Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
“look at the fact that Shiller was awarded a Nobel prize”
Shiller was awarded the Nobel prize for showing, in historical data, that valuations affect future returns. That’s as obvious as the nose on your face. That’s a long way from your “buy and hold is the enemy” stuff. I do realize I’m getting lower expected returns now than when bonds yielded 8%, and stock P/Es were at 12. So what? Buy and hold still made me rich. I rebalance regularly, and reduce risk as I age – I’ve got more in bonds now than my total portfolio value 10 years ago.
When Shiller showed that valuations affect long-term returns, he changed the world. He showed how price changes come about. They don’t come about just because of economic developments. That’s what the Buy-and-Holders thought. If price changes came about because of economic developments, prices would fall in the pattern of a random walk. Hence, the title of the book “A Random Walk Down Wall Street.” Shiller showed that that’s just not so.
Shiller showed that the primary cause of price changes is investor emotion. Economic developments have an effect because they influence investor emotion. But the revolutionary change in understanding is that we now know that we cannot treat all gains as equal. Gains that are the product of economic developments are lasting. You can count on those gains in planning your financial future. Gains that are the product of investor emotion are fleeting. You cannot plan a retirement based on those gains because they could disappear at any moment. Investors need to distinguish the real gains from the emotional gains.
Is Buy-and-Hold the enemy? It wasn’t intended to be. It is a model for understanding the world that was intended to help us all. There was no bad intent in the development of Buy-and-Hold. But the Buy-and-Holders obviously did not have access to research that had not yet been published when they designed Buy-and-Hold. Had they had access to Shiller’s research, they would have designed Valuation-Informed Indexing. Given how the research that they had available to them at the time limited their ability to think through this stuff properly, they designed Buy-and-Hold. Then they learned something new in 1981 and it became necessary to make a change. That’s where things got on the wrong track.
It’s hard for humans to acknowledge mistakes. It’s especially hard when those mistakes are over questions so important that they are likely to cause millions of people to suffer failed retirements. For 37 years now, we have been trying to get this mistake corrected so that the thing that the Buy-and-Holders designed — our model for understanding how stocks work — can do the work they intended for it at the time it was designed. The Buy-and-Holders wanted the model to help people and they need to make the correction that the last 37 years of research showed us is required for it to do that. We need to teach people not that the market is efficient and that investors may remain at the same stock allocation at all times but that valuations affect long-term returns and that investors MUST adjust their stock allocations in response to big shifts in valuations to have any hope whatsoever of keeping their risk profiles roughly stable over time.
You can’t reconcile what Shiller is saying with what Bogle is saying. They are saying opposite things. Obviously there are many points in common. Shiller only showed that Bogle was wrong about one thing (that price changes are caused solely by economic developments). But that one mistake causes a lot of problems. Buy-and-Hold is a numbers-based strategy. If you count gains that are not real as real, you get the numbers wrong. A numbers-based strategy that gets the numbers wrong is not a good thing.
Emotion has a huge effect on stock prices. We should all be doing all that we can to rein in that effect. We should want prices to be as real/unemotional/economic-based as possible. The way to do that is to make investors aware of the dangers of treating emotional gains as real. When we see something like what we saw in the late 1990s, we should be warning people how much suffering they will cause themselves if they treat the phony emotional gains that they are creating as something real and lasting. If we warn them, they will make an effort to rein in their destructive emotions and we will all be better off. The Buy-and-Holders CELEBRATE phony, emotional gains. They treat them as real. To a Buy-and-Holder, a real economic gain is equivalent to a phony, emotional one. There is no room in the Buy-and-Hold Model for emotion-based gains.
Buy-and-Hold hurts us because it fails to put a brake on the destructive human emotions that cause us great harm in bull markets. It doesn’t do this because the Buy-and-Holders are bad people. It does this because they made a mistake for the perfectly understandable reason that the research they needed to avoid the mistake was not available to them at the time. The mistake just needs to be corrected. That’s where we stand today. Had the Buy-and-Holders known when they were starting out that they were going to make a mistake, they obviously would have vowed to correct it as soon as they learned about it. Deep in their hearts, the Buy-and-Holders want the mistake corrected as much as the Valuation-Informed Indexers do.
What makes it hard is that stock investing is not a purely academic exercise. When we make mistakes in our model of how stock investing works, we hurt real live human beings, millions of them. And we build careers around those mistakes. We become reluctant to correct mistakes we make because we want to avoid the embarrassment associated with doing so. We trap ourselves.
Everyone needs to take a step back and calm down. We need to get it on the record that the Buy-and-Holders are good and smart people that advanced our understanding of how stock investing works in hundreds of important ways. The Buy-and-Holders are our friends. But they made a mistake. Or at least there is one school of thought as to how stock investing works that is rooted in a belief that the Buy-and-Holders made a mistake. We need to let people who hold to that school of thought speak about what they believe in clear and frank and unapologetic terms. If we do that, we will all learn from each other and over time we will make use of the magic of constructive communication to gradually move to a better place for all of us.
The Buy-and-Holders started a learning experience. That’s the most wonderful thing that they did. But you don’t always know at the starting point where a learning experience is going to take you. Robert Shiller taught us all things about how stock investing works that we never expected to learn back when we took on the learning experience. He didn’t do a bad thing by confounding our expectations. He did a good thing by pointing us to exciting new possibilities. We need to treat those who believe that Shiller is on to something important with the respect they merit as people seeking to join us in an effort to better our world. When we begin doing that, we will all feel better about ourselves and about our mutual learning project in about 500 different ways.
Shiller changed the world in a very positive way. You can invest however you please. That one is up to you. But you cannot tell other people what discussions they may have on internet discussion boards re the last 37 years of peer-reviewed research in this field. There’s 37 years of peer-reviewed research showing that valuations affect long-term returns. People have every right in the world to point out to their friends that the Buy-and-Hold retirement studies lack adjustments for the valuation levels that apply on the day the retirements begin and to fill people in on what the numbers are that come up if valuation adjustments are included. Each investor must decide for himself or herself which school of academic thought is for him or her. You cannot make that decision for others. You take on responsibility for any financial losses they suffer as a result when you do so. That’s not smart.
I hope that helps a small bit, Anonymous.
Rob
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