Set forth below is the text of a comment that I recently put to another blog entry at this site:
If the US economy grows at 3% and the stock market returns 6.5% real (which is even higher in nominal terms), how do you explain this 3.5%+ gap?
Most people understand that this gap is the equity risk premium and is compensation for the increased risk of owning equities. If that risk goes away because everything is ‘perfectly valued’ as in your utopia, why would stocks maintain any kind of premium?
Shiller’s “revolutionary” findings do not change just our understanding of stock investing, Laugh. They change our understanding of Economics as well. That’s why the guy won the Nobel prize.
You are citing ideas that are part of the Efficient Market/Rational Man/Buy-and-Hold Model. Those ideas have been discredited. I pointed out above how the idea of a risk premium has been proven absurd. Stocks were the most risky they have ever been in U.S. history in 2000 and the risk premium at the time was a negative number. You have’t even TRIED to explain that one. That’s because it is 100 percent impossible to explain. Our old ideas re how economics (and stock investing) work are WRONG.
Many people in the economics profession see that as a bad thing. They have made a good living for themselves pushing all this discredited nonsense. So they fight people who present legitimate research or who explore the implications of legitimate research. I take it just the other way. I LOVE it that we have learned amazing things about economics and about stock investing in the past 30 years. These advances will make us all rich beyond our wildest dreams once we give ourselves permission to talk about them openly on the internet. I am the leading figure arguing for honest posting on safe withdrawal rates and LOTS OF OTHER CRITICALLY IMPORTANT INVESTMENT-RELATED TOPICS.
If you really want to know where the 6.5 percent real return comes from, do a Google search for Bogle speeches on that topic. He does a fine job of breaking it down. Bogle is honest in a good part of his writings. It was by reading one of Bogle’s books that I learned about the errors in the Old School safe withdrawal rate studies.
Where Bogle turns dishonest (whether intentionally or not) is when he says that a Buy-and-Hold strategy can work. The thing that distinguishes a research-based strategy from a Get Rich Quick strategy is the extent to which the investor is willing to change his stock allocation in response to price changes. Buy-and-Holders say that it is okay to not make any changes at all. That’s the farthest you can go in the direction of Get Rich Quick. Valuation-Informed Indexing is the farthest you can go in the direction of research-based. VII says that you should make whatever changes are required to keep your risk profile constant and not any more and not any less.
Buy-and-Holders and Valuation-Informed Indexers have no difference of opinion on where the 6.5 percent comes from. You can read Bogle’s speeches on that question and know that I am happy to sign on to what he says 100 percent.
We have a big difference of opinion of what the Buy-and-Holders call the risk premium. There is 140 years of historical return data showing that the risk premium (as the Buy-and-Holders imagine it) DOES NOT EXIST. Risk was the highest it has ever been in 2000 and return was the lowest it has ever been in 2000. Risk was virtually non-existent in 1982 and returns were off-the-charts high.
There IS a connection between risk and return. So the Buy-and-Holders were sort-of on the right track. The mistake they made was ignoring investor perceptions. Risk was sky high in 2000. But the PERCEPTION of risk was very, very low. Risk was virtually non-existent in 1982. But the PERCEPTION of risk was sky-high.
There is a perception-of-risk premium. But there is no true risk premium.
Why did the Buy-and-Holders get it so wildly wrong? As always, they ignored INVESTOR EMOTION. It is investor emotion that causes the perception of risk to be so wildly off from the actuality of risk.
What is the answer here?
PERMITTING HONEST POSTING.
The interests of the Wall Street Con Men are directly opposed to the interests of millions of middle-class investors. The Con Men LOVE, LOVE, LOVE Buy-and-Hold. Why wouldn’t they? It has made them millionaires.
But in the long run their relentless promotion of the purest and most dangerous Get Rich Quick scheme ever concocted by the human mind hurts them as much as it hurts all of the unfortunate people who listen to their advice thinking that perhaps they are telling the truth. When you rape the middle class, you cause an economic crisis. People cannot buy things when they have no money! When you have an economic crisis, you have a political crisis. When you have a political crisis, all the money you obtained by pushing Get Rich Quick strategies is not of much value because you have no stable political system in which to spend it. Get Rich Quick is bad news!
That’s my sincere take in any event, Laugh. I believe that we should be permitting honest posting on safe withdrawal rates and on many other critically important investment-related topics at every board and blog on the internet.
My best and warmest wishes to you and yours.