Set forth below is the text of a comment that I recently posted to the SiteSell.com discussion forum:
I’ll provide a concrete example of how I see this working, Eli.
I have a calculator at my site called “The Stock-Return Predictor.” It applies a regression analysis to the historical return data to identify the most likely 10-year annualized return for someone who purchases shares in a broad index fund at any specified price point. It reports that those who bought stocks in 2000 were likely to see an average annual return of a negative 1 percent real for 10 years running. Treasury Inflation-Adjusted Securities (TIPS) were at the time paying a return of 4 percent real.
Say that every personal finance blogger who was around at the time told investors to switch from stocks to TIPS. Those who did so would increase their return by 5 percentage point real. Not once. They would add 5 percentage points of return every year for 10 years running. By following the conventional Buy-and-Hold strategy, millions of us lost 50 percent of the portfolio value we held in 2000.
No. We actually lost more than that. Say that the loss for a particular investor was $300,000. And say that that investor was 50 years old and will continue investing until he dies at age 80. He didn’t just lose $300,000. He also lost 30 years of compounding returns on the $300,000. We all know from articles that we have read on saving that the compounding returns phenomenon is a phenomenon of great power. Losing 30 years of compounding on $300,000 is a big deal.
Now —
The personal finance magazines want to help their readers, right? Why the heck didn’t they tell them this? Shiller published his research in 1981.
They didn’t tell because the implication of the message is that the true value of the portfolios people were holding was only one-third of what people thought it was. Telling the truth about stock investing in 2000 was like reaching into that person’s pocket and pulling out hundreds of thousands of dollars. That wasn’t the intent of the person telling the truth. But that was the way the message was perceived by the person being told the realities.
Shiller published his research in 1981. Shortly thereafter, we entered a huge bull market that was not perceived to come to an end until September 2008. And stocks are still insanely overpriced today. So there has not yet been a good opportunity to share the wonderful news.
After the next crash, stocks will be priced at one-half fair value. At that time, telling people the truth will be perceived as ADDING money to their portfolios. We won’t be telling a guy with a $600,000 portfolio that it is really worth only $200,000. We will be telling a guy with a $100,000 portfolio that it is really worth $200,000. The latter message has MUCH more appeal.
People don’t want to ruin their lives by giving in to fear and greed. People understand why there is a need for price discipline. Most middle-class people practice price discipline to at least some extent in every other area of their lives. The problem is that we didn’t know how stock investing worked prior to 1981 and, since we learned, there has not been a good opportunity to get the message out. One more price crash will change that. And then I expect all sorts of wonderful things to happen.
People want to do the right thing. But they need encouragement. They need to have magazines reporting the realities and investing experts reporting the realities and academic researchers reporting the realities. When they hear lots of people encouraging them to avoid feed and greed and to practice price discipline, they will do it. Perhaps not all. But I believe that millions of people will do it once they begin hearing encouragment to do it. I have spoken with thousands of investors and this is the strong impression that I have picked up as a result.
We need to see it become a money-making thing. We need to see investing advisors build big reputations teaching the realities. And bloggers break out big-time by teaching the realities. And companies develop calculators teaching the realities. And on and on. As Ken mentioned, there is now a fund based on the CAPE/VII concept. Things are starting to turn. I believe that following the next crash (which is not too far away), things are going to turn hard in the right direction. The only thing keeping the conventional Buy-and-Hold strategy alive today is the inflated prices that remain in place as of today.
Rob
Anonymous says
After the Next Crash, Stocks Will Be Priced at One-Half Fair Value.
This would be the one that will take stock values to 60% lower than they were in 2013 within three years, as per your prediction then. That’s about an 85% drop from today. We’ll see how close you were. 16 months to go!
Rob says
You can do the math as well as I can, Anonymous. Shiller has the data at his web site. Just go check what P/E10 level applies before a secular bear market comes to an end. We have had four of them so far in U.S. history. If you do the check, you will see that in the first three cases the turnaround did not come until we saw a P/E10 of 8 or lower. Then you can do the math to see how large a drop that represents from where we stand today. We’re not looking at a pretty picture, that much is for sure.
It’s important that you understand what will cause the next price crash. It will NOT be a change in economic realities. That’s what it would be if Fama were right and if Buy-and-Hold worked, that’s what it would be if returns played out as a random walk not only in the short term but in the long term as well. No. It will be a change in investor EMOTION that will bring about the crash. Shiller showed that it is investor emotion that determines stock prices. Economic realities play a secondary role because economic factors influence investor emotions. But they often do not do so in a rational way. Our emotions make of economic realities what we will them to make of them.
So it won’t just be the value of your portfolio that will be crashing. Your belief that Buy-and-Hold can work will be crashing. And the belief of millions of others that Buy-and-Hold can work will be crashing. It is the belief that price doesn’t matter when buying stocks that caused the insane, out-of-control bull market. And it is the belief that price doesn’t matter when buying stocks that is behind your burning hatred of anyone who mentions what the last 33 years of peer-reviewed research tells us about how stock investing works on a discussion board or a blog.
So all the people who hold back from calling you out today will be angry with you for what you have done following the crash. That follows, does it not?
I wish you well, old friend.
Rob