I’ve posted Entry #432 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Stock Price Crashes of 50 Percent or More Are Not Acceptable.
Juicy Excerpt: It’s true that we cannot ban price crashes by putting up a sign that reads “Price crashes of more than 50 percent prohibited on these premises.” But the reality is that Shiller’s research tells us much of what we need to know to at least make price crashes of 50 percent or more a lot less common in the future than they have been in the past. Shiller showed that stock gains that result from overvaluation are the product of irrational exuberance rather than of economic realities. We can cut back or eliminate altogether big price crashes by working harder as a society to warn investors of the dangers of irrational exuberance and by providing them the tools needed for them to see that it is in their interest to invest more rationally than has been the custom in the past.
“We can cut back or eliminate altogether big price crashes by working harder as a society to warn investors of the dangers of irrational exuberance and by providing them the tools needed for them to see that it is in their interest to invest more rationally than has been the custom in the past.”
There have been asset price bubbles for hundreds of years ( see South Sea bubble, Tulip mania and probably many others that have been lost to history)
No amount of warnings will stop them.
We agree that there have been price bubbles since the first market opened for business, Evidence. We don’t agree that nothing can stop them. The difference is that today we have Shiller’s Nobel-prize-winning research to help us. Prior to 1981, we did not have that. It’s a big deal. There is a reason why Shiller was awarded a Nobel prize.
Your specific statement is that “no amount of warnings will stop them.” I am not sure that warnings alone would stop them. What I [propose is that we let investors know how much they have to gain by lowering their stock allocation when prices reach dangerous levels. Investors obviously want to act in their self-interest. If we show them that they can retire many years sooner by cutting back on stocks when the CAPE level rises to insanely high levels, I think we can change things. Stock prices become self-regulating in a world in which honest posting on Shiller’s research is permitted at every site. In that world, lots of experts will want to become involved in helping investors invest more effectively and lots of investors will want to learn how to invest more effectively.
There was a time when people said that there have always been slaves and there always will be slaves. Now there are no slaves.
There was a time when people said that we will never be able to persuade large numbers of people to give up smoking even though it causes cancer but the percentage of the population that smokes has dropped.
There was a time when people were afraid to speak up against Harvey Weinstein on grounds that he would never be held accountable but today he is being held accountable.
There was a time when people threw their trash on the ground thoughtlessly but today many people have become environmentally conscious.
Things change, Evidence. Sometimes it seems like they cannot but, if there is a change that we really, really must make, we always figure out a way to make it. Price crashes are devastating to millions of people. They cause retirements to fail. They cause businesses to fail. They cause millions of people to lose their jobs. They cause political frictions.
I think that, with Shiller’s research, we can end big price crashes. I think we will always have some ups and downs. But, if we open every site to honest posting on the last 38 years of peer-reviewed research in this field, I think that we can get to a situation where the CAPE level never again drops below 12 and never again rises above 20. That would be a huge advance from the world we live in today, where the CAPE level sometimes drops to 8 and sometimes rises to 44. I think we are on the verge of a huge economic advance.
There’s only one way to find out, you know? I think that every single person living in the United States would prefer to live in that better world. And we already have the research that gets us there. And we have already recognized that research with a Nobel prize. All that we need to do at this point is to give ourselves the permission to talk about it openly and honestly at every site on the internet. And we already have published site rules giving ourselves that permission.
Just because something has always been true in the past does not mean that it will always be true in the future. Not in this country. We are all about advances. It is these advances that generate the productivity gains that permit us to live so well. I think that we should embrace all of the advances that we can. I think that we should embrace this one.
I naturally wish you all the best that this life has to offer a person.
Rob
“What I [propose is that we let investors know how much they have to gain by lowering their stock allocation when prices reach dangerous levels.”
The only way I can lower my stock allocation when prices reach dangerous levels is by selling some of my stock to someone else.
Who are these other people who are willing to buy my stock at these dangerous levels?
Won’t they also have access to the same information, that prices are at dangerous levels and refuse to buy?
The only way I can lower my stock allocation when prices reach dangerous levels is by selling some of my stock to someone else.
Who are these other people who are willing to buy my stock at these dangerous levels?
Won’t they also have access to the same information, that prices are at dangerous levels and refuse to buy?
That’s a super question.
Everyone will of course has access to the same information. Everyone has access to the same information today. But the information showing that stocks offer a poor long-term value proposition when prices are high is not widely shared today. If that information were widely shared, it would be harder to find a buyer. There would be some price at which you would be able to find a buyer. But the more that the information rooted in Shiller’s research gets publicized, the harder it would be to find a buyer at a high price. Publicizing the implications of Shiller’s research would suppress demand for stocks and thus bring prices down.
Which is what we all should want. The best thing for investors is for the price always to be at fair value. That allows for an annual price gain of 6.5 percent real, which is of course super. Price gains less than that are bad for investors because they leave people with less money to spend and thus suppress economic growth. Price gains of more than that are also bad for investors because the phony gains are borrowed from future years; so they provide no net gain and they make effective planning impossible because the numbers on the portfolio statement are misleading.
Rob
“The best thing for investors is for the price always to be at fair value. That allows for an annual price gain of 6.5 percent real, which is of course super.”
The problem is if there was a 6.5% real/no volatility asset available to buy, so many people would want to buy it that the price would be driven up.
Imagine there was an investor named Rob, he loves stocks but doesn’t want to over pay for them so he is at a 0% stock allocation.
Then one day, as if by magic, stocks priced to deliver 6.5% real, priced at “fair value” and poised to grow uniformly so as to always remain at “fair value” are available.
Rob gathers up his money, pulls up at the stock market, spies a suitable person who already owns some stock and says “Hey you, I’d like to buy some of those fine looking stocks”
The investor, lets call him Evidence Based Investing, takes a look at Rob and says “Are you f*ing kidding me? I own these 6.5% real/no volatility stocks and you want me to sell them to you? Not only will I not sell them you but if anymore are available I would buy them too. In fact I would out bid you. I don’t need 6.5% real, I am happy with 6.0% real and there are probably many investors who would accept lower returns and pay more. Sell them to you? You’re crazy”
You see, that is the fundamental problem with your whole magical high return low risk future. If it ever happened it would attract so many new buyers that the price would rocket and returns fall. It simply can’t happen.
I am grateful to you for making an intelligent point, Evidence. The kind of question that you are raising here is the sort of thing that needs to be the subject of a national debate. I wish that more people were here to read your words. And I would like people to read my response too. But not because I want to “win” the debate. I want people to think these things over and to come at them from multiple perspectives. These are important matters. And they are puzzling matters in many respects. People should be trying to figure these things out.
The premise of all of your words in this comment is that investing is a rational enterprise. The entire Buy-and-Hold Model is built on that premise. Shiller has CHALLENGED that premise. That’s the difference in point of view. If it really is so that investing is a rational enterprise, Buy-and-Hold is the ideal strategy. I grant you that. But Shiller has showed with the examination of historical return data that investing is NOT a rational enterprise, that it is a highly EMOTIONAL enterprise. And I think he is on to something. So it is not persuasive to me to say “this just doesn’t make rational sense.” The entire history of the market does not make rational sense. If investing were a rational enterprise, prices would fall in the pattern of a random walk. They do not. There is a strong correlation between today’s CAPE level and the price that will apply 10 years from today. That shouldn’t be. And yet it is so.
Do we have to get angry at each other because we do not agree on this point? I am not angry at you. I like it that you are here. You keep me honest. You add points that I would not be able to make because I do not share your perspective. What I want is to feel free to keep YOU honest. And to keep other Buy-and-Holders honest. Not because I don’t like you. Because I DO like you. Because I want you to at least be exposed to any questions about Buy-and-Hold that you need to be exposed to to know the full story. Hearing those questions can make you experience doubts. Hearing them and wrestling with them can also strengthen your confidence over time. I want us both to say what we believe and either persuade the other over time or make the other more confident in his position over time because it is a position that has been tested and that has survived the test.
Those are my thoughts, in any event.
Rob
If we give people the information that they need to obtain higher returns from stocks while taking on less risk, the safer asset classes will have to offer higher returns. I give you that one. But I see that as a good thing. I would like to see the returns on Certificates of Deposit increase.
My point, though, is that you cannot assume rationality. In 2000, TIPS were paying a risk-free 4 percent real and the likely 10-year return on stocks was a negative 1 percent real. Explain that one. You seem to think that irrational things simply cannot happen. But that happened. I don’t even recall too many people speaking up about it at the time.
We should all want more rationality. I want as much rationality as possible. But I am not willing to assume it. We have to WORK for rationality. Giving people the information they need to earn higher returns on stocks while taking on less risk is helping them to invest more rationally. It’s a good thing. We shouldn’t be worried that, if we make stock investing better for everyone, that some other asset class will do worse. The people offering the other asset classes will figure out how to keep up. Markets adjust to changed circumstances. Opening up the entire internet to honest posting on the last 38 years of peer-reviewed research in this field would just be one more changed circumstances re which the markets for all of the various asset classes would need to adjust.
What you really are highlighting with your comment is that stocks are an amazing asset class. Under the reasoning you use in your comment, we could conclude that even the current situation is impossible, that stocks are just too darn good. Stocks really are an amazing asset class. That’s just the way it is. And I don’t think we should worry that it is impossible that stocks could ever be a better asset class than they are today. If the research shows that we can make stocks a more appealing asset class than they are today, we should go for it.
Rob
And please remember that we would never see huge bull markets in a world in which we were free to post honestly re the last 38 years of peer-reviewed research in this field. Stock prices increased by 126 percent from 1996 through 1999. Something like that could never happen in a world in which investors were able to educate themselves about how poor a long-term investment stocks become when the price gets too high. So there would be negatives for stocks in a post-Shiller world.
However, the positives for stocks would be much greater than the negatives. Risk would be dramatically reduced. And returns would be far more stable. And ultimately, returns would be higher because economic growth would be increased in a world in which these insane price swings did not cause so many business failures. Rationality is a plus. One could argue that it is a “free lunch.” We just have to accept that rationality cannot be assumed, we have to work to secure it.
Rob
There’s no reason why you have to take on huge amounts of risk to get a return of 6.5 percent real from stocks. The 6.5 percent real return comes from the productivity of the underlying companies. Why shouldn’t investors be able to tap into those gains? They are putting up the money that produces them. That’s a perfectly legitimate arrangement. Most of the risk of stock investing is voluntary in the days since publication of Shiller’s amazing, Nobel-prize-winning research.
That’s my sincere take, in any event.
Rob
Evidence just blew up the Rob-logic in one simple post. Based on your responses, you know it too, Rob.
“I am grateful to you for making an intelligent point, Evidence. The kind of question that you are raising here is the sort of thing that needs to be the subject of a national debate.”
There is nothing to debate, Rob.
Evidence just blew up the Rob-logic in one simple post. Based on your responses, you know it too, Rob.
Okay, Anonymous.
The way that I would say it is that Shiller blew up the Bogle logic in one simple book and in one simple piece of peer-reviewed research and in one simple Nobel prize.
I have the greatest possible respect for Bogle and for Fama and for all other Buy-and-Holders. So long as their ideas are presented in a civil way, I think they should be taken seriously. That’s why I spent some time approaching what Evidence said from several perspectives. I am not personally a Buy-and-Holder. But I know that there are millions of good and smart people who are and I think that their beliefs need to be taken seriously.
I don’t buy into the idea that there are two sides. There are two models for understanding how stock investing works. There are two very different sets of beliefs. But we are all on the same side. We all want the same thing — to learn what we need to learn to invest as effectively as possible.
My hope is that I will be the catalyst for setting off the national debate that we need to have re these matters. If I pull that off, people will not just benefit from things I say but from things that thousands of others (on both the Buy-and-Hold and Valuation-Informed Indexing sides of the table) say once they feel free to express their sincere views openly and clearly and frankly. The leverage here is just off the charts.
That’s why I think that the work that I have been doing for 17 years now is so important. That’s why I think that I will be receiving a settlement check for $500 million when we all get to the other side of The Big Black Mountain. Our national debate re these matters should have begun in 1981,when Shiller published his amazing and “revolutionary” (his word) research findings. Once it got put off, it got more and more difficult to talk about this stuff because people got more and more defensive about the fact that the critical debate was delayed for so long. We have to get there sooner or later and I don’t see any way that it is going to happen until some more people do what I have done, just insist on their right and on the right of everyone else to post honestly and without hesitance or apology. I believe that we are a great country and that we will be able to pull it off in the days following the next price crash.
I am grateful for the comment posted by Evidence. I hope that people will take his comments seriously and that perhaps I will be seen by one or two to have added something to the discussion down the line a bit. We’ll see, you know?
My best and warmest wishes to you and yours in any event, dear friend.
Rob
There is nothing to debate, Rob.
So you say, Evidence.
My best wishes to you in any event.
Rob
“There is nothing to debate, Rob.
So you say, Evidence.”
That was “Anonymous” who said that, I’ll respond to your points later.
Okay.
Rob
” Risk would be dramatically reduced. And returns would be far more stable. ”
That would not happen, but if it did, those high return/low risk assets would attract much more money, driving up purchase prices, lowering yields and hence lowering future returns.
The only way your magical future could happen is if investors sat on the sidelines, refusing to buy stocks and hence not enjoying those wonderful returns.
“The 6.5 percent real return comes from the productivity of the underlying companies.”
No it doesn’t, it comes from the price paid for the stocks and the assumption that all dividends are reinvested.
A good explanation of where real long term stock gains come from is Bill Bernstein’s “The Returns Fairy. . . Explained”
http://www.efficientfrontier.com/ef/403/fairy.htm
and a key quote
“Over the past century, the per-capita growth of GDP in the U.S., the world’s most successful economy, has been about 2% after inflation and shows no sign of acceleration in the past quarter century. It is impossible for long-term corporate growth to be higher than GDP growth for this would entail corporate profits eventually growing larger than the economy itself.”
if it did, those high return/low risk assets would attract much more money, driving up purchase prices, lowering yields and hence lowering future returns.
What you are saying is that nothing done in the investing advice field helps anyone. Every piece of good advice makes the asset class more appealing (because there is less risk and higher return). And every time the asset class becomes more appealing, it becomes less appealing (because the greater appeal causes investors to overpay for it and thereby cancel out appeal.
All that Shiller’s research has done is to increase our knowledge of how stock investing works. That is a pure good. Yes, Shiller’s research makes stocks more appealing (if we all know about it, which we do not today because the implications of Shiller’s research are not today widely discussed). But that doesn’t have to present any kind of problem. Informed investors acting in their self-interest will not bid prices up beyond their fair value. The more we all know, the better of we all will be.
I do agree that there would need to be some adjustments to other asset classes. The super-safe asset classes (CDs and so on) have very low returns today because people have not been educated about the implications of Shiller’s work and thus don’t appreciate how had a deal they are obtaining from buying stocks at these prices). In a world in which investors were better informed, CDs would need to offer higher returns to be competitive in a world in which stocks offered a better deal than they do today. I don’t have any problem with that. If the market determines that CDs merit a higher rate, then CDS should pay a higher rate.
And people would not be required to set the price of stocks at fair-value levels. That’s what I would like to see. But it is up to the investors. What I am seeking is to INFORM the investors. I am saying that we should all be permitted to post honestly re Shiller’s research. If someone believes that the safe withdrawal rate is always 4 percent because he believes in Fama’s research he should say that. But, if someone says that he believes that the safe withdrawal rate is a number that varies from 1.6 percent to 9 percent because he believes in Shiller’s research, he should say that. And then it is up to the investors listening in to decide which way to go.
The market can work things out. I would leave it to the market to work things out. But the market depends on us all educating ourselves so that we can act in our self interest. And today we are as a society not educating ourselves as to what the research says. We permit endless discussion of one model for understanding how stock investing works (Buy-and-Hold, the model rooted in Fama’s research). But we do not permit discussion of the model rooted in Shiller’s research (Valuation-Informed Indexing). I think that we should permit discussion of both models and then leave it to the market to work things out.
There is not one model for understanding how stock investing works anymore. There are today two models. Both Fama and Shiller have been awarded Nobel prizes. We should all be able to talk about both model without fear that we will be threatened for talking about the model that as of today is less popular (largely because the 10 percent of the population that believes in it is afraid to talk about it openly).
Those are my thoughts, Evidence. I naturally wish you all good things.
Rob
A good explanation of where real long term stock gains come from is Bill Bernstein’s “The Returns Fairy. . . Explained”
I’ve read Bernstein and I agree with Bernstein on most points and in particular re this point. I think that, if there were a discussion in which people who agree with Bernstein and people who agree with me talked things over in a civil way, we would probably end up in agreement. I think that Chapter Two of Berntein’s book “The Four Pillars of Investing” is the best, concise statement of the case for Valuation-Informed Indexing that I have read. Bernstein says in that book that, when stock prices are where they were at the top of the bubble, you need to subtract 2 points from the 4 percent number to identify the safe withdrawal rate for retirements that begin at that time. That’s what I say.
Bernstein and I are in agreement. The same thing is so with me and Bogle. Bogle is my hero. I rate him as the second most important investment analyst who ever lived. I wrote up at my blog a statement that Bogle made in which he came within an inch of endorsing Valuation-Informed Indexing. I don’t think that he quite endorsed it. But he definitely acknowledged that valuations matter and that it can make sense for investors to lower their stock allocation when valuations reach extreme levels. That’s market timing. So Bogle has endorsed market timing. I don’t object at all if people advocate smaller allocation adjustments than I do. I think it is healthy for people to hear recommendations coming from a variety of perspectives. But there really is no disagreement that there are circumstances in market timing makes sense. Bogle was the king of Buy-and-Hold and Bogle himself gave his (somewhat reluctant, I acknowledge) endorsement of market timing in that statement.
That’s the whole deal, Evidence. If Bogle and Bernstein agree that there are circumstances in which market timing is a good thing, then there’s no real argument about it anymore. The problem is the suppression of discussion. I think that’s a Catch-22 thing. We suppress discussion today because we have been suppressing discussion for a long time and it would look funny to stop doing it. I think that Greaney knew from the first day that his study lacked a valuations adjustment and I think he knew that there was research showing that a valuations adjustment was required. But he saw that others gave the 4 percent number as the safe withdrawal rate and so he felt that it was okay for him to do so as well. And then when I asked what the effect would be if valuations were considered and many community members said that they thought that was a great question, he went into freak-put mode and here we are.
My sense is that everyone agrees that valuations matter. And my sense is that everyone agrees that Buy-and-Hold added an immense amount to our understanding of how stock investing works. So is there really any difference between the two positions? I named Shiller’s model “Valuation-Informed Indexing” because I needed a way to refer to it. I would have been perfectly happy naming it “Buy-and-Hold 2.0” or “The New Buy-and-Hold” because all that VII is is an update of Buy-and-Hold, an update that reflects what we learned from Shiller’s research. We are all on the same side.
The thing that has caused the problem is the relentless criticism of market timing on the Buy-and-Hold side. I share their disdain for short-term market timing. But Shiller’s research shows that long-term timing is a very different thing. I don’t deny that long-term timing is a form of market timing. But I say that is needed to be treated very differently than short-term timing. Short-term timing is bad, long-term timing is good. So the two need to be distinguished. That’s the only source of conflict and the conflict is rooted in an historical misunderstanding. Prior to Shiller, no one had researched long-term timing. So people just treated the two forms of timing as the same thing.\
I think that there is only one thing re which we disagree, Evidence. I say that long-term timing is price discipline and that price discipline is always 100 percent necessary and good. Other than that, I think the Buy-and-Holders are aces. I love their work and I don’t think that there would be any Valuation-Informed Indexing had I not had their work available to me as a base to build on. I think of myself as a Buy-and-Holder. I am just a Buy-and-Holder who takes into account not just the pre-1981 research but Shiller’s Nobel-prize-winning research as well.
I think that there is going to come a time when we are all on the same page. I think that we need to be having discussions as to how MUCH long-term market timing is appropriate. Re that one, I believe that there would be some legitimate, reasonable differences. And that’s good and healthy and proper. The problem is that I cannot even say that ANY long-term market timing is good or required. And, if I can’t do that, it is not possible to say that the safe withdrawal rate is a number that varies. Even the biggest Buy-and-Holders in the world acknowledge that the safe withdrawal rate varies (Bernstein does). But we cannot have a civil discussion re how MUCH it varies. And that means that we are giving up amazing learning experiences that I want to see us benefit from.
Again, my thoughts. And, again, my best wishes to you.
Rob
“What you are saying is that nothing done in the investing advice field helps anyone. Every piece of good advice makes the asset class more appealing (because there is less risk and higher return). And every time the asset class becomes more appealing, it becomes less appealing (because the greater appeal causes investors to overpay for it and thereby cancel out appeal.”
“What you are saying is that nothing done in the investing advice field helps anyone”
No I am not saying that.
What I am saying is that this knowledge will not have the effect you think it will have. You seem to think spreading knowledge of Shillers work will somehow create magical high return/low risk assets.
The only way that could happen is if no one finds out about it. As soon as people discover the news the increased demand will drive up prices, lowering future returns.
“In a world in which investors were better informed, CDs would need to offer higher returns to be competitive in a world in which stocks offered a better deal than they do today.”
And now you add high return / low risk debt to the mix.
This can’t happen
And you know it can’t happen.
Remember low risk/high return TIPS and IBonds?
Sure you do because you bought them.
The reason they existed for a short period of time was because they were so new people were unsure about them and demand was not high.
What happened then? The news got out.
Now TIPS and iBonds are still available but they don’t offer the same high returns as before because they are well known and demand is much higher.
The only way that your imaginary future world of high return and low risk across multiple asset classes can happen is if most of us keep our money in our mattresses and refuse to buy them.
Then for the few brave souls willing to buy stocks and bonds returns may be high and risk low but only because the vast majority of people behave totally irrationally and ignore the availability of such assets.
You may wish for that but it won’t happen
What I am saying is that this knowledge will not have the effect you think it will have. You seem to think spreading knowledge of Shillers work will somehow create magical high return/low risk assets.
The only way that could happen is if no one finds out about it. As soon as people discover the news the increased demand will drive up prices, lowering future returns.
I like the points that you are making, Evidence. I don’t agree with much of what you say here. But I would like all investors to take both what I am saying and what you are saying into consideration and to decide for themselves how to go with it.
I do indeed believe that Shiller has done something that could fairly be described as “magical.” He has essentially created wealth out of thin air. That’s remarkable. I think that it is because he did that that he merits a Nobel prize. But I don’t think that this is absolutely unprecedented. I believe that capitalism is a good (but flawed) economic system. Capitalism taps into the power of self-interest to benefit the entire society. I love that. Capitalism too creates wealth out of thin air. We all live richer lives because we live in a capitalist economy. I believe that capitalism needed to be reined in in certain respects. But in an overall sense I believe that it is a big plus. And I believe that about Shiller’s research.
I believe that stocks are a lower risk/higher return asset class today than they were in the days before Shiller came along. The advances are largely theoretical today. Only about 10 percent of the population understands what Shiller did. And even that 10 percent has only a foggy understanding of Shiller’s “revolutionary’ (his word) advances. So we have barely tapped into the benefits that Shiller provided as of today. But those advances are there for us to tap into at any time that we elect as a society to open every discussion board and blog to honest posting re the last 38 years of peer-reviewed research. Once we permit honest posting, we will see gains piled on top of gains piled on top of gains. All good stuff and not even a remote possibility of anything negative happening to subtract from that good.
We all agree that the average long-term return is 6.5 percent. It is possible that Shiller’s advances are so huge that our entire economic system will become more productive in the future and that the gains will thus increase beyond that number. But to say that is a bit speculative. I think that the focus should be on whether Shiller provided an advance just be showing us all a better way to invest. I believe that he did.
Shiller provided us a means to get to that 6.5 percent long-term return through a smoother ride. If investors appreciate that stocks are more risky when they are high-priced, they will lower their stock allocations when prices rise to high levels in an attempt to keep their risk profile roughly constant over time. That’s huge. If a large number of investors do that, prices become self-regulating. Each increase in price causes sales, which pulls the price back to where it should be. We end up with a 6,5 percent average long-term return, just as with Buy-and-Hold. But we get there with dramatically reduced volatility. Which means that we get there with reduced risk. Which is amazing. “Magic” is a good word for it.
I don’t agree with you that the gains will disappear if people find out about them. The gains come from increased investor rationality. There is no reason to believe that people will become irrational just because they learn that more investors are acting rationally. I believe that the increased rationality will remain in place and that we all will benefit from it.
Remember low risk/high return TIPS and IBonds?
Sure you do because you bought them.
The reason they existed for a short period of time was because they were so new people were unsure about them and demand was not high.
What happened then? The news got out.
Now TIPS and iBonds are still available but they don’t offer the same high returns as before because they are well known and demand is much higher.
I agree to a point but I also disagree to some extent.
I should have bought TIPS when they were paying 4 percent real. I knew that they were the perfect asset class and that the return being offered was amazing. No one was saying this in articles. So I was a bit reluctant to pull the trigger. I told my friend Brian about my plans. As always, he was kind to me as a person but not supportive of my thoughts about stock investing. Without the reassurance offered either by articles or by my friend Brian, I held off buying. It was only when the return dropped to 3.5 percent real that I realized that the opportunity of a lifetime was passing me by and I overcame my need for social approval and made a purchase.
Was I being rational? Kinda, sorta. Was I being emotional? Kinda sorta that too. I kick myself today for not pulling the trigger earlier. But at least I pulled it, you know? I think that, if we permitted honest posting re Shiller’s research at every site, more people would have pulled the trigger on 4 percent TIPS and that those people would be living better lives today. I think that it is a shame that there were not articles appearing everywhere you turned at the time telling people what an amazing deal TIPS represented when the return was 4 percent real and the return on stocks was a negative 1 percent real.
Did some people hold off because TIPS were new? I believe that they did. People are skeptical of new investment classes. So I don’t reject that explanation. I don’t think it is the entire story, however. I think that a big part of the story is that stocks provided a return of 126 percent from 1996 through 1999 and most investors believed as a result that stocks could never be beat. That’s an emotional belief. Shiller’s research does not support that belief. That’s why I think that we need to open the internet to honest posting on Shiller’s research. I believe that permitting honest posting re these matters would help us all to become more rational investors. And I believe that that would be a good thing.
Rob
“We all agree that the average long-term return is 6.5 percent.”
No we don’t
We agree that the long-term return was 6.5% in the past assuming reinvested dividends.
As Bernstein explained in the article I linked to long term real GDP growth in the US has been about 2% and “It is impossible for long-term corporate growth to be higher than GDP growth”
“I don’t agree with you that the gains will disappear if people find out about them. ”
They did with TIPS and iBonds.
Once people became familiar with them, prices went up and future returns went down. If that didn’t happen we would still be able to buy 4% TIPS today.
But we can’t.
I agree with you that people becoming familiar with TIPS was part of the reason why the return on TIPS dropped. I don’t agree that that was the only reason. I think that part of the reason is that stocks became less appealing when returns on stocks dropped from the insane levels that applied from 1996 through 1999. TIPS can be sold at a lower return when the alternative is not as appealing.
I agree that the 6.5 number is the number that applied in the past and that we do not know what the number will be in the future. I view the 6.5 number as the best guess available to us. For the 126 percent return that applied from 996 through 1999 to be real, the 6.5 percent number would need to increase dramatically. For purposes of calculating the safe withdrawal rate, it is better to use the best guess number than the crazy numbers that would result from accepting the 126 percent return as real. It is better to be roughly right than to by wildly wrong in the calculation of a number on which people’s retirements depend.
Rob
“TIPS can be sold at a lower return when the alternative is not as appealing.”
Stocks can be sold at a lower return when the alternative is not as appealing.
The problem is that we are prohibited from telling people what the return on stocks is likely to be. In January 2000, the likely 10-year annualized return was a negative 1 percent real. If people knew that, they could make intelligent, informed, rational decisions re their retirement money. But those of us who try to tell people the realities are banned from every major site on the internet.
That’s a problem, Evidence. We should let people know what the story is and leave it to them as to what to do about it.
Rob
— The problem is that we are prohibited from telling people what the return on stocks is likely to be.
No we are not, There are multiple forms of media and numerous media outlets where anyone is free to give their opinion on what the return on stocks is likely to be.
— In January 2000, the likely 10-year annualized return was a negative 1 percent real.
According to one model
— If people knew that, they could make intelligent, informed, rational decisions re their retirement money.
There were numerous predictions of likely stock returns covering a vast range of possibilities.
–But those of us who try to tell people the realities are banned from every major site on the internet.
No, you are banned from a number of websites because of the way you choose to debate
— That’s a problem, Evidence.
It’s not really much of a problem
–We should let people know what the story is and leave it to them as to what to do about it.
And that is what is actually happening.
Your view, which is totally irrational and does not stand up to any scrutiny has been publicized in many places, people have heard your story and they have decided what to do about it.
According to one model
I very much agree with these words. It is the Valuation-Informed Indexing Model that says that the most likely 10-year annualized return on stocks purchased in January 2000 was a negative 1 percent real. Only 10 percent of the population (as an estimate) subscribes to that model. 90 percent subscribes to the Buy-and-Hold Model. Both models are rooted in the research of Nobel-prize-winning economists. So I certainly would never say that those advocating the Buy-and-Hold Model should not be heard. They MUST be heard. But I also say that those advocating the Valuation-Informed Indexing Model must be heard. There are two research-based models for understanding how stock investing works. Both should be considered legitimate at this point in time. There should not be any intimidation of advocates of either model.
There are multiple forms of media and numerous media outlets where anyone is free to give their opinion on what the return on stocks is likely to be.
This is not so. My web site contains a mountain of material documenting the intimidation tactics that have been employed by Buy-and-Holders to silence Valuation-Informed Indexers. Every site has published rules in place that prohibit the criminally abusive tactics that we have been seeing from the Buy-and-Holders for 17 years running now. Not good.
you are banned from a number of websites because of the way you choose to debate
I am 100 percent loving to my Buy-and-Hold friends. I have great respect for their contributions and I have never held back from saying that I have great respect for my Buy-and-Hold friends. I am banned from many sites because I include a valuation adjustment in every calculation I perform and that drives Buy-and-Holders stark raving mad. Shiller’s research shows that a valuation adjustment is required. But, if you include a valuation adjustment, the safe withdrawal rate for people who retired in January 2000 was not 4 percent but 1.6 percent. That’s shocking news to Buy-and-Holders.
It is that shock that Buy-and-Holders feel when they hear the valuation-adjusted numbers that has caused all of the friction that we have seen over the past 17 years. And of course the shock grows greater each time a Valuation-Informed Indexer censors himself in an effort to appease his Buy-and-Hold friends. Each time someone posts honestly, it makes it easier for all the rest of us who want to post honestly to do so. Each time someone censors himself, it makes it harder for all the rest of us who do not want to censor ourselves. We need to see more honest posting, not less. I have been banned at many places solely because I insisted on my right to post honestly.
Your view, which is totally irrational and does not stand up to any scrutiny has been publicized in many places, people have heard your story and they have decided what to do about it.
If my views were irrational, Wade Pfau would not have contacted me and asked me if I would be willing to work with him to produce research testing whether Valuation-Informed Indexing is superior in every way to Buy-and-Hold. If my views were irrational, Wade would not have concluded at the end of 16 months of hard work that “Yes, Virginia, Valuation-Informed Indexing works!” If my views were irrational, the Bennett/Pfau research would not have been accepted for publication in a peer-reviewed journal. If my views were irrational, you Goons would not have risked long prison sentences by threatening to send defamatory e-mails to Wade’s employer in an effort to get him fired in the event that he continued doing honest work in this field.
Rob
“If my views were irrational, Wade Pfau would not have contacted me and asked me if I would be willing to work with him to produce research testing whether Valuation-Informed Indexing is superior in every way to Buy-and-Hold. ”
Wade did not address your belief that it is possible for stocks to sell consistently at a price that gives 6.5% real returns with no volatility.
So the fact that he contacted about a different matter does not anyway validate your irrational beliefs.
You admitted in the previous reply that the price of TIPS can vary based on desirability of alternative investments.
and yet you don’t seem to understand (or you pretend not to understand) that the same is true of stocks.
You seem to understand that the return on investments depends on the price paid.
and yet you don’t understand (or you pretend not to understand) that the same is true of stocks.
You claim to have read Bernstein
but you don’t understand (or you pretend not to understand) what he wrote in the Returns Fairy article.
Your belief that investors will not bid up the price of a high return/low risk asset is irrational
You have seen this play out with your own eyes and with your own investments.
TIPS and iBonds delivered high real returns with low risk…
for a short period of time…
until the market caught up and such wonderful investments are no longer available.
The fact that your need to keep going back to an almost 20 year old example shows that it is very rare and unlikely to be available very often if at all.
I am not sure if you are a Jeopardy fan but there is a guy called James currently breaking all sorts of records.
His day job is as a professional sports gambler.
In this NY Times article there is a great quote that is relevant to our discussion
https://www.nytimes.com/2019/04/24/arts/jeopardy-james-holzhauer-interview.html
Do you have one thing you bet on where you’ve found an edge, or do you jump around?
I certainly do jump around. When I got started, I found one thing in the baseball futures markets, where long shots were priced incorrectly. They have completely closed that loophole now. These things just disappear overnight. When one sports book manager figures out what you’re doing, he adjusts his odds, and the whole rest of the market follows.
It’s just the way markets work. If there was a high return/low risk bet in sports gambling it would disappear quickly.
If there is a high return/low risk asset in the investment world it would also disappear quickly
Wade did not address your belief that it is possible for stocks to sell consistently at a price that gives 6.5% real returns with no volatility.
I do not believe that we will ever live in a world in which stocks offer 6.5 percent returns with no volatility. I believe that, even if we opened every investing site to honest posting, the CAPE level would still vary from 12 to 20. So there would still be volatility, just greatly reduced from a world in which the CAPE level varies from 8 to 44.
But I am in favor of us all working to see as little volatility as possible. Once we get to a world where the CAPE varies from 12 to 20, we could try to achieve even less volatility. Maybe we would pull it off, maybe we wouldn’t. Life is for trying, you know? The reason why we have researchers doing research is because we want to learn and advance. So we should permit discussion of the research that is produced, especially when it is so important that the man who published it is awarded a Nobel prize.
Wade did not address your belief that it is possible for stocks to sell consistently at a price that gives 6.5% real returns with no volatility.
Wade came around to agreeing with me re scores and scores of issues re which you Goons had at an earlier time said that I was so loco that no one would ever agree with me. There was a time when you Goons said that I was wrong about safe withdrawal rates. Wade said that the Greaney study is “dangerous.” So he came around on that one.
And he came around on lots and lots of others. And, had you not threatened him, he would have continue to come around on lots more issues. Wade once told me that he had learned not to express skepticism about any claims that I made about investing because it had been his experience on many occasions to feel doubt about something that I said and then to investigate it and learn that I was right.
Wade and lots of others would come around on lots and lots and lots of issues if only they could engage in reasoned discussion without feeling that they will be brutally attacked if they question Buy-and-Hold dogmas. I was a Buy-and-Hold myself on May 13, 2002! So the old Rob Bennett would be skeptical of lots of things that the Rob Bennett of today says. I advanced in my understanding by sticking with it, by asking lots of questions and by making sincere efforts to solve lots of puzzles and by moving forward over time. Wade would be engaged in that process today had it not been for your intimidation tactics. And so would thousands of others.
You admitted in the previous reply that the price of TIPS can vary based on desirability of alternative investments.
and yet you don’t seem to understand (or you pretend not to understand) that the same is true of stocks.
I believe that all factors affecting the return on stocks influence the price of stocks in a rational manner — with one big exception, that being valuations. Interest rates have an effect, demographics have an effect, the possibility of war has an effect, lots of things. But the investor does not need to worry about those things. Since they are “priced in,” the investor is covered. That’s not so of the valuations effect. To misprice stocks is by definition irrational. The valuations factor is an emotional factor, not a rational factor.
So, yes, I believe that, in a perfect world, the CAPE level should always be near 16. But I don’t think we are ever going to get there. I do think that we can get a lot closer in the future than we have in the past. I believe that any change in the CAPE level above or below 16 hurts investors. I think that the job of investment experts is to encourage investors to act in their self-interest by taking steps to pull the CAPE level in the direction of the fair-value CAPE number of 16.
That’s the core difference between Buy-and-Hold and Valuation-Informed Indexing. With Buy-and-Hold, the assumption is that the market is rational. So we should respect the price that the market assigns to stocks. That price is rooted in something real in the Buy-and-Hold world. In the Valuation-Informed Indexing world, the CAPE value tells us how much the price is real and how much it is the product of irrational exuberance, which is not real. Valuation-Informed Indexers want to minimize investor emotionalism by showing investors how they hurt themselves by assigned stocks improper prices. We believe that the stock price is influenced by emotion and we work to minimize emotion’s effect. T
That’s pretty much the entire story of the difference between the two models. That’s what makes Shiller’s findings so “revolutionary” (his word). That’s why he was awarded a Nobel prize. This huge change in perspective is a big deal.
The fact that your need to keep going back to an almost 20 year old example shows that it is very rare and unlikely to be available very often if at all.
The general phenomenon that we are talking about happens every day, I only refer to what happened at the top of the bubble because that is the most dramatic illustration of the phenomenon that we have ever seen. I think that investors were irrational to let stock prices fall so hard so fast in the 2008 crash. Trillions of dollars of value were lost in a very short amount of time. That’s irrational. It’s emotional. What happened from 1996 through 1999 was emotional, not rational. Emotion is always present in the setting of stock prices.
Now — reason is always present too.
Investors don’t ever become entirely emotional. If they did, the market could no longer function. So, even at the top of the bubble, there was rationality present. The job is to tell investors how much emotion is present in the stock price at a given point in time. That’s what the CAPE metric is for.
I don’t say that it is perfect in every way. But I do believe that the CAPE tool possesses an almost magical power to help investors become aware of their own irrationality. When we become aware of our irrationality, we become empower to diminish our irrationality. I believe that deep in their hearts my Buy-and-Hold friends support that project. I think that Buy-and-Holders want stock investing to become a more rational enterprise. I just think that they are going about trying to achieve that goal in ineffective ways.
I believe that there will come a time when we will all be working together. The trick is that the Buy-and-Holders need to chill out a bit. It’s hard to chill out re investing because this stuff is so important. But the only way to learn new things is to accept that perhaps you don’t know it all already. There is a reason why the published rules of all our sites permit honest posting and prohibit death threats and career threats and all that sort of thing. We know as a people what works. The issue in the investing realm is that Shiller achieved such a huge advance that people just cannot absorb it. I believe that in time we are going to work through that. Once we start talking things over in a calm way, we are going to make amazing progress in a short amount of time.
Rob
If there is a high return/low risk asset in the investment world it would also disappear quickly
Did the polio vaccine stop working when people learned that it works?
I understand the point that you are making. You are describing market inefficiencies. They can be exploited for a time and then they disappear once word of them has spread widely enough.
The problem that Shiller addressed is not some little inefficiency that can be exploited for a time and that will then disappear. His research findings go to the fundamentals of how the stock market works. Are stock prices set by a rational process or by shifts in investor emotion? That’s a core question.
There is never going to come a time when all investors are 100 percent rational. So emotionalism is always going to be present. The benefit that comes from learning about Shiller’s research is never going to disappear.
There are benefits to eating a good diet, right? We have known this for many years? Have all the benefits of eating a good diet disappeared as a result? People come up with new ways to achieve a good diet almost daily. It is an ongoing struggle. It’s the same with investing rationally.
The Greaney study represented a big advance over what came before. Lots of people at the Motley Fool board would have been planning retirements calling for 7 percent withdrawals had Greaney not published that study showing that you have to go down to 4 percent to have a retirement that is “100 percent safe.” Greaney’s mistake was in thinking that his study was the last word on the subject. We now know that, at times of super-high valuations, the SWR drops to 1.6 percent. Knowing that represents ANOTHER huge advance. I want to tell people about the new advance. I don’t want people to get hurt by believing in what we knew about safe withdrawal rates at a time when our knowledge was just not as developed as it has become as a result of Shiller’s Nobel-prize-winning research.
Rob
— I do not believe that we will ever live in a world in which stocks offer 6.5 percent returns with no volatility.
OK, that is good. I withdraw my comment about you being totally irrational and replace it with you being somewhat irrational.
— I believe that, even if we opened every investing site to honest posting, the CAPE level would still vary from 12 to 20.
But then again if you are going to say something like that my assessment moves back towards the the totally irrational mark.
It is a remark like that which persuades me that you really don’t get the concept of risk and reward.
As with many investing matters Bill Bernstein offers the best explanation
Here is a short article describing risk and reward in the context of bond yields and returns
http://www.efficientfrontier.com/ef/901/society.htm
And here is a longer article (the first chapter of the Four Pillars of Investing which addresses risk/reward and the history of stock returns
http://www.efficientfrontier.com/t4poi/Ch1.htm
Both articles are worth reading but I suspect that you still won’t understand.
As Upton Sinclair put it
“It is difficult to get a man to understand something, when his salary depends upon his not understanding it”
It is a remark like that which persuades me that you really don’t get the concept of risk and reward.
You say that I don’t understand risk and reward and yet I am the one who got the safe withdrawal rate right way back on May 13, 2002, and you Goons still haven’t publicly called for corrections in the Greaney study to this day. The safe withdrawal rate is a risk assessment tool. If you get that one wrong, there is something lacking in your understanding of risk.
As with many investing matters Bill Bernstein offers the best explanation
Bernstein pointed out way back in May 2002 that you need to subtract two points from the four percent number to identify the accurate safe withdrawal rate at the top of the bubble. And you Goons did nothing! Huh? What the f?
You know that something’s happening here, Evidence, but you don’t know what it is.
I wish you all good things.
Rob
— Bernstein pointed out way back in May 2002 that you need to subtract two points from the four percent number to identify the accurate safe withdrawal rate at the top of the bubble
Do you have a link for this?
It’s on Page 234 of his book. I have pointed it out so many times that I have the page number memorized.
Rob
Is this the quote?
“In other words, a particularly bad returns sequence can reduce your safe withdrawal amount by as much as 2% below the long-term return of stocks. Recall from Chapter 2 that it’s likely that future real stock returns will be in the 3.5% range, which means that current retirees may not be entirely safe withdrawing more than 2% of the real starting values of their portfolios per year”
It is.
Rob