-Informed Indexing? Bad Buy-and-Hold creators! Bad, bad, bad!
The people who developed Buy-and-Hold didn’t know what they were doing (because knowledge in this field is primitive) and didn’t have available to them the investment vehicle needed to make effective long-term stock investing possible. We’ve already explained why they messed up! But let’s go on. What’s Chapter Three?
Chapter Three is that they got excited about a very powerful insight that they were capable of discovering despite all the limitations that held them back. The Buy-and-Holders discovered that short-term timing never works. That’s only the second most important discovery in the history of investing analysis. Can we begin to develop some understanding of why they made that finding the core principle of the model they were creating? Short-term timing really doesn’t work. The only mistake they made was in improperly writing up the finding that “short-term timing doesn’t work,” which is what the research really showed, as “timing doesn’t work,” something very, very different. They didn’t know it was different because long-term timing wasn’t possible at the time because long-term timing only works with index funds and index funds were not then available. That’s the mistake. That’s what all the noise is about.
Okay then. They made this terrible mistake, which can only be seen as terrible today, 40 years later, because it was a practical impossibility to get it all correct at that time in any event. What comes next?
What comes next is Chapter Four. Chapter Four is Shiller’s research showing that valuations affect long-term returns. Published in 1981. Not available to people creating the Buy-and-Hold Model in the late 1960s and early 1970s. Are you beginning to get the picture?
Chapter Five is the revolutionary nature of Shiller’s work. In an ideal world, Shiller would have published his research in 1981 and all the Buy-and-Holders would have smacked their foreheads with their palms and declared “Oh, now I get it! Short-term timing never works, but long-term timing ALWAYS works and is in fact required for investors who seek to have any realistic chance of long-term success. Buy-and-Hold isn’t the answer! Buy-and-Hold is a Get Rich Quick scheme. Buy-and-Hold undermines price discipline, rendering the market dysfunctional. So THAT”S why each of the four times in U.S. history when Buy-and-Hold strategies became popular we saw the portfolios of all those who followed the strategy wiped out and an economic crisis to boot! What a mistake we almost made! It’s not Buy-and-Hold we want to spend hundreds of millions of marketing dollars promoting, it’s Valuation-Informed Indexing! It’s lucky for us that that Shiller fellow is so on the ball.”
That’s the way it would have worked in an ideal world. We don’t live in an ideal world. In the world we live in, people fall in love with their theories and become reluctant to abandon them when new research comes in the door. That’s doubly the case when the new research doesn’t say that the original idea is a wee bit off but wildly off. People become defensive. People fall prey to cognitive dissonance. People tune out discussions of the new research People dig in their heels.
You have interacted with the humans from time to time. Surely you have seen this on display by the portion of the population that is not comprised of investing experts. Well, in Chapter Five of our story we learn that the same defense mechanisms that are available to all the humans who do not go to Investing School apply to those who go to Investing School as well.
In Chapter Six, we experience the biggest bull market in U.S. history. Guess what effect that has on the people who developed Buy-and-Hold and then told people they had found the answer to our investing woes?
They call John Bogle “Saint Jack.” That should give you an idea. People feel in love with Buy-and-Hold during the bull. It’s not that it outperformed Valuation-Informed Indexing. It didn’t, except from 1996 through 1999 (and Buy-and-Hold is now down for the entire time-period from 1982 through today). Valuation-Informed Indexing did not exist. So there was no reason for anyone to make comparisons. What people knew is that Buy-and-Hold worked just great. Those people who developed the Buy-and-Hold Model were geniuses! No mistake-makers in that group!
And so we turn to Chapter Seven. Shiller appears at a hearing of the Federal Reserve and reports that Buy-and-Hold is in the process of causing an economic crisis the likes of which we have never yet seen in the United States. This Buy-and-Hold idea that there is no need for investors to lower their stock allocations when prices rise to insanely dangerous levels isn’t working out so hot.
How many of the humans wanted to hear it? I did! I did! Greenspan, not so much. Bogle, not so much. Millions of middle-class investors who saw the nominal values of their retirement portfolios soar during the 1980s and 1990s, not so much.
So the mistake remained unfixed. So the mistake grew ever larger.
In Chapter Eight, Old Farmer Hocus enters the picture. I put a post to a Motley Fool discussion board noting humbly that, if this Shiller fellow knows what he is talking about, those crazy safe withdrawal rate studies are going to cause millions of failed retirements in days to come. The safe withdrawal rate isn’t 4 percent, as thousands of financial planners have been telling aspiring retirees every chance they get. It’s 1.6 percent! For a retiree with a $1 million portfolio, that’s the difference between taking out $40,000 every year to cover living expenses and taking out $16,000 each year to cover living expenses. A wee calculation error! We now get to see in dollars-and-cents terms what it means to look at research showing that short-term timing never works and mangle the message in millions of marketing brochures into “timing isn’t necessary” or even “timing doesn’t work.”
Chapter Nine is when our good friends in The Stock-Selling Industry elect not to fix the mistake but to cover it up, thereby leaving themselves subject to hundreds of billions of dollars in legal liabilities after stocks crash and then crash again (Shiller’s research tells us to expect prices to fall 65 percent from where they stand today). Lots of people ask me why people make such a fuss over correcting the discredited retirement studies. Why not just correct the darn things? That certainly is what they should do. But, if you know anything about the humans, you know that, once they have taken on hundreds of billions in legal liabilities, they become shy about acknowledging mistakes openly and frankly and clearly and cleanly. The studies need to be corrected. But the experts in this field have a very big personal financial incentive to pretend otherwise. It’s a big mess!
And it gets worse as time goes on. It’s one thing to cover up errors in retirement studies for a month. It’s something else to cover them up for a year. It’s really, really something else to cover them up for five years! It’s really, really, really, really something else to cover them up for ten years! Oh, my!
Chapter Ten is Wade’s chapter. He came into our story seeing that the 140 years of historical data really did say everything I have been telling people it says for ten years now. He’s a smart guy and a fine researcher. Why not write some studies up telling the people how retirement planning and stock investing really work? What harm could come of it?
The Buy-and-Hold Goons and their friends in the industry know what harm can come of it. That Wade Pfau fellow can ditch the Nobel-prize-worthy research anytime he pleases. And, if he knows what is good for his career in this field, he will please very soon.
Is the story plausible or is the story implausible?
My take is that the the one-line summary of the story — Internet Goons Threaten Academic Researcher Who Publishes Research That Could Lead to Hundreds of Billions of Dollars in Legal Liabilities for InvestoWorld Big Shots — is implausible as all get-out.
None of the ten chapters taken by itself is all that hard to swallow, however.
Our society is in a big mess. Fix the mistakes and we are on the road to the biggest surge in economic growth we have ever seen. Fail to fix the mistakes and we are on the path to the Second Great Depression.
Fix the mistakes! Fix the mistakes!
But Wade tried. And he couldn’t take the abuse that was dished out to him.
Does any other bright boy or girl want to step up to the plate? Do we have any long-ball hitters sitting on the bench today?