I’ve posted Entry #393 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called To Say That Stock Prices Are Determined by Emotions Is Not to Say That Economic Developments Don’t Matter.
Juicy Excerpt: Market prices recovered quickly in the wake of the 911 attacks. Could it be that that’s because the underlying emotional mood of investors at the time was strong enough to permit emotions to swing quickly from a negative place to a positive place? What if the terrorist attacks had taken place in late 2008 or in early 2009, when investors were in an emotionally sensitive place? Would the losses resulting from the attacks have been deeper? Would they have lasted longer? Would there have been any recovery to pre-attack prices at all in those circumstances?
I believe that it is investor emotion that is the primary driver of stock price changes. It doesn’t follow that I believe that economic developments play no role. Economic developments affect investor psychology. So those of us who believe that investor emotion is the primary driver believe that economic developments are important. Our difference with the Buy-and-Holders is that, while we believe that economic developments are important and unpredictable, we do not believe that price changes are entirely unpredictable. The potential for big and lasting price drops is far greater at times when valuations are high because high valuations instill worry in investors that prices will be falling hard at some point in the future and that causes them to react differently to bad economic developments than they would at times when stocks were reasonably priced.
Hello Rob,
I read the ” Intelligent Investor” by Graham last couple of weeks. In his book he mentioned at least 50 times or more that before you invest one needs to be sure that you are not paying to much for stocks. Because you make your money down the road if you buy when stocks are cheap, or undervalued. He recommends a 25- 75% portfolio, that is 25% when they are overvalued and 75% when undervalued. He does not recommend buy and hold, he even mentioned PE10. He also says it is inevitable that markets will always correct by 50% to 90% at a certain point when overvalued. I am just a retired middle class guy learning , but no way would I have 50 or 100% of my portfolio invested in stocks right now. I currently have it at 25%, I can emotionally handle a 50% drop which would be 12.5% of my total portfolio.
So the point being is the evidence of value investing is irrefutable, by the” experts” , but mostly by common sense to me. When I buy tomatoes I wait till prices are at normal levels not high, WHY is it than the buy an holders , do not have an open mind about this and want to stop any discussion about it? More than that making fun your work and others. . They have a plan of a 50-50 mix of bonds and stocks, or a 100% level in stocks no matter what values are.? Well that is ok that they believe this .What is so bad about discussing different methods of analysis? It could only be that that they are like robots marching along to Bogles plan,. Yes, I have also read the Boglehead’s investing and boards. The lessons of 2008 are so quickly forgotten, the anguish ad pain of people’s lives and marriages being wiped out. Like Gramn says ” there is always a new and better plan about doing things ” right before a crash.
I thank you for your research and your blog, this is only my 2 cents , my thoughts of just and average guy learning…
Max
Everything you say here is right on, Max. Thanks much for stopping by.
Taking valuations into consideration is exercising price discipline. How could that ever be a bad thing? As you point out, the case for Valuation-Informed Indexing is “irrefutable.” The way that I say it is that precisely 100 percent of the evidence available to us today supports Valuation-Informed Indexing and that precisely 0 percent of the evidence available to us today supports Buy-and-Hold.
You are right to cite Benjamin Graham, who was Warren Buffett’s mentor. Graham is the godfather of Valuation-Informed Indexing. The references he makes to the concept in his book are the earliest references to it that I have seen.
So why are there still people today advocating Buy-and-Hold?
One reason is that people love it, Love it, love it, love it. Millions of middle-class people are today invested in stocks to provide for their retirements. Most of them are not as far along in the process as they would like to be. Say that you are a middle-class guy who is age 64 and would like to be able to retire next year. Say that you need $1 million to retire. Say that you have $900,000 in your account. You expect to put aside $10,000 this year. If you earn 10 percent on the $900,000 in your account, you will barely make your goal in time. So you are a little worried. The Buy-and-Holders don’t say that you will get a 10 percent return. But they say it’s possible. They say that there’s a chance that you will make it and that, if you don’t, there’s a better chance that you will achieve your goal one year late (you would only need to earn 5 percent each year to pull that one off). So — not an ideal situation. But not too terrible either. Kinda, sorta okay.
Now —
What is this Rob Bennett fellow telling you?
He’s telling you that you need to take valuations into account to know where you stand. Stocks are today priced at two times fair value. So you need to divide your portfolio number by two to know its true, lasting value. Divide by 2 and you have $450,000 in your account with one year remaining to reach your goal of $1 million saved. What do you think your chances are of pulling that off?
There was a discussion at a Canadian Bogleheads board of whether to ban me or not. One woman said: “Rob is the sweetest and most polite poster I have ever encountered on the internet. And he irritates me to no end!” Do you see? That’s the story here. She voted for banning me not because I violated any posting rule or because I said anything that is not true and backed by 37 years of peer-reviewed research (as well as by common sense, as you quite properly note). She voted to ban me precisely because I told the truth! A truth that she very, very, very, very much does not want to hear.
The second reason is that the “experts” support Buy-and-Hold. The people we call “experts” in this field (with the rare exception of someone like Robert Shiller or Rob Arnott or Benjamin Graham) are the people who are able to make a living giving investing advice. What is the key in every field to getting people to buy what you are selling? The first and most essential step is getting people to like you. People will buy just about anything from someone they like. People will not buy a sweater in February from someone who irritates them to no end!
LOTS of people who work in this field want to tell the truth about how stock investing works. Lots and lots and lots of them. Why don’t you hear about them? Those who actually go ahead and tell the truth are removed from the field. They can’t make any sales and so they don’t make any money and so they have to find another way of making a living. And all the others who are giving thought to telling the truth see what happens to the few who work up the courage to do it and learn the lesson that they need to learn to be able to continue to put food on the table for their families.
The tragedy here is that the valuations story plays out slowly. Yes, those who ignore valuations pay a huge price in the end. Buy-and-Hold always fails and it always fails spectacularly. The peer-reviewed research that I co-authored with Wade Pfau shows that investors can lessen the risk of stock investing by 70 percent by being willing to abandon Buy-and-Hold and instead follow common-sense strategies when investing in stocks. If I had showed people how to reduce the risk of stock investing by 10 percent, I would have had my face on the cover of Time magazine as “Man of the Year.” I showed them how to reduce the risk of stock investing by 70 percent and I am banned for life at every large investing site on the internet. Why? Because to reduce risk by 70 percent, you need to acknowledge that Buy-and-Hold is a scam. And the fellow with $900,000 does not want to acknowledge that $450,000 of his life savings is the product of a scam, the product of irrational exuberance.
That’s the entire story in a few paragraphs. We all want to be scammed. And, if you want to make a living in the investing advice field, you have to go along with the scammers. Point out the scam and you are perceived as a threat by the people making a living promoting the scam and you are eliminated. That’s the way it works.
If Shiller’s research is legitimate (it is), the next price crash will cause millions of middle-class people to lose 50 percent of their lifetime savings. What do you think is going to happen to our economic system then? People who lose that much money cut back on spending. When millions cut back on spending, hundreds of thousands of businesses fail.. When hundreds of thousands of businesses fail, millions of people are thrown out of work. When millions of people are thrown out of work, political frictions intensify. We are not just looking at an economic crisis if stocks continue to perform in the future somewhat as they have always performed in the past. We are looking at a political crisis.
Is the situation hopeless?
Not even close!
The Wall Street Con Men want to tell the truth, Max. The experts in this field are people. They are just like all other people. They chose their careers in part to make money to feed their families and in part because they wanted to put their talents to work helping other people. I am 100 percent sure of this. There is a mountain of evidence supported this claim residing in the Post Archives of the first 16 years of The Great Safe Withdrawal Rate Debate.
We didn’t always know how stock investing works. Benjamin Graham was the first to catch on to the basic idea. Shiller developed that idea in his “revolutionary” (his word) peer-reviewed research of 1981. The fine people who awarded him a Nobel prize for that research advanced the ball in a major way by doing so. I have developed the concept in hundreds of ways in the work that I have been doing on a daily basis for 16 years now. John Walter Russell devoted eight years of his life to helping me out in many amazing ways. Wade Pfau put his career on the line to help us all out. Bill Bernstein has helped us out in big ways. So had Larry Swedroe. So has Bill Shultheis. So had Carl Richards. So has Jack Bogle. So have lots and lots and lots of others.
We are on the one-yard line. Once we have one large investing site that permits honest posting, that site is going to get so much traffic as a result that the money will be flowing in and then other sites will copy what it is doing and the ideas will go viral. When you reward something, you get more of it. We have been rewarding the pure Get Rich Quick approach and punishing the first true research-based approach for a long time now. And of course we are suffering as a result, both economically and politically. What do you think is going to happen when we start punishing the pure Get Rich Quick approach (by pointing out the ocean of human misery caused by the Buy-and-Hold “strategy” over the years) and rewarding the first true research-based strategy? I think it would be fair to say that we will see the biggest economic expansion in this history of our nation.
We will see a new form of capitalism, a form in which the average middle-class person finally has a chance to get a bit ahead over the years and does not have to worry that one day he will wake up to find most of the savings of a lifetime vanish into the mist in one of those mysterious price crashes that seem to appear out of nowhere from time to time to ruin the Buy-and-Hold fantasies.
We live in a great country, Max. I am sure. We are close. We just need to hang in there. And of course we need to help each other out. You are helping lots of people out with your posts here. The Goons win by intimidating all of the good people. When they intimidate us into silence, they fool us into believing that the world is populated solely by Goons. No! I have had thousands of people thank me for the work I have done in the investing realm. There are lots of people just like you who want to know how this stuff really works so that they can plan effectively for their futures. The Goons want us all to feel isolated so that they can cut us off one by one. When one of us works up the courage to speak out, it helps the rest of us to feel less alone. That’s how we get a fire started.
We have the law on our side. That’s a big deal. The Goons go to prison following the crash. We don’t. That puts us a big leg up on them. We would not as a people have enacted laws against financial fraud if we wanted to have internet Goons robbing us of our retirement money. I mean, give me a freakin’ break. I have seen how this saga ends. The good guys win it all on the last page of the story. Yes, there have been some suspense-filled moments along the way. I was there for all of the action. I saw it all go down. But I always knew how it was going to turn out. I always knew that it was going to turn out in the only way that it could turn out if our economic system and our political system were going to survive for very much longer into the future.
Whew!
My sincere take.
It’s always nice to hear from you, my good friend. I remember the day that I learned that Benjamin Graham was telling the truth about stock investing many, many years ago. It wasn’t just that I had forgotten to take my meds! Knowing what Benjamin Graham believes about how stock investing works puts you ahead of 90 percent of the “experts” in this field, Max. And they get paid big salaries to push their smelly Buy-and-Hold garbage. The sad thing is that, the harder you push Get Rich Quick, the more money you make in this field. And I think it would be fair to say that Buy-and-Hold is the purest and most dangerous Get Rich Quick scheme ever concocted by the human mind. Quite the money maker! And quite the human life destroyer!
Benjamin-Graham-Following Rob