I’ve added Podcast #89 to the “RobCasts” section of the site. It’s called The Equity Risk Premium Explained! (Perhaps)
Academics have long been puzzled by the 6.5 percent real return paid to long-term stockholders; they say that the risk premium is too high. It may be that the reason why the nominal risk premium is so high is that only a small percentage of stockholders (Rational Investors) earn the average return or better in the real world; most investors follow a Passive Investing approach and are forced to sell in the huge price crashes that result when highly emotional strategies become popular.
Many early studies avoided the issue of valuations because the researchers considered the issue to be too controversial.
That turned out to be an easy way to get a wrong answer.
Have fun.
John Walter Russell
It seems strange that Benjamin Graham defined investment academia in his time. He taught a course at Columbia part time. Later, Warren Buffett’s ideas were ignored. So were David Dreman and others. Now, Professor Shiller has built upon Benjamin Graham’s ideas. Part of academia listens to him.
If you haven’t taught a course in investing, academia hasn’t paid attention.
Have fun.
John Walter Russell
Many early studies avoided the issue of valuations because the researchers considered the issue to be too controversial.
Maybe they were the smart ones!
Rob
Adding to your hypothesis that most people do not get a 6.5% real return: mutual fund managers cannot afford to invest sensibly. If they did, they would have low allocations when the market rises to higher and higher levels, irrationally so. They would lose their jobs before enjoying the benefit of their good sense.
Have fun.
John Walter Russell
Great podcast. Keep it up.
Have fun.
John Walter Russell
‘forced to sell in the huge price crashes’
Who is forced to sell and why?
Who is forced to sell and why?
It’s generally those who are following a Passive strategy who are forced to sell, BigProblem.
The Passive model dramatically understates risk at times of high valuations. Because this strategy was promoted so heavily during the days when prices were at insane levels, we now have millions of middle-class people who took on far more risk than they could afford. Most of those people are going to need to sell.
We need to provide people with sensible and accurate and realistic investing advice. It’s not just one group of investors that benefits when we do that; it’s everyone. We all are suffering from the effects of this economic collapse.
My take.
Rob
But why are they forced to sell?
Seems to me that to achieve nearly exactly the 6.5% or whatever long term real return of stocks, you just hold stocks for the same period of time.
No timing needed.
Seems to me that to achieve nearly exactly the 6.5% or whatever long term real return of stocks, you just hold stocks for the same period of time.
The historical data supports that claim for those in circumstances which permit them to wait 30 years to see a good return on their stock investment.
Rob
But why are they forced to sell?
Because it is a rare middle-class investor who can afford to wait 30 years to see a decent return on his or her money.
We should be letting people know how reckless and irresponsible the Passive strategy is for those with middle-class incomes.
Rob
But if a person is investing for retirement they often times have much longer than 30 years.
If they are investing in a short time frame – why would they invest in equities?
If they are approaching retirement why would they be mostly equities? If the are approaching retirement they should mostly be in bonds so an equity downturn should not overly concern them.
It seems like you are trying to solve a problem that does not exist except for people’s stupid decision to invest in equities inappropriately.
But if a person is investing for retirement they often times have much longer than 30 years.
The idea that any middle-class person invests solely for retirement is a Passive Investing myth, BigProblem.
People want to see their wealth increase gradually over time. The huge price crashes that always follow after large numbers of people are persuaded of the merits of a passive strategy mean that most people are seeing not gradual increases in their accumulated wealth but bone-crushing reversals that are likely to remain in place for decades. That means that people cannot start businesses or cannot send their children to college or cannot move to bigger houses. All of those effects hurt the economy and thereby hurt all of us. Passive is a loser idea times ten.
It seems like you are trying to solve a problem that does not exist except for people’s stupid decision to invest in equities inappropriately.
Most of the people who were taken in by the Passive concept were impressed by the fact that 90 percent of the big-name “experts” endorsed it. Who had a greater responsibility to inform themselves of the realities, the “experts” getting paid millions to know about this stuff or the middle-class workers taken in by it who have a hundred other things going on in their lives that they need to pay attention to? I have a lot more sympathy for the middle-class investors than I do for the “experts” who directed hundreds of millions of dollars of marketing muscle to promoting this junk.
Again, my sincere take.
Rob
If people want to see wealth grow gradually over time, they should NOT invest in stocks. People want a lot of things, it doesn’t mean they get to have them.
If people want to start a business they should be using their capital to start a business, not speculate on short time frame equity movements. Whoever heard of the business plan of raising capital by speculating in the stock market? It seems like a loony idea to me. Likewise on speculating on the stock market so people can move to a bigger house – equally crazy. Finally, college is typically a 20 year savings activity so you might as well invest as though you have a 20 year time frame which implies a fairly conservative approach.
I really have no idea where you are going with this. It honestly seems like you are trying to use fear/greed to promote your gimmicky ideas.
1) Stock markets go down for a long time sometimes! (Fear)
2) But don’t worry! I have the answer that can make it so you can start a business, send your kids to college, and buy a bigger house by timing the stock market! (Greed)
I think you have an excessively negative view of stocks, BigProblem. But I thank you for sharing your thoughts with us.
Rob