Set forth below is the text of a comment that I recently put to the Joe Taxpayer blog:
You get the numbers part of it perfectly.
But I feel a need to add a non-numbers reality that I believe explains the problem we are seeing with the signal-to-noise ratio.
Say that all scales and mirrors were removed from the world. And say that a law was passed saying that no one was permitted to tell someone else that he was putting on weight. And say that we all were forbidden from looking to see how much our bellies had come to stick out. Do you think that the average weight would increase over time or decrease over time?
It would increase. A LOT. We all love chocolate ice cream. We all struggle not to let our weight get too out of hand. But, to do that effectively, we need FEEDBACK. We need people telling us how we are doing and we need scales and we need our own eyes.
Buy-and-Hold took away our feedback!
Buy-and-Holders say it doesn’t matter. If you ask them whether valuations matter, they say “yes.” But they never say to do anything about it! That’s the practical equivalent of saying they don’t matter. They say one thing with words but their actions (staying at the same stock allocation at all price levels) send a very different message.
Say that you go from 160 pounds to 240 pounds because you are not receiving any feedback on your habit of indulging yourself with too much chocolate ice cream. How do you now feel when someone says: “You are really, really FAT, brother! You’re probably going to die soon because you are so fat.”
You don’t like it. Nobody likes to hear that kind of message.
We need to be reminded on a regular basis of the dangers of overvaluation so that things never get too far out of hand. It’s a terrible mistake to wait until stocks are priced at three times fair value because at that point people freak out when you give them an accurate report on what the numbers mean. What we need are tools that tell us — stocks just went up x and that means that your long-term return just went down y, so you need to reset your stock allocation so that it continues to make sense for someone with your particular risk tolerance.”
We didn’t do that when stock prices started rising. The primary reason is that we didn’t know enough to tell people what worked back in those days. Shiller didn’t come out with his research until 1981 and it really was revolutionary stuff. People are not able to absorb the significance of revolutionary stuff overnight. So it took some time before we were able to develop tools like The Stock-Return Predictor (a calculator at my site that applies a regression analysis to reveal to investors the most likely annualized 10-year return starting from any possible starting-point valuation level).
We NOW know what we need to know to inure that we never see another bull market. Which means that we will never see another bear market (every bear in history was caused by the runaway bull market that preceded it). Which means that we probably will never see another economic crisis (every economic crisis in U.S. history was caused by the loss of wealth we experienced in one of those bear markets that was caused by the bull market that preceded it).
We are in a very, very good place today. Intellectually.
We are not yet in such a good place emotionally. We need to break it to investors gently that we didn’t always know it all and as a result we made some mistakes and as a result they are in the process of suffering some very big losses. The future is bright. But for the good stuff to happen, we need to explain what works. And that requires acknowledging that we did not understand things perfectly back in the days when the Buy-and-Hold concept was getting off the ground.
The story here is a very positive one. But we cannot talk about the positive stuff until we explain why just about everything we have told people about how stock investing works for the past 30 years is wrong. People get angry with me when I spill the beans because it is upsetting to learn that you have been doing everything wrong for so many years. But how else do we get to the good place where we all deep in our hearts want to be?
If we cannot acknowledge that there was a time when we did not know it all, we have ruled out all learning experiences. Why do that? We are looking at the most wonderful learning experience in personal finance history.
The change is small in one sense. Everything stays the same except instead of ignoring valuations we make it Job #1 to ALWAYS, ALWAYS, ALWAYS pay attention to valuations when buying stocks. The payoff for making that change is so great that it is impossible to overstate it.
Think about the payoff that comes from paying attention to your weight. It’s huge, no? You live longer. You look better. You have a higher energy level. It’s good stuff piled on top of good stuff piled on top of good stuff.
Imagine that we once had research that seemed to show that the key to keeping your weight in line was always to eat six bowls of ice cream a night and that the people who gave that advice didn’t want to acknowledge the mistake once it was discovered. We would all die early deaths. For no good reason.
The Buy-and-Holders did not intend to cause this problem. We certainly should show them great respect and gratitude and affection for all of the many good things they did for us all. But we are not being kind to them to pretend that they didn’t make a mistake. Their intent was to help us. Instead, they caused the biggest economic crisis in U.S. history. We are making them feel worse about themselves by pretending that the mistake doesn’t need to be corrected.
We all want the same things. We all should be working together to learn the realities. We all should be grateful to those speaking from the other side because it is by being challenged re our current beliefs that we become capable of learning new stuff.
We need to inject the consideration of valuations into our consideration of every possible investing topic. Getting your stock allocation right is 80 percent of the game. If you get that part right, you can get everything else wrong and you will still probably do very well. If you get that one wrong, you can get everything else right and you will still probably do poorly. Valuations is pretty much everything you need to know to become a successful long-term investor. And, because of a mistake we collectively made 30-some years ago, we have as a society prohibited the intelligent discussion of the effect of valuations on investing decisions. This MUST change (in my view!).
The numbers stuff is important. But the non-numbers stuff is important too. Because all the investors are humans and humans are influenced by emotions as well as numbers. We have created circumstances that make it hard for people to hear this message. But we just have to do the best that we can do. We all lose from any further delay in getting the message out. Learning the realities causes some short-term pain. But the long-term benefits are so big that it is hardly even worth taking note of the short-term downside. After you get over that initial shock, it’s good stuff piled on top of good stuff piled on top of good stuff.
The purpose of my talk was to highlight the FUNNY side of this. My thought was that, if people could learn to laugh about this stuff, we could all come to see the wisdom of working together. A very smart and fun person that I met at the conference told me this morning that the people sitting around her said that I sounded “bitter.” That’s the OPPOSITE of how I was trying to sound . And I worked this one hard. Viewed objectively, those slides were lighthearted, not bitter. I am SURE.
People need to take the defensiveness down about seventeen-thousand notches. I mean, come on.