Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
Who says there are two schools. Are you the finance dictator of investing?
That’s a good question. It is unfortunate that it is phrased in a hostile way; I obviously am not the dictator of anything, nor do I care to be. But the question being asked is an intelligent one and an important one. It would be helpful for people concerned about these matters to think this one through.
I cannot link you to the New York Times article reporting on the awarding of Nobel prizes to both Eugene Fama and Robert Shiller on the same day; the Times keeps their articles behind a paywall. But I read the article in paper form and in real time. It remarked on how odd it was that the highest award in the field was being given to two men who had opposite ideas of how stock investing works. That’s the story.
Fama and Shiller cannot possibly both be right. Fama says that the market is efficient and Shiller says that valuations affect long-term returns. If valuations affect long-term returns, the market is not efficient. If the market is efficient, valuations cannot affect long-term returns. Fama and Shiller are saying opposite things. The name for the school of thought that believes that Fama is right is “Buy-and-Hold.” The name for the school of thought that believes that Shiller is right is “Valuation-Informed Indexing.” There are two schools. That’s just the way it is.
All of the friction that we have seen results from the unfortunate reality that we have as a people tried to paper over the differences between what Fama is saying and what follows from it and what Shiller is saying and what follows from it. Most Buy-and-Holders acknowledge that Shiller has done important work. But I have never seen a Buy-and-Holder integrate Shiller’s findings into his or her understanding of how stock investing works. Buy-and-Holders ignore Shiller. They credit him with having done important work. But then they go about their lives as if Shiller did not exist.
That’s why my famous post of the morning of May 13, 2002, caused so much controversy. What I said should not have been even a tiny bit shocking. If valuations affect long-term returns, then you OBVIOUSLY need to take valuations into consideration when calculating the safe withdrawal rate. But most Buy-and-Holders had never stopped to realize that. Most Buy-and-Holders don’t believe that the market is purely efficient. But they believe that it is LARGELY efficient. So they think that the numbers you get from a study that does not consider valuations are at least in the right ballpark. But they have never checked the numbers. They don’t in fact know how much of a difference it would make to count valuations. They react with shock when someone says that they should count valuations because doing that would put them in a different world than the one that they have always lived in and they don’t like the idea of going to that different world.
Shiller created that different world, I didn’t. I have done nothing but advance views that follow from a belief that Shiller’s research is legitimate, which is a perfectly reasonable belief given that he was awarded a Nobel prize for his work. But when I say the things that I say, Buy-and-Holders are shocked because they have not heard these things before. The things that I say sound outlandish to them because they have never heard them before. And they are not too cool with thinking them through for the first time because their entire lives are riding on their belief that Buy-and-Hold is solid.
I am not the dictator of anything and I do not want to be the dictator of anything. But it is a simple fact that you don’t get the same numbers when you include a valuation adjustment in your calculation of the safe withdrawal rate. If Fama were right, there would be no need to include such an adjustment. But, if Shiller is right, an adjustment is required. So there are two schools of thought, no? One school says that you need to include the adjustment (because it affects the result), the other says that you do not need to include the adjustment (because it does not).
People who belong to the different schools should not be enemies. We should be working together to try to arrive at the truth of things. It is the shock that causes the friction. And the shock is the result of the unfortunate reality that as a society we have developed the habit of sweeping these differences under the rug rather than speaking about them openly and frankly. I think that Fama was wrong. I think he merited his Nobel prize because I think he made huge contributions. But I do not believe that he was right because I do not believe that the market is efficient. But I sure am not angry about the fact that his beliefs about how stock investing works are different than my own. And I am not angry that anyone else’s views are different than my own.
Should I lie when I post at boards, Anonymous?
I obviously believe that valuations affect long-term returns. So I obviously don’t believe that the safe withdrawal rate is the same number at all times. Should I lie about that to make you Goons happy? You cannot possibly believe that I should do that. It would be an absurd thing to believe. But I have never been able to figure out anything else that would satisfy you. You want me to lie. And that just can’t be right. The better way to go would be to acknowledge that there are two schools of thought and be friends despite our differences.
It is the 37 years of peer-reviewed research showing that valuations affect long-term returns that says that there are two schools of thought. Buy-and-Hold was developed at an earlier time, a time in which is was believed that the market was efficient. If the market were efficient, Buy-and-Hold would be the ideal strategy. But those of us who believe that Shiller’s research is legitimate do not believe that the market is efficient. So we of course have different ideas.
I hope that helps a small bit, Anonymous.
My best wishes to you.
Finance Dictator (According to My Goon Friends But Not According to Me) Rob
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