I’ve posted a Guest Blog Entry at the Free From Broke site called How to Change Your Stock Allocation in Response to Valuation Shifts.
Juicy Excerpt: Stock valuations do not jump randomly from super-low levels to super-high levels. They change gradually over a 30-year or 35-year time period. They start at super-low levels, move to fair-value levels, continue moving up until they reach insanely high levels, and then crash hard.
We are today at a P/E10 of 21, working our way down from a P/E10 of 44 to a P/E10 level somewhere in the neighborhood of 7. The Return Predictor tells us to expect an annualized 10-year return of 2.7 percent real. We likely will see returns far worse than that in the early years of the 10-year time-period (while stock valuations continue to drop) and much better than that in the later years of the 10-year time-period (after we achieve capitulation and begin on the path to economic recovery).
Please understand that you will not obtain the 2.7 percent return unless you hold any stocks you buy today for a full ten years. Unless you are certain that bone-crushing losses in the early years will not cause you to sell, you would be better off in some other asset class until the price for stocks improves a good bit more.
Good piece.
While stocks are somewhat over-valued today, the alternatives aren’t great. I think stocks can deliver more than 2% than alternative “safe” investments (yields being depressed), albeit with wild swings across the next 10 years.
Of course, it is always better to sit in relative protection than getting a big loss—by forcing an issue with too much equity. Still, something like 20%-40%, depending on individual risk taste might be something to consider, despite the gains this week. My crystal ball is cloudy, but I think we are in for a wild trading range for some time to come.
You mentioned that valuation informed indexing will keep on working even if folks discover it. I agree. But I think it is because the drivers of the valuations mechanism—fear and greed—will always endure. Besides, Shiller’s work is known by the big institutional managers, gets mentioned on CNBC, but they generally don’t heed it because their jobs are based on consistent outperformance.
Ironically, they *would* outperform with PE/10 informed investing, but their pressure to outperform is constant—yearly, not a 10-year span—and a PE/10 strategy means, necessarily, that sometimes you will underperform the general market for a time. One does need a 10-year perspective in this, as you also mention. That sort of prudent patience is a challenge to many.
Hope this finds you well.
Arty
It’s always good to hear your voice, Arty.
All that you say makes sense to me.
I strongly agree that exercising prudent patience represents a challenge for today’s investors. My view is that all in this field should work as hard as they possibly can to help people meet that challenge. We won’t achieve 100 percent success. But we could work this a lot harder than most of us are working it today, in my assessment.
Rob
I think you have made strong points concerning valuations and that these have made their way, in various forms, to a broader community, even when you are not directly credited for this. Though, sometimes, readers mention having found your work. I think many more individual investors who take the time to research these things, today have their plan informed by PE/10. And I think you play a role in that.
John Hussman, who is read by many, also helps, as he mentions PE/10 frequently. Though, I think Hussman gets too cute with his weekly adjustments, which then drive up the price on his funds due to transaction costs. One can be “too smart by half”.
Ironically, Shiller is so sheepish when he speaks, that his advocates (like Hussman and Grantham and you) do a better job of calling it to attention than he does. Shiller is far more effective a writer, in my view, whereas Grantham, Hussman, and Bogle do a good job expressing themselves all around.
What is nice about a PE/10-informed strategy is that it is truly simple. Basically, just use the S&P 500 as that is where the research rests, and adjust only the exposure to that. No need to wonder about “diversification” via asset classes or even foreign exposure, which can often lead to further complexities, market-timing, expense, and this all weakens the implementation of the model.
The fixed income portion is an easier way to go, even if one chooses to use only the “riskless” T-Bills for the portion not in stocks. And perhaps soon, T-Bills will be preferable to bonds (with their current yields).
The really hard part is addressing the emotions and patience that a PE/10-informed approach requires. Sort of like when Buffet says that investing is “simple but not easy”.
The only thing I take issue with a bit is your last paragraph, Arty.
I agree that handling the emotions is the hard part of stock investing. I do not agree that following a P/E10 approach is harder than following an approach in which one doesn’t look at P/E10.
Perhaps that seems to be so for a time. But look at what the Buy-and-Holders are going through today. They are stressed to the max. Some acknowledge it, some don’t. But every thread shows it to be so.
When you use P/E10, you know in advance what is going to happen (not with precision, but close enough). So there is nothing to get upset about. In the long run, taking valuations into consideration reduces the stress of stock investing by 80 percent. And it is emotional stress that causes all the complexity.
I’m a believer, Arty. So I am biased. But this is what this obviously biased observer truly believes.
Rob
I agree. Biased? Yes but also experienced—and that matters a lot, as I’ll explain.
I agree Buy and Hold can wreak havoc on the emotions. 2008-09 proves that. “Plan B” proves that in spades. Even rebalancing, in hostile downturns, can become a huge hurdle.
But (AND) PE/10 asks more than simple rebalancing (beyond educating yourself about it) because it requires one to commit *far more* equity in a downturn than a simple rebalance would. And in that sense, it is harder emotionally, even if you (“you” meaning anyone) understands the PE/10 theory and the financial history that informs it.
Now, you say, “When you use P/E10, you know in advance what is going to happen (not with precision, but close enough). So there is nothing to get upset about. ”
I can argue (so can you) that the books that advocate Buy and Hold have similarly prepared investors for “what is going to happen”—the necessary hard downturns (Bogle’s work is full of such writing, and other writers too). But all those words have not necessarily helped folks weather their emotions or avoid being upset!
So like combat maneuvers and military theory, real war is a decidedly different thing, emotionally. It is true for ALL investing approaches that partake of equities that asks for greater equity commitments at times. Nobody I think comes to any of this fully- formed. We all must make mistakes to learn—and we must make them *while under fire*. That is the nature of experience.
You are an experienced investor and you’ve lived this approach for quite some time (whether you’ve chosen to be in equities or not for your own reasons). And so have I, for a lesser time. So, perhaps, we are not so frightened at the March Lows (PE/12 or so) or so confident at higher valuation levels—because we have experienced some of that (you longer than I have). That is, we have done more than just read the book and inferred an approach (as you have articulated).
But others, who haven’t yet done this must then do the same—*live through the implementation*—even if the the PE/10 argument, if we can call it that, is the superior approach. I think it probably is better compared to most conventional investing. So does Grantham and Hussman. Buffet would likely agree, and he is famous for buying when others are most fearful. So still, Buffet’s words have value: “simple but not easy”.
I don’t agree that the Buy-and-Hold books properly prepare investors for crashes, Arty.
Yes, they have a few vague paragraphs that say something like “You need to hold through hard times.” The rest is Get Rich Quick mumbo jumbo that gets people all emotional and excited. It’s like casinos that put up a sign saying “bet with your head, not over it.” Fine. The same casinos spend millions trying to get people to bet over their heads. This is what marketing is all about.
Stocks were priced at three times fair value in 2000. We always go to one-half fair value in the wake of huge bull markets. So those heavily invested in stocks should have been expecting to lose something in the neighborhood of five-sixths of their lifetime savings. The Buy-and-Hold books were NOT putting these numbers in front of people, Arty.
How do I know?
I know because I WAS putting those numbers in front of Buy-and-Holders and I saw the reactions. The reaction of 90 percent of Buy-and-Holders was shock.
If the Buy-and-Hold books had been telling the story straight, there would have been a ho-hum reaction. People would have said “tell us something new, Rob.” That’s not how most people responded to my posts reporting on what we have learned from the academic research of the past 30 years.
Rob
My reading of Bogle (one of the fathers of buy and hold) is that what he says is, in the main, “age in bonds” (as a starting point) and then “buy and hold and rebalance”. Other authors seem to say the same. Now, I disagree with buy and hold, and “age in bonds” is a nebulous way for assessing personal risk taste.
But just so we are on the same page, what are the precise quotes from, say, Bogle, that are “get rich mumbo jumbo”? I just want to be clear on the precise language used by specific authors that support that notion.
But yeah, the books have not as yet done a good job in addressing the realities of equity investing.
—
My basic point is that there is no way—EX ANTE—to properly prepare an investor for a highly emotional experience, just as no amount of boot camp can simulate real battle. At some point, even if armed with the better argument, an investor has to *live through the implementation* of a concept. ANY concept.
But I also think that the better investing book—the one that prepares an investor better for the realities you describe—has not yet been written. Shiller’s book isn’t it; it is only the bedrock. Such a book needs to contain not just historical background (Shiller), supportive studies (like Wade), perhaps some copy by Hussman and Grantham, but also suggestions for implementation (that builds, say, on your article or some other relevant work). It would also include examples of what PE/10 can really mean as a holding period. I’d like to see that book.
Then, I’d say investors would be better prepared.
But just so we are on the same page, what are the precise quotes from, say, Bogle, that are “get rich mumbo jumbo”?
Please understand that Bogle is one of my heroes. I view him as a giant in the field. There would be no Valuation-Informed Indexing without John Bogle. I learned as much from Bogle as I learned from any other expert, including Shiller and Russell.
That said, the sort of thing that Bogle says that causes huge trouble for millions of middle-class investors is his injunction to “Stay the Course!” What does that mean?
If it means “try to keep your risk profile roughly stable,” Bogle is the leading advocate of Valuation-Informed Indexing alive on Planet Earth today. It’s not possible to keep your risk profile stable without changing your stock allocation in response to big valuation shifts. So, if that’s what the phrase means, Bogle and I are soul brothers.
But that’s not how the Lindauerheads interpret “Stay the Course.” The Lindaurheads say that it means to stay at the same stock allocation. That’s the opposite of maintaining the same risk profile.
Bogle won’t tell us what he means. I offered to make a presentation to the annual Bogleheads conference and to ask him that question and find out what he thinks and the owners of the forum elected to start a new forum to escape me and my annoying questions rather than to permit me to ask those questions in a public meeting. So I think it would be fair to say that there is some funny business going on re these matters, Arty.
I know that the Lindaurheads interpret what Bogle says in very dangerous ways. I don’t know precisely what Bogle thinks because he won’t answer questions about these matters. I have sent him three e-mails trying to learn more about what he really believes. But he has not responded to those e-mails.
I have never seen Bogle correct the Lindauerheads. That suggests that he does not have a big problem with what they tell people.
That’s pretty much all I can say about this topic, Arty. I wish that some others would get involved and try to find out in more detail precisely what Bogle believes. We need Bogle promoting Valuation-Informed Indexing. That would be huge. And he has indeed said many things supportive of VII. But I don’t think that I can quite say today that The Big Guy has endorsed VII. I wish I could.
If anybody has any ideas as to what I might do to persuade him to make a flat-out endorsement, I would be grateful to hear them. Once we get that endorsement from The Big Guy, I believe that we are on our way to bringing this economic crisis to an end.
Rob
My basic point is that there is no way—EX ANTE—to properly prepare an investor for a highly emotional experience
Stock investing would no longer be a highly emotional experience if we could just open the internet to honest posting on the academic research of the past 30 years, Arty.
There is not one person alive who does not want to be an effective investor. Let people know what works and people are going to do it. Once we persuade most investors to drop Buy-and-Hold and go with a Valuation-Informed Indexing strategy, there can never again be another bull market. Each time prices got too high, there would be enough sales to bring prices back to fair-value levels. Permit honest posting and stock prices become self-regulating.
It’s this idea that Buy-and-Hold can work that has caused all our troubles. I know that people have a hard time letting that in. But I have studied this for nine years and I have come to believe that with my entire mind, heart and soul.
Buy-and-Hold was a mistake Had Shiller published his research in 1971 rather than 1981, there never would have been any Buy-and-Hold. We would all have been Valuation-Informed Indexers going back to the publication of A Random Walk Down Wall Street, which would have been a very different book had all the key research been available to the author at the time it was published.
We have known what works for 30 years now. Our trouble has been persuading the Buy-and-Holders to acknowledge their mistake. This has been a big, big, big, big hold-up. Once they do that, we are all off to the races. I think we could be looking at the economic crisis in the rear-view mirror within six months.
Rob
Regarding “stay the course”. I think Bogle and many authors mean to establish an asset allocation (risk profile, etc.) and then stick to those percentages (buy and hold) even when the market is going down. The percentages change only as one ages or personal circumstances dictate a change in risk profile.
Bogle introduces nebulous (and contradictory) things like “tactical asset allocation” and make small changes if afraid (here, these statements are almost always a response to fear in *downturns*). However taken, these, in my view, are really just ways of trying to maintain his first principle—stay the course with same allocation— close as possible.
Bogle also mentions possible tinkerings when the market is absurdly high or low. Those statements just beg the question and fall short of arriving at the place they really should land.
I agree with your main points on valuations, more now than before. I still think there can be versions of buy and hold that can and do work all-weather (like the Permanent Portfolio or perhaps conservative balance plays like holding equity at only 35-40%) but I don’t see these as practical for most.
What is practical for most is something that uses the big benchmark—S&P 500 or its proxy TSM). This is what even casual folks understand because the media represents it—hourly. The S&P IS stocks and the essential valuations work was done on it (though the concept could also work for those living abroad using their equivalents). Grantham differs from Shiller in that he assigns valuations to multiple asset classes. He’s not wrong but that is not necessary and confusing for most. The simple way is better for most.
Finally, even if folks understand the concept of valuations, the implementation part remains the place where more explication is needed. Glad to see you doing more work there. And good to see Wade’s work. Would like to see an established author take that to the bookshelves—from concept to implementation—in an accessible manner.
Every word of that post makes a great deal of sense to me, Arty.
I think that the only thing holding us up today is the Social Taboo on talking about this stuff frankly. We all want the same thing. We all want to learn how to become effective investors. Once we reach a consensus that it is okay to discuss this stuff, we are just going to move forward very quickly and feel much better about our financial futures and start regaining our self-respect and our confidence and our appreciation and respect for our fellow community members and all sorts of wonderful things.
All of the content stuff is easy as pie. I don’t mean that we can come up with perfect answers to every question. There will never be perfect answers to every question, so that’s a silly expectation. I mean that there is nothing intellectually difficult about any of this. People from all different perspectives can make their case and all those listening in can elect which case to go with. That’s the way it is done in every other area of life endeavor and that is how it should be done with stock investing too.
The problem has always been on the process side. The Buy-and-Holders say “You cannot talk about the dangers of Buy-and-Hold and that’s that!” and so the job never gets done. And then they point to a poll showing that most people don’t think Buy-and-Hold is dangerous. How could they? They have never been permitted to hear about the dangers! Open up the boards and blogs to honest posting and those polls will change! Fast!
That’s the entire story and it has been the entire story since the first day. Humans learn by talking things over and so we must permit ourselves to talk about investing if we are ever to learn anything new about investing. We don’t know it all today. So it is critical that we permit ourselves to learn new things.
I could be proven wrong about every substantive point I have ever made and I still would know that I have played a valuable role in these discussions. Why? Because I am the one who has been saying since the first day that we must HAVE the discussions. That’s the #1 thing. The content questions are secondary to the process questions. And it is flat-out IMPOSSIBLE that I am wrong on the process question. The idea that honest posting on investing should be banned on the internet is not just wrong, it is INSANE.
I wish that there were not so many of my fully humans who have come to hold insane views on stock investing. I really do. And it shocks me. And it amazes me. But I can’t deny what I see appear before me on the computer screen each morning. Lots of us have come to hold insane views on stock investing and it is killing us. I don’t want to see any of my friends hurt. So I have no choice but to speak out in favor of the idea of lifting the ban.
Anyway, I am grateful that you have been willing from time to time to share your thoughts with us. You add a great deal. I hope that there is no one who believes that I think I know it all. I know that I do not. I want to hear what all the others think. I would be scared to death to have anyone going by what I say if I didn’t know that there were thousands of people offering very different takes every day.
I’m one guy whose primary qualification for writing about investing is that he figured out how to get stuff posted on the internet. Take it or leave it, you know? That’s what I bring to the table, nothing more and nothing less.
And I am one of those darn humans too. So there’s a good chance that some of the things I say are insane.
I’m sincere. I know that for sure. And I am right on the process issue. I know that for sure.
The rest is just some guy talking. Take it or leave it. You (I don’t mean just you, Arty, but anyone who happens to hear these words) remain my friend either way.
Rob
Let’s get more talk going on the implementation side of investing in this way. Funny thing, but I was listening to that guy Jim Cramer on MAD MONEY. It is entertaining and sometimes CNBC gets good guests like Shiller and Bogle.
Anyway, Cramer (who is the stated enemy of many “investing vs. speculation” camps, including buy and hold) just said something that spoke to all this. He said to add money when the market drops (4%) and take some off the table when it went up (4%). Now he was speaking about this crazy *current* market requiring that sort of approach but it sounded a bit like that fellow Norbert who created a similar “model” for an incremental VII some time ago.
I think your 25/50/75 based on various PE/10 (was that your proposal?) seems a better baseline approach (baseline adjusted to personal profile, of course) for most folks and the shifts would not occur very frequently.
Author Ben Graham had a recommendation for these numbers too but did not articulate the market conditions fully:
“Remember, Graham’s philosophy was, first and foremost, to preserve capital, and then to try to make it grow. He suggested having 25% to 75% of your investments in bonds, and varying this based on market conditions.”
You know, Buffet, who recognizes the COST of stocks better than most men, would agree with you on one point, a point you have made years ago in several ways:
Buffett says, “stocks are the only thing people don’t like to buy on sale.”
There is something very important in his words that needs to be articulated.
I get this question about implementation all the time, Arty. I want to be responsive. But my sincere belief is that people worry about this aspect of the question far too much.
Say that you were buying a car and you asked your friends for advice. One person might say “always buy used.” Another might say “always lease.” Another might say “never pay more than $20,000.” Another might say “always buy certified used.” Another might say “always check the prices in Edmunds first.” Another might say “always bring a friend to the dealership with you.” And on and on.
Who is right?
There is no one bit of advice that is right for every car buyer in every circumstance. What you want is just to let everyone have his or her say. If you listen to a variety of perspectives, you will do fine. Perhaps you won’t get it perfectly right. But you’ll get close enough so that you can be confident you obtained good value for your money.
There is no one perfect way to buy stocks.
The problem with Buy-and-Hold is that it is so intensely emotional that, once you start walking down that path, you become unable to bear to hear what the academic research says or what the historical data says or what common sense says. When you find yourself getting so insanely irrational that you are looking to get friends of yours banned from discussion boards, you should know that you are very much on the wrong track.
That’s the biggie.
The trouble with Buy-and-Hold is that it is mindless. The most important decision you make as an investor is your choice of a stock allocation. Buy-and-Holders do not even try to get this one right! They choose one allocation and then stick with it even when circumstances change dramatically. I mean no insult to my Buy-and-Hold friends, but that makes precisely zero sense. It is insanity to always stick with the same stock allocation. There is no way to justify such a choice.
Grantham said go with 75/50/25. I think that’s a good choice. I lean more towards 90/60/30. That might be good in some circumstances. Personally, I have been at zero stocks for 16 years. That made sense for me but my circumstances are unusual. Going by pure theory, it might make sense to make 5 percent changes in allocation with each 1 or 2 point change in P/E10, a gradualist approach. There are scores of different ways to do this.
We do not need to settle on one implementation approach. It’s not a good idea to do that. We just don’t know enough today. We have never even allowed people to talk about the last 30 years of academic research. First, we need to have some conversations. Then, over time we will be able to narrow things down to a small number of good implementation approaches. We are putting the cart before the horse in trying to do that before we even permit conversations to be held.
The key thing that people need to understand today is that Buy-and-Hold is the worst of all possible choices. Why? Because Buy-and-Holders don’t even TRY to get it right. The only appeal of Buy-and-Hold is that it is mindless. That makes it simple, according to the advocates. But being mindless ends up being 10 times more complicated in the long run. You can never possess confidence in a mindless approach. So you add all kinds of emotional angst by turning off your brain.
There is no one perfect way. Each investor is different and needs to take into consideration different factors. If you want to do a test to show that VII always performs better, you can choose something like 90/60/30 to test. But that doesn’t mean that that’s the best approach for any particular investor to go with. The fact that it works in hypothetical tests using historical data does not prove that it is going to work for any one particular investor in the future.
When we open the internet up to honest posting, we are going to have hundreds of blogs and boards looking at dozens of different ways to implement Valuation-Informed Indexing. Each will add something to the discussion. Even the ones that get it wrong will help us by showing us what doesn’t work.
There’s an advantage in having the discussion. We learn through conversation. We need to stop trying to jump ahead to reporting the conclusion without first going through the PROCESS of talking over different possibilities.
You and I could never figure this all out if we spent 1,000 years trying to do it, Arty. We need Bogle participating. And Bernstein. And Burns. And the Bogleheads Forum. And Shiller. And Motley Fool. And Arnott. And the Early Retirement Forum. And on and on. It’s a community project and there just are no shortcuts. We learn by talking. So we MUST talk.
The only thing that we know with absolute certainty doesn’t work is banning honest discussion. That has proven to be a complete and unmitigated disaster. That’s Buy-and-Hold. That’s fear-based investing. That’s Get Rich Quick. Get Rich Quick is not the answer, Get Rich Quick is the PROBLEM.
Any move away from that is a move in the right direction.
Rob
Buffett says, “stocks are the only thing people don’t like to buy on sale.” There is something very important in his words that needs to be articulated.
Yes. This is huge.
People need to understand why the stock market does not operate like all other markets.
When you buy a car, you are pushing for a low price and the dealer is pushing for a high price. The market works things out so that the price ends up being somewhere in the middle.
It doesn’t work that way with stocks. Why? Because the buyers prefer higher prices! That’s the insanity!
Why do the buyers prefer higher prices? It’s because they are also part owners of stocks. They have portfolios and the portfolios have dollar values assigned to them. They want those dollar values to be as high as possible. So they turn off their brains and pretend that the nominal values are real values. Once they do that, the market stops functioning properly. There is no longer one party pushing prices up and another pushing them down. Both parties are pushing in the same direction and the market cannot do its job.
The magic of Valuation-Informed Indexing is that every price change has both a positive and a negative effect. When prices move up, your portfolio has a higher value but the long-term return on stocks goes down. When prices move down, your portfolio has a lower value but the long-term return of stocks goes up.
Do you see how that changes everything? It adds EMOTIONAL BALANCE.
When each price change has both a positive and negative component, investors become indifferent to whether prices go up or down. That takes the emotion out of stock investing! No one will ever again root for bull markets once we open up the internet to honest posting. If we never have another bull market, we will never have another bear market. We can eliminate volatility from the stock market. Volatility is optional!
People have a hard time accepting that. But it logically follows from Shiller’s finding that valuations affect long-term returns. We can eliminate volatility. Which means we can eliminate risk. Stocks are not by nature a risky asset class. We MAKE stocks risky by banning honest posting because a ban on honest posting causes us to become hyper-emotional about stocks and it is our hyper-emotional reactions to price changes that cause all the risk of stock investing.
You bring an end to stock risk by permitting people to report the realities. It really is that simple. And that complex. The Buy-and-Holders HATE this idea. But we don’t have any choice but to move forward. We are in an economic crisis that is getting worse by the month. And the only way out is to open up the internet to honest posting on safe withdrawal rates and many other critically important investment-related topics.
I’m sure of it!
Rob
Of course, I agree that there is no perfect formulaic implementation in stocks purchase, and for many reasons.
I cited 75/50/25, and Norbert, above, only to give a landmark example. Your example is fine too. They both speak to a basic concept that is the same. But once an investor (say someone who formerly knew only buy-and-hold) understands that his equity must (should) shift in line with valuations, he will arrive back at the same place—with how to do it?
All I am saying is continued discussion on possible approaches is helpful to a person who has not been looking at this, once he is arrived at the place of understanding that price matters here too. And if there were a book that discussed this concept, it would need a big chapter on *examples* in implementation. Beyond that, I agree folks have to sort it out themselves.
So, 75/50/25, 90/60/30, Norbert’s more granular approach, could all be examples for folks of different ages and circumstances to modify and contemplate.
if there were a book that discussed this concept, it would need a big chapter on *examples* in implementation.
I don’t think that’s so, Arty.
If you write a book about how to buy a car, do you need to list every possible thing a salesman might say and then tell people what their response should be? You don’t. You tell them the general idea, that they want a low price and they can take it from there.
It’s the same with stocks. The message you want to communicate is — You want a low price! Once people get it that high prices are bad, they can figure out the rest.
Buy-and-Hold sends the opposite message. Buy-and-Hold encourages price indifference.
My vision is of a world in which investing experts see it as their primary task to come up with tools that help their readers understand that valuations matter. We need to have this message repeated over and over and over again. It should come up at least once in every discussion of investing.
When we get there, there will never again be another bull market. So all these implementation questions will go away. If valuations never change, there will be no need for anyone to figure out how to implement their allocation shifts.
The great paradox of this is that, once we permit posting on the dangers of Buy-and-Hold, Buy-and-Hold will work!
It’s because we cannot talk today about the dangers of Buy-and-Hold that Buy-and-Hold has become so dangerous!
Say that the person who invented the car didn’t see that there was a need for brakes. So people driving cars were getting killed all the time. And the people who sold the cars didn’t want it to get out that they had made a mistake, so they spent hundreds of millions of dollars making the case for why cars don’t need brakes. The crisis that would be created would get worse and worse and worse.
Now think what would happen once they put brakes in the cars. Brakes would become a non-issue!
People would apply the brakes when needed. But it would no longer be such a big deal. People would apply brakes when needed and not apply brakes when they were not needed.
It’s like that with allocation changes. It is critical to make allocation changes today because 90 percent of investors are following a pure Get Rich Quick approach and stock investing has been as dangerous as all get-out since 1996. But once we permit brakes to be installed in the cars, all the risk of stock investing disappears.
We THINK of stocks as being risky because all we know is what stock investing is like in a world where no one is permitted to question Get RIch Quick strategies. Change that and the entire investing experience is changed in a fundamental way. There is no law that says that stock prices need to be volatile or that stock investing needs to be risky. We MAKE it risky with our promotion of Buy-and-Hold.
I am proposing that we stop promoting Buy-and-Hold. Once we did that, we would have brakes in the car. But we wouldn’t need to talk about brakes anymore because it just wouldn’t be a big deal anymore. All of the drama dissipates once we give up on this silly idea that it is okay to drive a car without brakes.
Rob
I agree about the buy and hold part. That is the essential component of understanding. And as that is the main message the rest is detail.
But I disagree that examples should not be provided to help folks think about the valuations question in general and how it applies to them in particular. It is always important to understand that the audience includes folks who never read investing books or certainly never monitored investment boards. Sometimes it is hard for people who do only that to see things from the perspective of those who do none of it. Which is to say, most people who are invested.
Also, I think the last 2 bears have, for a time, dampened any “get rich quick” messages. I think pain can makes people better receptive to ideas that might lessen future pain. At least for some.
Do you have specific quoted examples where Bogle or other well-known buy and hold authors have promoted “get rich quick” strategies. In my reading of his books, Bogle seems to discuss things from a much longer term perspective. But I don’t have all his books. I would like to see those specific quoted examples so I can better understand your take on that “get rich quick” aspect.
I don’t think that people follow what I am saying when I use the phrase “Get Rich Quick,” Arty. To make sense of what is going on, I think you need to consider the history of our efforts as a society to learn how investing works.
Before 1960, there was no systematic analysis of how stock investing works. We were living in the dark ages. They started to study investing in academic studies in the 1960s.
One of the things they learned is that short-term timing does not work. This was a big deal and people got very excited and hopeful for the future. This led to the development of the Buy-and-Hold Model.
They didn’t know at the time that they needed to distinguish short-term timing from long-term timing. Shiller was the first to show that long-term timing is different. So this was an understandable mistake. Still, it WAS a mistake. It’s not true that timing doesn’t work since long-term timing always works. But smart and good people came to believe at the time that timing does not work, period.
If timing doesn’t work, Buy-and-Hold makes perfect sense. Bogle thinks that timing doesn’t work. So to Bogle Buy-and-Hold makes perfect sense.
But he is wrong. If long-term timing works, investors MUST engage in long-term timing. If long-term timing works, then the risk associated with stock investing is not a constant but an ever-changing thing. Investors who fail to engage in long-term timing are failing to stay the course. Bogle himself acknowledges that failing to stay the course is a terrible mistake.
Bogle did not intend to endorse a Get Rich Quick scheme. He is trying to steer people away from Get Rich Quick schemes. But the objective reality is that Buy-and-Hold is a Get Rich Quick scheme.
Buy-and-Holders are counting their bull market gains as real even though they are not real. That’s the Get Rich Quick component. Your portfolio statement says that you have $300,000 when you really have $100,000 and you are making plans as if you had $300,000. To overstate your wealth by $200,000 is to pretend that wealth can be created out of thin air. That’s Get Rich Quick thinking.
I am not saying that Bogle himself dreamed all this up. He just went with the Efficient Market Hypothesis, which was the dominant idea of the time. The trouble is that he won’t give up on it! Shiller’s showing that valuations affect long-term returns discredits the EMH and people are still acting as if the EMH is valid. It’s like acting as if the sun circles the earth after it has been shown that it works the other way around.
We are in a Twilight Zone. Shiller discredited Fama’s ideas. But no one in a position of influence has the nerve to point out that the emperor is wearing no clothes because The Stock-Selling Industry has put millions into its marketing effort and millions of people are going to be upset to learn that they have been following a doomed strategy for many years now.
There are risks involved in using research to craft a strategy. One risk is that new research might discredit your ideas. That’s what happened with Buy-and-Hold. Now we need to figure out some way to help the Buy-and-Holders save enough face to agree to acknowledge that their first draft effort to develop a research-based strategy was flawed.
We all benefit from moving forward. But how do we get from where we are today to where we all want to be tomorrow? How do we make the transition from the discredited model to the model that really works (at least according to the research available to us today)?
Rob
I disagree that examples should not be provided to help folks think about the valuations question in general and how it applies to them in particular.
I’m not saying that examples are not helpful. I’m just saying that it is not a big huge deal to provide lots of example. If you provide a few, people will get the general idea and just getting the general idea will be a huge plus. Those who want to go deeper could look at more examples and that might be a bigger help.
Rob
the last 2 bears have, for a time, dampened any “get rich quick” messages. I think pain can makes people better receptive to ideas that might lessen future pain.
I’ve seen a big change in the reaction to Valuation-Informed Indexing since the crash. There’s no question about it whatsoever.
But there’s still a wall of resistance to some points. People shut down when you say “Buy-and-Hold was a mistake.” They don’t want to hear it. They worry that it hurts people’s feelings to say that.
If there was another way to say it, I would go with the other way. But nothing less than a frank statement about this key point will get the job done, in my experience.
VII is market timing. It’s long-term timing, the kind of timing that always works. But it is market timing all the same. You tell people who believe that Buy-and-Hold works that they should be timing the market and they freak. They say “But timing doesn’t work!” It happens every time.
We must distinguish short-term market timing from long-term market timing. The Buy-and-Holders are heroes for pointing out the dangers of short-term timing. But they must accept that long-term timing always works and is in fact required for those hoping to have some realistic hope of long-term success. We cannot get to first base until they do that. That’s the hurdle.
We want to be encouraging market timing (only the long-term variety!) not discouraging it. That’s the big change. That’s what makes Buy-and-Hold workable. Doing that changes the worst investing strategy of all time into the best investing strategy of all time.
It’s taken me nine years to see what a big deal this is. Once you can predict returns, stock investing is no longer risky. Could anything be better than being able to obtain the high returns available from stocks without having to take on more than minimal risk? This is investor heaven!
But Buy-and-Holders come up with a hundred silly reasons for not making the switch. It is emotionally painful for them to give up on Buy-and-Hold.
You are 100 percent right that the pain of experiencing huge losses is slowly bringing people around. But it is horrifying to watch this play out so slowly. We have not yet reached the point where the Buy-and-Holders will acknowledge that honest posting should be permitted. We need to see more pain even to get that far!
How much pain can we all bear? That’s the scary question. If it takes going into the Second Great Depression to open the internet up to honest posting on stock investing, we may never get to see the benefits of what we have learned from the last 30 years of research. Another Great Depression could cause the collapse of our political system and that would mean “Game Over” for Buy-and-Holders and Valuation-Informed Indexers alike.
Yikes!
Rob
“You are 100 percent right that the pain of experiencing huge losses is slowly bringing people around. But it is horrifying to watch this play out so slowly.
Yeah… Some ideas, like religious dogmas, require more pain to create change. My guess, is that most will never come around to what we are discussing regarding valuations, due to the nature of greed and fear.
Curiously, many of the leaders who advocate buy and hold are on record as saying “valuations matter”. But then what follows is either no detailed explication from the guru, or pretense on the part of the listener that the statement wasn’t really uttered, or something else was really meant. Together, they go on whistling past the graveyard.
But to extend the religious metaphor, there are those who can choose to become saved. It ain’t easy. Wasn’t for me. But I’m glad I came to your original board years ago (this was at least prior to 2007). I learned about Shiller and the ramifications of his work, and then did tons of my own research. Funny, if folks listened even at that late date (near PE 30), they could have been spared a lot of pain. Hell, knocking back to even 40% equity (which was rich at that level) would have been tolerable for many.
Now, because of low yields in fixed income, a new threat looms: High dividend paying stocks. Folks will now have to learn that these are still equities and thus no proxy for bonds. Dividends are great but the equity allocation must still jive with current valuations. Or else:
Meet the new pain. Same as the old pain. But with higher dividends.
Anyway, the pain is necessary, Rob. Few great developments have happened absent it. How much more? I fear we have to get to your “yikes” point. That’s how much more. We were almost there, then came those two super recovery years. That won’t happen this (next) time, methinks.
Again, I agree with all you say here, Arty.
There are lots of smart and well-informed people who think we will never get to the good place I envision. The logic is — it’s never happened before and human nature is not going to change.
I see three reasons for believing we may work our way to a better place this time:
1) This is the first time in which we have had academic research helping us to understand the realities. We can now quantify the effect of valuations. I think that empowers us, just as the discovery of electricity empowered us in many ways that were not clear at the time we began learning how to make use of it. We will never change human nature. But I believe it is possible to advance in our knowledge of our to rein in our most self-destructive human emotions;
2) We have no choice. Middle-class people generally did not invest in stocks in earlier days. Today they have no choice if they hope someday to be able to retire. So we must find a way to get accurate information on stock investing out to people or our entire society will collapse. The overvaluation was so bad in the late 1990s that we are looking at the Second Great Depression. Our political system cannot take that sort of hit unless we provide people some means of recovering their money — that’s Valuation-Informed Indexing; and
3) The internet provides us a means of getting the message out that does not require that we get advance buy-in from The Stock-Selling Industry. Once enough middle-class investors have been informed of the realities, The Stock-Selling Industry will have no choice but to acknowledge what the academic research says. Once that happens, we are off to the races. The hundreds of millions of dollars that has been spent in recent decades promoting Buy-and-Hold will in coming days be spent promoting Valuation-Informed Indexing instead.
I am optimistic. But a a fair case could be made that going back to the early days of our discussions I have been willfully optimistic about all sorts of questions and have been proven wrong over and over again. That's the other side of the story.
Rob
Rob,
When you mentioned 90/60/30 as a personal preference for VII implementation, what are the corresponding PE/10s?
Example, is 90 at PE/12 or lower, and 30 at PE/24 or higher (with the 60 being anything between PE/12 and PE/24)?
PE 12 and PE 24 are the main PE/10 landmarks I use for serious allocation shifts. Seems lots of pain occurs past PE 24 and PE 12 (or lower) has excellent long term returns.
Thanks.
Those cut-off points make sense, Arty.
Rob