Yesterday’s bog entry set forth the text of a comment by researcher Wade Pfau in which he advanced the idea that “perhaps the Trinity study was not meant to be a safe withdrawal rate study.” Set forth below is the comment that I posted in response:
The study uses a word very similar to “safe,” Wade. I believe the word it uses is “sustainable.” People just shortened that to “safe.” The two words mean essentially the same thing. A 4 percent withdrawal rate is no more sustainable than it is safe for retirements that begin at times of high valuations.
There are millions of people who are likely going to suffer failed retirements because of the demonstrably false claims put forward in the Trinity study, Wade. We have also seen numerous discussion boards burned to the ground because the authors of discredited studies and calculators based on the Trinity study did not want people to find out about the errors they made in them. The Trinity study and all the studies and calculators based on it should have been corrected when the errors in them were first made public (May 2002).
You are suggesting that the thousands of experts in this field who heard people calling the number generated by the study the “safe withdrawal rate” never corrected the record — Why? This doesn’t add up. If this was just a question of people using the wrong word, someone would have spoken up many years ago.
The reason that the authors of the study got the numbers so wildly wrong is that the authors of the study believe in the Efficient Market Theory. Under the Efficient Market Theory, stocks are always priced rationally and properly. Thus, both overvaluation and undervaluation are meaningless concepts.
We know that this is the reason for the errors because this same error (a failure to account for the effect of valuations in an investing analysis) was made in the examination of many other questions. For example, you see this error made in 90 percent of the analyses you see relating to what stock allocation is best (see, for example, the entire book Stocks for the Long Run).
Are we going to say that there was some mistaken terminology used throughout the entire book Stocks for the Long Run? No. Siegel was influenced by the Efficient Market Theory into thinking that there is no need to consider valuations when setting one’s stock allocation, just as the authors of the Trinity study were influenced by the Efficient Market Theory into thinking that there is no need to consider valuations when planning one’s retirement.
The error at the core of the Efficient Market Theory is fundamental. It has influenced every aspect of investment analysis for decades now. It needs to be corrected, not rationalized.
I agree with you 100 percent that the intent of the authors of the Trinity study was to point out that 7 percent withdrawal rates are not safe. The same is true of the authors of the follow-up studies and calculators. When you talk about intent, you move from the objective realm (the study gets the numbers wrong) to the subjective realm (the authors were trying to do a good thing). There’s no doubt in my mind that the vast majority of the people promoting the Efficient Market Theory (perhaps every last one of them) have good intent. It’s possible for someone to have good intent and still get something wrong. That’s what has happened here.
The real trouble has been the difficulty that people have experienced acknowledging the error. It is only by acknowledging that we don’t know everything that we are ever able to learn anything new. So discovering errors we have made opens up wonderful growth opportunities. The question we should all be reflecting on is: Why is it that in the investing field it is so darn hard for people to acknowledge obvious analytical errors (Shiller published research in 1981 showing that valuations affect long-term returns)?
I believe that, ironically, the reason is because investing is so darn important. If the errors didn’t matter, the people who made them would be happy to correct them. The errors we are talking about here are HUGE in their effect. It is the widespread promotion of Buy-and-Hold investing strategies that was the primary cause of the economic crisis. As you point out, the people who published these studies did so with good intent. Now they are being asked to acknowledge that errors they made played a big role in causing the second biggest economic crisis in U.S. history. That’s a lot to swallow.
To understand how humans react when they are faced with having to swallow that much, you need to go outside the literature published in the investing area or even the economics area and read the literature published in the field of human psychology on the phenomena of cognitive dissonance. Widespread cognitive dissonance is the only possible explanation of the behavior we have seen from so many otherwise good and smart people over the course of the past nine years.
Should we be charitable to people suffering cognitive dissonance? Of course. Obviously. They are fellow humans in pain. Our job is not to make them feel bad but to take them to a place where they can begin for the first time in a long time to feel a whole big bunch better.
Is it an act of charity for us to engage in word games that permit us to pretend a little while longer that the studies are not in error? It is not. That is an act of cruelty.
The next step is another price drop of 65 percent. A price drop of that size on top of what we have already seen is likely to put us in the Second Great Depression. How are the authors of the Trinity study (and all those who have put forward convoluted rationalizations on their behalf over the course of the past nine years) going to feel about themselves after they are forced to add to their record that they caused the Second Great Depression because they were not able to work up the courage to say the words “I” and “Was” and “Wrong” about a numerical error they made in a retirement study? Putting off recognition of the error just makes things far, far, far worse than they already are.
There IS a life-affirming way to proceed. The ultimate reality here is that we now have available to us the most effective investing strategy the world has ever had available to it (Valuation-Informed Indexing). If we could publicize VII, we could restore the confidence of middle-class workers that their retirement plans are going to work out. If we did this, we would be within six months looking at this economic crisis in the rear-view mirror. I think it would be fair to say that, once we did that, there wouldn’t be too many focused on any of the boo-boos made at earlier times.
And there’s more. When people wrote the history of how we got to the wonderful place that we can all go to for the price of acknowledging that humans are still capable of making mistakes, they would need to acknowledge that the authors of the Trinity study (and all the follow-up studies and calculators) played an important role in getting us there. Humans don’t learn all there is to know about a subject in one attempt. As you point out, the Trinity authors taught us something important — that 7 percent is not safe. People who came later built on that work and taught us even more — that even 4 percent is not safe at times of insanely high valuations and that even 9 percent is safe at times of insanely low valuations. No, the Trinity authors did not say that in their study. But they played a key role in the story and fair-minded people are going to acknowledge that.
But they can’t very well acknowledge it today, can they?
They can’t acknowledge it today because it isn’t so today. It isn’t so because we cannot move forward to learning what we need to do to enjoy far higher returns with far less risk UNTIL WE GET ABOUT THE BUSINESS OF BUILDING A NATIONAL CONSENSUS THAT VALUATIONS AFFECT LONG-TERM RETURNS, THAT THE EFFICIENT MARKET THEORY IS THUS INVALID AND THAT BUY-AND-HOLD IS THUS (HOWEVER MUCH THIS MAY BE CONTRARY TO THE INTENT OF THE PEOPLE WHO CAME UP WITH IT) THE PUREST AND MOST DANGEROUS GET RICH QUICK SCHEME EVER DEVELOPED BY THE MIND OF MORTAL MAN.
That’s the price of admission, Wade. I don’t say that because I am a meanie. I say it because I am an anti-meanie. There is no other way to take this to a good place. I have spent every day of the past nine years trying to think up some other way, some way that lets people not have to say The Three Magic Words, and there simply is no other way. If we can reach a consensus that The Three Magic Words really must be spoken, we thereby enter a very magical place for all of us — high investment returns at minimal risk, huge economic growth, an end to the economic and political crisis, thousands of new studies and calculators and blogs and books and discussion boards that describe strategies that actually work in the real world. If we cannot work up the courage to do that, we in all likelihood bring on the Second Great Depression and only the devil himself knows what horrors follow from that.
I say that the Trinity authors got all the numbers wildly wrong. Not by intent. They were in the company of a whole big bunch of good and smart people in thinking that the Efficient Market Theory was valid. But it is not. There is now a mountain of evidence showing that valuations affect long-term returns and precisely zero rational grounds for believing otherwise. I believe (strongly) that we all need to move on.
Scott Burns once told me that he viewed my effort to let middle-class investors know what the historical data really says about safe withdrawal rates as “catastrophically unproductive.” I don’t agree with Scott re this one. I see the efforts of all those (including Scott) who have helped with the cover-up as “catastrophically unproductive.” I love learning. That’s why I became a journalist. I love asking questions, learning the answers to them and sharing what I have learned with others. It fills my heart with joy that we have learned so many wonderful things about how stock investing really works during the first nine years of our SWR discussions. My strong hunch is that we will all be working together to learn a whole big bunch more in days to come. I very much look forward to the experience.
I have a funny feeling you are going to be right in the middle of all the good, exciting stuff that will soon be going down, Wade. We are getting close to the time when the real fireworks (the good kind!) begin! Let’s all let that in and put this ugly rationalization junk behind us once and for all.