A Rich Life

The Old Ideas on Saving & Investing Don't Work -- Here's What Does

Archives for August 2008

I’d Be the Growlingest Bear on the Internet If Only I Were a Bear (Words Only, No Music)

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I recently wrote a guest blog entry at the Shark Investor blog entitled I’d Be the Growlingest Bear on the Internet if Only I Were a Bear.

Juicy Excerpt: I’m a reporter. I report things. That’s how I’ve made my living for a long time. Never have I seen such an emotional reaction to anything I have reported as I have seen after reporting what the historical data says about how stocks are likely to perform over the next 10 years.

Today’s Passion: The other version of this one includes jazzy intro and exit music, which even Schroeder agrees sounds just fine.

“The Future Cannot Be Predicted
Based on Historical Empirical Observations”

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Frank Voisin, author of the frankly speaking blog, has written a review of The Stock-Return Predictor. It is entitled Prediction Madness. Oh, phooey!

I’m just joking around. Here is some of what Frank has to say about my favorite investing calculator in the whole wide world, the one that changes everything forevermore.

Juicy Excerpt: Taleb provides compelling evidence why the future cannot be predicted based on historical empirical observations. The reasoning is that the majority of that which impacts our world is the result of Black Swans which are inherently unpredictable…. When Rob runs his regression algorithms, he is not taking into account the billions of variables that had an effect on the markets in the past that may not exist in the future….

Frank is bringing something important to the table. Anyone who thinks that he or she can use the Return Predictor as his or her only source of investing guidance is a fool. That’s my take. And I think it would be fair to say that Frank agrees.

Where I part company with Frank is re his suggestion that someone who does not use the Predictor or some similar tool is not also a fool. I think that it would be just as much a mistake to fail to take into consideration how stocks have always performed in the past as it would be to consider only how stocks have always performed in the past. How stocks have always performed in the past is not the only thing that matters. But how stocks have always performed in the past does matter.

Is it possible that we will see something worse than what we have ever seen before? It is possible. But how likely is it? Black swan scenarios are by definition uncommon. They can turn up and people need to know that they can turn up. People need to consider the possibility of black swan scenarios in their planning. It makes all the sense in the world for someone to say “I am going to put a bit less into stocks than the Predictor indicates is wise because the data used to construct the Predictor covers a time in which there were no black swan events and yet these are a real possibility.”

What I don’t think makes sense is to be paralyzed by the possibility that a black swan scenario may turn up. It is true that this may happen. But what are we to do about it? What are the practical implications of an acceptance of the possibility of a black swan scenario? Are we to avoid stocks altogether? Is that a realistic way to go? I don’t see it.

Things would have to get pretty darn bad for us to see stocks perform worse than they ever have in the past. In the wake of the bull market of the 1920s, we saw a drop in stock prices of 89 percent. Anything less than that is something less than a black swan event, a possibility that is taken into consideration by those using the historical stock-return data as guidance re what may happen in the future. I don’t rule out the possibility that we could see something worse than that. I don’t let it paralyze me, however. I view the possibility of a black swan event as something that we just need to live with, like we live with the possibility that lightening might strike us dead someday.

The purpose of the Predictor is not to persuade people that black swan events will not turn up. It is to persuade people that, when they look to the historical data for guidance re how stocks may perform in the future, they should examine the data in analytically valid ways. We all consider what has happened in the past when investing, whether we acknowledge it or not. How can a stock investor not consider how stocks have always performed in the past? The point of the Return Predictor is to encourage people not to fall for the idea that always becomes popular when prices are where they are today, that this might be the first time in history when valuations will not affect future returns. The danger of falling for that one is a high-probability danger, one that has been causing the ruin of investors since the day the first stock market opened for business.

Please do consider the black swan possibilities. They are real. But please don’t get so worked up over black swan scenarios that you fall victim to the far greater risk that this will be the first time in history when following the Passive Investing model will work out in the long run. The historical data says it isn’t going to be that way. The smart bet is that things will probably turn out this time at least somewhat as they always have before.

Long shots sometimes come in. People are always amazed when they do but the reality is that from time to time they do. That said, it’s not a smart idea to bet all your retirement money on a long shot. You should be taking into consideration how stocks have always performed in the past when deciding how to invest today.

Today’s Passion: Felix Salmon, author of the Market Movers blog, said of the Predictor that: “For People Who Like to Take a 30,000-Foot View of Investing, This Is a Handy Little Tool.”

Rob Sympathizes (Kinda, Sorta) with Mel
re the Morningstar Ratings Boxes

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A poster named “Yabbadabbado” argues that Mel Lindauer (co-author of “The Bogleheads Guide to Investing”) is overly sensitive. The comment comes in response to a complaint by Mel about the Morningstar ratings boxes, which permit posters to give posts they like a thumbs up and posts they do not like a thumbs down. Mel has been getting a good number of thumbs downs at the Diehards board of late because of his long history of abusive posting there.

I see merit in what both Yabba and Mel have to say re this one.

Yabba is right that Mel and lots of the others who post on discussion boards are overly sensitive. It’s a good thing that they didn’t have those rating-box thingamabobbles in place when I was posting over there. I would have been piling up negative 40s! I would have been attracting so many thumbs-down ratings that I probably would have caused the Morningstar discussion-board software to crash! I would have had people urging that a policy be adopted that a bomb be dropped on the home of the community member with the most thumbs-down ratings! And the proposal would have brought crowds to the little yellow house across the street from the post office to hear the imminent “Ka-Boom!”!

Mel — I feel for you, man. I very, very much know how it feels.

But you gotta let it go. Sometimes you’re up, sometimes you’re down. If you’re wanting to hear the applause, you’ve got to be willing to hear the boobirds too. It’s all part of the wonderful game.

I agree with Yabba that people take this stuff too personally. That causes a lot of trouble. Mel needs to chill out. Lots of others need to chill out with him.

That said, Mel has a point as well.

Mel has a lot of accomplishments to his credit in that board community. The Vanguard Diehards board was once the most successful investing board in the history of the internet. That was to a considerable extent Mel’s doing. He had put forward tens of thousands of helpful posts. Is he not entitled to some respect from his fellow community members in return for that? Should he have to listen to jeering?

Yes and no.

Mel is not being jeered because of the tens of thousands of helpful posts. He is being jeered because of the many hundreds of abusive ones. It’s taboo to say that. But he knows it, Yabba knows it, and every poster who has been paying even a tiny bit of attention knows it. To get back in the good graces of that community, Mel would need to do the things that humans do to get back in the good graces of communities they have harmed. But that would mean admitting the harm that has taken place. That cannot be done. That must not be done. Right?

I don’t think that’s right.

There’s a reason why it has become the cultural norm among all civilized peoples for those who discover they got an important number wrong in a study to correct it (Mel did not himself publish a study that got an important number wrong, but he cites without criticism the Greaney study in his book and has not done anything about the misimpressions he created by doing so since learning of the analytical errors in the study). There’s a reason why it has become a cultural norm among all civilized peoples for those who act rudely and abusively and do harm by doing so to apologize for the harm they have done. If the internet discussion board is going to achieve its potential (I very much hope that it does), the people who run the boards are going to have to start to take seriously their responsibilities for seeing that cultural norms are given the respect they merit.

Morningstar has rules prohibiting the tactics that Mel used to destroy the Diehards board. Had those rules been enforced in even a halfway reasonable manner, Mel would not be in the fix that he is in today. Had those rules been enforced in even a halfway reasonable manner, he would have been given a warning when he first began posting abusively. My guess is that he would have altered his behavior in response to the warning. He would have reined himself in. That board community would still be thriving today. Mel would still be loved there.

It’s Morningstar’s fault that it did not happen that way. Morningstar wrote its rules in the way it did to attract people of intelligence and integrity to its boards. Then it abandoned them by failing to administer its own rules in a reasonable manner. It did a whole big bunch of people a whole big bunch of harm by failing to do so. Morningstar should be ashamed of its behavior re this matter. That’s my take.

I can’t tell you precisely why Morningstar didn’t enforce the rules. It appears that part of it is that they thought that they might lose some posters if they did so and they didn’t want to lose those people. That’s wrong. That doesn’t work.

By failing to rein Mel in, Morningstar put him in an untenable position. He felt forced to become increasingly abusive to stomp out the efforts of the hundreds of community members who were interested in engaging in honest discussions of safe withdrawal rates and other valuation-related topics. Now there are hundreds and hundreds of abusive Mel posts in the files. Not good. Not good for Mel. Not good for Morningstar either (the abusive posting destroyed the board, so Morningstar ended up losing not the small number of posters who would have fled had they enforced the rules but pretty much the entire board community).

When a site owner publishes rules to govern posting at its site, it is making a promise to us to enforce those rules in a reasonable manner. We should hold the site owners to those promises. To fail to do so creates problems for everyone — for us, for the site owners, and for the abusive posters too. No one benefits from a failure to enforce the rules that prohibit abusive posting.

I admire a lot of what Mel has done. I of course do not admire his abusive posting one little bit. He’s a grown-up and he needs to take responsibility for what he has done. But Mel’s abusive posting is not solely Mel’s doing. Morningstar permitted it to happen; by failing to act, an argument can even be made that Morningstar encouraged it. We encouraged it too when we failed to speak up in clear and direct and firm terms. The Normals played a role in the destruction of that board too.

Mel blames his troubles on the ratings boxes. That’s not it. I’ve seen ratings features used well and I’ve seen them used poorly. In the days when the Motley Fool board was being built up, community members there used the recommendations feature responsibly; we used it to point other community members to the best stuff on the board. In the days when the Motley Fool board was in decline, community members used the recommendations feature to advance savage smear campaigns.

It’s not ratings features that make a board succeed or fail. It’s people. Attract people who love community and the community will grow. Attract people who hate community and the community will fail. Mel loved the Diehards community until the community expressed a strong desire to engage in honest posting re safe withdrawal rates and then he decided he hated it instead. That was his failing. Morningstar’s failing was not doing anything to rein him in until too many good people had left in revulsion and too many bad people had been drawn in by the out-of-control ugliness.

The Vanguard Diehards board was an amazing resource for middle-class investors for a long time. People insult it when they suggest that the adoption of ratings boxes is what did it in. The board was done in by one of the ugliest and most sustained rampages of abusive posting ever seen in the history of the internet. If we deny that, we fail to learn any lessons from the experience.

We need to learn these lessons. We need to stop hurting ourselves in this way. Mel deserves a lot more from us than what we have given him thus far.

And it’s not just Mel who deserves better, of course. Truth be told, we all deserve a lot better from us than what we have given ourselves thus far.

Love is the answer. Mel hates it when I quote from the lyrics of popular songs in discussions of investing. But I really do believe that Jackie DeShannon nailed it when she told us that “What the Vanguard Diehards Need Now Is Love, Sweet Love.” With a little more love, Mel never would have even considered posting abusively. With a little more love, Morningstar would have reined him in had he done so. With a little more love, hundreds of community members would have insisted that Morningstar act had it falled to do so. With a little more love, Mel would have responded to those thumbs-down ratings by acknowledging the problem and getting about the business of setting things right with his fellow community members.

Lord, we don’t need another SWR study.
We’ve got Old School ones and New School ones enough to read.
We’ve got calculators generating all the numbers you could want to show.
Lord, if you really want to know…

Today’s Passion: You can read my reaction to learning that I had been banned from the Vanguard Diehards board (now that’s a thumbs-down rating!) in a blog entry entitled Banned at Morningstar!

Should You Resist Hunches Or Yield to Them?

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Neither.

You should explore them. You should try to figure out where they are coming from, what they mean.

Hunches are not the product of logic. In that sense they are irrational.

But some hunches represent a sort of super-logic. There are circumstances in which a hunch can permit you to jump over the limits of pseudo-logic to something better and more financially rewarding, a healthy, emotionally balanced logic.

At the root of the paradox is the human capacity for self-deception. Logic alone can never get us to where we want to go for so long as we are so prone to tell lies to ourselves. Lie-inspired logic can take you over a cliff by insisting that you continuine to move in a straight line no matter what your eyes tells you about the dangers just up ahead. There are cases in which a hunch can serve as a veto over the mad logic that if not questioned could ruin you.

Say that you’ve bought into the Passive Investing idea. It’s worked well for a good number of years. The logic says that you must never change your stock allocation no matter how wrong it comes to feel not to do so. Yet a hunch tells you that the Passive Investing idea was yesterday’s hot investing strategy, that the smart money is moving to a new understanding of what it means to “Stay the Course.”

Listen to that hunch!

In all seriousness, that’s a good hunch. That’s just common sense. The idea that you should stick with a stock allocation chosen at a time of reasonable prices when prices have gone to la-la land is obviously the product of a wild bull-market psychology. When the bull market goes bye-bye, so should the bull-market “logic.”

The problem is that you’ve adopted an irrational idea as the core principle of your investing mindset. You’ve left no means for common sense to persuade you through ordinary channels. So it takes a different route. In this case, common sense appears to you in the form of a hunch. It dresses up in irrational clothing to bring a rational message to a guy or gal who tried to abandon rationality for good but who is a bit too smart to stick with the program once the emotional pull toward doing so has disappeared. That hunch is the better part of you, the smart side of you. Let that good-looking fellow in the door! Give that clever gal a hand with her coat!

Not all hunches are like that, unfortunately. Hunches have a bad reputation in the investing realm because hunches cause a lot of trouble in the investing realm. You don’t want to let just any good-looking fellow in the door. You don’t want to be jumping up to help just any clever gal with her coat. You need to be discriminating.

You lower your stock allocation to bring it to where it should be at a time of sky-high prices. And prices really do come down. You feel like a genius. You feel like so much of a genius for anticipating the price drop that you begin to feel uncomfortable with even the small stock allocation you are now going with. The newspapers are now saying that stocks are for losers. They sure changed their tune! Maybe you should sell it all? Selling worked for you before. There must be a reason why the newspapers, which have in your experience always been biased in favor of stocks, are now urging you to dump them.

No, no, no. no, no.

In this case the hunch represents not common sense, but common fear. The newspapers are consistent enough. They are consistently emotional, consistently irrational. They reflect our own irrationality back at us. We should pay about as much attention to the newspapers when they are pushing us to get out of stocks for emotional reasons as we do when they are pushing us to stay overinvested in stocks for irrational reasons.

This is a hunch that comes from a bad place. This is a hunch that I would try hard not to listen to.

Some hunches are good. Some hunches are bad. How the heck are we supposed to know the difference?

Lift your hunch up in your hands and examine it. Study it. Check its history — where did it come from? Hold it up next to your other investing beliefs. Does it fit in? If it doesn’t fit in, is it because your other investing beliefs don’t get out enough, that you have become too insular, too dogmatic?

There is no one rule on investing hunches. Hunches can be of great positive value or of great negative value. I can say that you do not want to ignore hunches. Even the ones that you do not want to listen to can make you aware of weaknesses in your understanding of how stock investing works (if you were confident in your beliefs, bad hunches would not trouble you). So don’t be dismissive of hunches. Try to gain a sense of why you are experiencing them.

The person who says that he or she never experiences a hunch is like the person who says that he or she never gets annoyed with his or her spouse. I mean, come on. Hunches are a sign that you do not know it all. And you don’t. So it is not necessarily a bad thing to see this sign of the obvious reality appearing before you.

Don’t kick your hunches out as if they were unworthy, irrational things. And don’t embrace them casually. The appearance of a hunch is a sign that you have not thought things through carefully enough. It’s better to have a hunch getting you back to work than to experience a poor investment result.

Don’t automatically resist hunches and don’t automatically yield to hunches. View them as an reminder of the need to continue looking at things from different angles, to continue learning. Hunches are frightening only to the overly dogmatic.

Today’s Passion: I have a funny feeling that we will talk more about hunches as we continue boldly into The Future of Behavioral Finance.