Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
“When we get to the other side of the Big Black Mountain, we will never again need to worry about seeing our plans for the future disrupted by crazy swings in stock prices.”
Crazy swings in stock prices will always be with us. They are the reason that stocks provide great returns. If you somehow removed the risk inherent in stock ownership you would also remove the great returns. If a low risk/high return asset was available for purchase the the huge demand for such an asset would drive the price up lowering the return.
Your problem is that you want the great stock returns but are not willing to stomach the associated risk.
I do not agree that crazy price swings will always be with us, Evidence. And I do not agree that it is the crazy price swings that somehow cause the high returns associated with stocks.
I believe that stocks provide high returns because the underlying businesses are highly productive. In the United States, they have always been productive enough to support returns of 6.5 percent real per year. More than that is just emotional garbage. So I don’t trust returns of any more than that. But 6.5 percent annual returns are real and there is no need to take on foolish amounts of risk to obtain them. The underlying companies are going to be just as productive if I invest in a rational risk-reducing way as they are if I follow a Buy-and-Hold strategy.
I want the high returns for sure. And, no, I don’t like taking on risk. I would be willing to take on some added risk to obtain some added return. That part of what you say makes sense. But I don’t buy this idea that it is only by investing foolishly that I can obtain a good return. No. I like Bogle’s original idea of using the peer-reviewed research to guide one’s investing choices. That’s what makes sense to me.
The peer-reviewed research that I co-authored with Wade Pfau shows that investors can reduce the risk of stock investing by 70 percent just by being willing to leave the smelly Buy-and-Hold stuff in the rear-view mirror and so that’s what I do. I’ve been beating Buy-and-Hold on a risk-adjusted basis for 22 years running now and I have a funny feeling that I will be continuing to beat it for a long time to come.
But we’ll see, you know?
You’re not going to believe what I say just because I say it. Time is going to tell the tale. I go by what the research says. That tells us how stock investing has always worked IN THE PAST. In coming days, we will see whether the research is telling us something important or whether it is all going to turn out different this time. I think that the next crash will tell the story in a sufficiently compelling manner that even my good friend Jack Bogle will sign up with the good guys. And then where will you Goons be? I think that a good number of you Goons may come out in support of the idea of permitting honest posting re the last 37 years of peer-reviewed research in the days following the next crash. I will welcome the change. I will enjoy being able to talk things over with you in less friction-filled discussions.
I understand that you are going by one of the Buy-and-Hold dogmas when you say that stocks pay high returns only because of the risks associated with them. But I just don’t buy it. Shiller “revolutionized” (his word) the field with his Nobel-prize-winning research. So those old dogmas just don’t have the explanatory power that they once possessed, at least not for me.
Stocks have never in history been as risky as they were in January 2000, when the P/E10 level hit 44. They have provided an average annualized return of 3.3 percent real in the 18 years since. That’s far below the usual return of 6.5 percent real. It’s half of the normal return. For 18 years running. If investors are compensated for taking on extra risk, the return to stock investors should have been higher during those years, not lower.
The Buy-and-Hold dogmas don’t hold up to scrutiny. They possess a certain surface plausibility. But they just don’t stand up to scrutiny. When you test them with any sort of vigor, they always fail the test.
You believe in Buy-and-Hold because you want to believe in it, because you are emotionally invested in the concept, not because the ideas are strong enough to stand up to tough scrutiny. That’s why you get so angry when I challenge Buy-and-Hold in a forceful manner. You want to believe and I am making it harder for you to believe and so you strike out at me.
That’s my sincere take re these terribly important matters, in any event. I could be wrong. It has been known to happen.
Take good care, man.
Rob the Buy-and-Hold Challenger
Good Morning Robb
The Pe/10 at this point is 32 , 50% over fair value.Using Value Informed investing the most likely stock return is .13%. Going to cash in retirement I would feel more comfortable with only a 20% allocation to stocks. Problem is in today’s world Tips pay less than 1%, and CD’s pay approximately 2.2% -2.8% less taxes. So my effective return is zero , but is it fair to say zero is better than a 50% loss? To me yes zero is better than stocks because the extra risk is not worth a only .13 return . Does this make sense to you? I won’t be brainwashed by the buy and hold’s to not panic. I am not a pro just a middle class retired guy. But even I can see and be open minded that Buy and Hold doesn’t work. Thank you for the time you put into your blog…Max
It’s always nice to hear your voice, Max.
Your concern is one shared by millions. It is actually not too hard to find people worried about investing in stocks at today’s prices. The big issue that many people have with lowering their stock allocations is that the returns available from alternative asset classes are not big enough to help their portfolio ever grow to the size they need it to grow to to permit them to retire.
You are of course correct that a zero return is better than a 50 percent loss. The trouble of course is that no one knows when the 50 percent loss is coming. This is why I push so hard on the need to look at the historical return data. Buy-and-Holders make it seem like 50 percent losses just sort of pop up out of nowhere. No! Crashes that have lasting effect (those in which the losses remain in place for a significant length of time) only take place at times of super high prices (like today). And, once we get to super high prices, we always experience a crash sooner or later. There are no exceptions. We cannot identify the date when the crash is coming. But we know with certainty that it is coming sooner or later. So we need to make all of our investing decisions with that knowledge in mind.
I ordinarily say that investors should never let their stock allocations drop below 30 percent. That’s because you don’t want to experience too much regret if prices continue upward. If you have a 30 percent stock allocation, you are at least getting some of the temporary goodies and perhaps that will be enough to help you stay the course. You have a stronger appreciation of the importance of keeping valuations in mind that most. So it is my view that a 20 percent stock allocation is not crazy for you. However, it is my personal take that you should not go below that.
It is important that you understand that it is not that stocks are a dangerous asset class in general, only that stocks become a dangerous asset class when prices rise to insanely dangerous levels. If you start thinking that stocks are dangerous in general, you will feel confirmed in that belief when prices crash. Then you will be reluctant to invest in stocks even after prices drop. That will not work. You will not be able to accumulate the funds you need to retire without investing in stocks. Over the course of a lifetime, Valuation-Informed Indexers go with the same stock allocation as Buy-and-Holders, they just go heavier in stocks when prices are good and less heavy when prices are bad.
The exciting thing about being in CDs or IBonds today is that you are not earning only the return marked on the certificate or the bond. Your intent is only to own the asset with the low return for a few years. Then that money will be shifted into stocks paying a high expected return (the likely long-term return on stocks can rise to 15 percent real in the wake of a price crash). If you earn 1 percent for three years and then 15 percent for seven years, your 10-year return is not 1 percent, it is a lot higher than that. The purpose of being in CDs or IBonds today is to preserve the capital you will need to invest heavily in stocks when the long-term value proposition on stocks is strong.
Do you see how it helps to talk these things over? You are not the only person who has doubts about stocks at today’s prices. Millions of people do. But most of us are highly reluctant to act on those doubts until we first give voice to them and then hear feedback from others re our thoughts, in some cases positive feedback and in some cases negative feedback. We think by talking things over with our friends and neighbors and co-workers. Talking things over is an essential part of the intellectual process. We cannot think clearly without first gaining the freedom to talk things over in peace.
This is the real harm that has been done to us all by the relentless promotion of the Buy-and-Hold strategy. Buy-and-Holders have a hard time persuading themselves that valuations do not matter. It’s a position that just doesn’t make sense. They do believe in the strategy enough to follow it; they are not entirely lacking in belief. But they are very much lacking in confidence. They just cannot find peace following a strategy that requires them to ignore price. So, when they hear others talk about the consequences of ignoring price, they freak out. The result is that the Buy-and-Holders insist that everyone else keep quiet about their doubts re this “strategy.”
For Buy-and-Hold to survive, we all need to keep quiet about what our common sense tells us and about what the last 37 years of peer-reviewed research in this field tells us. And, when we keep quiet about what our minds tell us, we lose the ability to think clearly. Most of us end up going along with the crowd because to develop the strength to engage in independent thought we would need first to be able to talk things over with others and the Buy-and-Holders cannot permit that. What a predickelmint!
The Buy-and-Holders are not bad people. They came up with tons of good stuff. But, like all the humans, they just are not capable of knowing it all and never needing to ask others for help. Over time, they have developed a hyper-sensitivity to criticism that keeps them trapped in the stone age of investing analysis, the pre-1981 time-period. And, because they sense in a dim way that they are living in the stone age, they feel a need to stop all of those who are trying to learn how this stuff really works from having the discussions they need to have to engage in effective learning experiences.
Yes, that’s my favorite rant! I have put a lot of blood, sweat and tears into perfecting it over the years and I am sticking to it!
Take good care, old friend.
Rob
Robb,
Thank you very much for your reply ,it does make a lot of sense staying the course with small return vehicles until the stock market valuation is at a reasonable level. So that I can increase my stock levels as the valuation gets more reasonable. Off the subject I was thinking an all purpose total S&P 500 ETF might be best for the stock portion. What is your opinion of these “advisers” I see on some of the web sites like SA, claiming a 9% return with dividend stocks? I know you do not give stock advise but if you just have a personal opinion about this
Be well
Max
It’s not something that I know anything about, Max. Please understand that I am NOT an investment expert. I don’t claim to be one and I am not one. I am a journalist. I have the skills of a journalist. I happened to do some writing about investing and I saw a huge positive response to it and I also saw an intense negative response to it and I thought “this is amazing — what a story!” So I tried to figure it out. I wanted to be able to tell this super important story completely and fairly. So I worked it and worked it and worked it.
I have to talk about investing stuff because that is part of the story. So, for example, with safe withdrawal rates, I had to develop a calculator that gives accurate reports of the safe withdrawal rate so that I could tell people how far off the Buy-and-Hold retirement studies are. No one else has those numbers. So it makes it appear as if I am some sort of expert in that I am giving people important information that is not available elsewhere. But it is not my intent to create that impression. My intent is to report this important story accurately and completely and fairly. It would be fair to say that I have become an expert on the question of how emotions and valuations interact. I think it would be fair to say that I am the world expert re that one. But not by choice exactly. I did not set out to be an expert even in that area. I became one because I wanted to tell the story effectively and I had to settle certain questions to do so and that made me a bit of an expert in relative terms.
But I just do not make any effort to become knowledgeable re funds and that sort of thing. There are lots of people who do a better job of that sort of thing and I don’t see that there’s anything that I can add to the mix. So I just don’t go down that road. Vanguard has good index funds with low fees. That’s where I would look for a fund. I would look for a broad U.S. fund. Keep it simple.
I don’t know what the claims are re 9 percent returns. There is certainly no asset class where you can get a guaranteed 9 percent real return. I don’t know precisely what the claims are that are being made. I DO have positive feelings about dividend stocks. When stocks have high dividends, you are protected to an extent. So I think it makes sense to explore that sort of thing if you have the time. But if you move away from a broad index fund, you need to put time into research to be sure that you understand what you are doing. I have run into very smart people who believe that investing in high dividend stocks is a good idea and I am persuaded that they are on the right track. So I would not dissuade you from the general idea of looking at dividend stocks. I would just check into that 9 percent claim. When something sounds too good to be true, there’s a good chance that it is not true. But perhaps the claim is explained when you look at all the details of it. I have not done that. So I cannot say.
That’s probably not terribly helpful. I don’t want to go down the road of moving outside of my area of “expertise.” I think the question of whether the market is efficient or valuations affect long-term returns is HUGE. I think that I could write about that for the rest of my life and never have time to move on to other issues. I can just go deeper and deeper and deeper and never run out of exciting stuff to explore. And there are very few others exploring that particular, hugely important, question. So I just intend to stick to that. I will work it and work it and work it to come up with good answers in that area. But I think it is better to leave it to others to work all the other areas because they know more than me about those areas and I just don’t feel that I have much to add outside of that one super-big matter.
That’s where I am coming from, in any event. The valuations thing is so big that it is my view that it’s almost impossible to mess up if you come to a good understanding of the valuations thing while it is also almost impossible to do well in the long run if you fail to come to a good understanding of the valuations thing. I see the valuations thing as being 70 percent of the stock investing story. I don’t claim to understand it all myself. I am still working it. It really has to do with understanding human psychology. That’s a big topic! And we have not done a good job in the past of applying what we know about human psychology to the stock market. I think it scares us. We don’t like to accept that human emotions affect stock prices because it causes us to lose confidence that we know where we stand financially. So there is a lot of work to be done in that particular area.
I hope that helps a tiny, tiny bit and I of course wish you the best of luck with whatever choices you make. I’ll tell you the tricky one. You could get it all right and still see bad results because most other investors fail to get it right. When the market crashes, it does great harm to our economic system. And we all suffer when damage is done to the economic system. That’s my big fear. I could figure all this valuations stuff out perfectly and the fact that millions of others don’t understand how it works could cause a crash, which could cause a Great Depression. Where am I then? We are all in this together. That’s my most important message. We all need to be concerned with the functioning of the market as a whole, not just with our personal returns. Very few people pick up on that message. That reality is my greatest frustration. When the stock market becomes mispriced, it’s like the air becoming polluted or the water becoming polluted. We all feel the effects.
My best wishes to you.
Rob