Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
Thankfully I didn’t take his advice.
I can certainly understand why someone would say that, Evidence. I believe that the vast majority of investors share your view. Shiller’s prediction did not prove out. That’s an objective fact. At the end of the 10 years, the investor who remained heavily in stocks would be ahead. So the numbers support your view, from one popular way of looking at things.
All that said, my view is that Shiller’s advice was good advice. It all comes down to one thing. When prices go up beyond fair-value levels, are the extra gains the product of economic realities, as the Buy-and-Holders believe? Or are they the product of irrational exuberance, as the Valuation-Informed Indexers believe? If those extra gains are the product of irrational exuberance, they are going to disappear sooner or later. We don’t know when. But we know that they are going to disappear. So the risk of going with a heavy stock allocation at those sorts of prices is sky high. I think Shiller gave good advice in suggesting that investors with high stock allocations lower them.
I think you are wrong to say that you are happy that you didn’t take Shiller’s advice. Have you done calculations to see where you will stand if we see a 50 percent price crash, as we will if Shiller’s research is legitimate? You won’t be ahead at that point. So what good will having been in stocks all those years end up having done for you? Even in a case in which Shiller’s prediction ends up failing (which it did), those who ignore it end up behind in the long run. Huh? What the f?
The big deal here, in my assessment, is — What causes overvaluation? If it is true economic gains, Buy-and-Hold is the ideal strategy. If it is irrational exuberance, which is going to disappear in time, you have to consider the risk that you are taking by investing your retirement money in something that could disappear at any moment. I don’t like taking that sort of risk with my retirement money. So I follow Shiller’s advice. Even when he gets the timing wrong, the general point that he is making — that stocks are more risky when prices are high — is so important that the advice pays off in the long run.
That’s my sincere take, in any event.
I naturally wish you all good things.
Risk-Aware Rob
“stocks are more risky when prices are high”
This is the kind of thinking that lead you to confidently predict the market was going fall 50% within three years a few years ago. The rest of us stuck to our buy and hold strategies, and were rewarded for it.
Financial markets have no memory, and don’t adhere to any fixed scientific rules of nature.
You were not rewarded, Anonymous. If you want to say that you were TEMPORARILY rewarded, I could go along with that. Your portfolio number is bigger than it would have been had you lowered your stock allocation. But if 50 percent of the portfolio number represents irrational exuberance rather than economic realities, then any rewards that you have experienced are only temporary. When they go “poof!,” where are you going to be then? You will be down financially and you will have lost years that could otherwise have been put to use making up for those losses. A good argument could be made that, the longer it takes for the temporary gains to go “poof!”, the worse off you are.
I don’t want temporary gains. I want real gains. I don’t think that others should want temporary gains either. Now, it is not for me to tell others what to do. There are lots of good and smart people who love Buy-and-Hold. I wish them the best of luck with it. But it’s something else for me to endorse this strategy that I find so dangerous. People should do what they think is best. But no one has a right to demand my endorsement for something that I find dangerous. That’s a bridge too far.
Financial markets DO have a memory. That’s precisely what Shiller showed. If markets did not have a memory, returns would play out in the pattern of a random walk. That’s why the famous book that popularized Buy-and-Hold was titled “A Random Walk Down Wall Street.” Shiller’s book has a different title. Shiller’s book is titled “Irrational Exuberance.” Shiller showed that valuations affect long-term returns. That couldn’t happen unless the market had a memory. Do you think that valuations have just randomly been affecting long-term returns for 150 years now? Valuations affects long-term returns because the market remembers when prices go up due to irrational exuberance rather than economic realities and then it erases those temporary gains in time because the market’s ultimate objective is to get prices right.
I don’t quite get what you are trying to say when you say that markets don’t adhere to fixed scientific rules of nature. Markets operate in some way. The question that we all should be trying to determine is — HOW do they operate? We need to know how the stock market operates if we want to invest effectively.
The Buy-and-Holders advanced a theory as to how the stock market operates. They said that the market is efficient. That means that all factors known to affect price are taken into consideration in the setting of the price. Another way of saying it is that the market price is determined by rational actors, people trying to achieve their best interests. Shiller’s wife is a psychologist. So he knows that humans are not purely rational actors. He knows that they can be swayed by emotion. So he had doubts about this idea that investing is a purely rational business and he tested it scientifically. He found that, indeed, stock prices are set by a HIGHLY emotional process. And he gave us a tool (P/E10) to determine how emotional the market is at a given point in time so that we can protect ourselves from the effects of all the craziness.
If the market were rational, do you think we would have seen death threats? Board bannings? Thousands of acts of defamation? Threats to get academic researchers fired from their jobs? Those are emotional phenomena, Anonymous. We see that stuff because the Buy-and-Holders cannot bear to hear what the last 37 years of peer-reviewed research tells us about how stock investing works. The rational response would be for the Buy-and-Holders either to integrate the new research into their thinking or to try to form a rational case for why they reject it. A death threat is not a rational case. Neither is a board banning. Neither is an act of defamation. Neither is a threat to get an academic researcher fired from his job. The behavior of you Goons shows that Shiller was right. You would not be so upset if you were confident that your investment strategy was a realistic one.
There is going to be a national debate re these issues, Anonymous. The matters in dispute are too important to the futures of too many people for there not to be a national debate. If I were king of the world, that debate would have been launched on the afternoon of May 13, 2002. Or, better yet, in 1981, when Shiller’s “revolutionary” (his word) Nobel-prize-winning research was revealed to the world. We all would be better off today had the national debate been launched at one of those earlier times.
But here we are, you know? We cannot hold off on the launching of the national debate indefinitely. It is just too important for that national debate to take place. So we will launch it in the days following the next price crash. Not my preference, you know? Not by a long shot. But it’s an outcome a lot better than any alternative realistically available to us at this point in the proceedings. It appears to me that we are just going to have to accept these somewhat mixed realities, make the best of it that we can, and move on to a better place for each and every one of us.
The market has a memory. Otherwise prices would play out in the pattern of a random walk. That’s my sincere take, in any event.
National-Debate Launching Rob
“So the risk of going with a heavy stock allocation at those sorts of prices is sky high. I think Shiller gave good advice in suggesting that investors with high stock allocations lower them.”
— Wade Pfau’s study showed that if you tried to execute the VII market timing system using only the information available at the time of investing (the “rolling average” figures) then the return would be the same as the S&P500 return, no advantage at all.
No. The peer-reviewed research that Wade and I co-authored shows that throughout the entire history of the U.S. market Valuation-Informed Indexors could either enjoy the same returns as Buy-and-Holders while taking on a small fraction of the risk or take on the same risk and enjoy far higher returns. That’s why he declared that: “Yes, Virginia, Valuation-Informed Indexing works!”
Financial fraud is a crime, Evidence. It is a felony. That means prison time.
Not this boy.
Rob