Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
You risk forward looking assumptions. You don’t risk adjust actual outcomes. As you said, you are not a math person.
I’m certainly not a math person. No argument there.
You don’t need to be a math person to read Robert Shiller’s book on “Irrational Exuberance.” If Shiller’s Nobel-prize-winning research is legitimate, then stocks are a lot more risky when irrational exuberance is sky high (when the CAPE value is off the charts) than they are when irrational exuberance is under control (when the CAPE value is at moderate or low levels).
Shiller published a paper in 1996 telling investors that, given the insane CAPE value that applied at the time, stock investors who failed to lower their stock allocation would live to regret that decision in 10 years. As things turned out, today’s CAPE level is even more insane that the one that applied in 1996. When you say that you don’t risk-adjust actual outcomes, it seems to me that you are saying that, now that we know how things turned out, we should not be saying that the many stock investors who ignored Shiller’s advice (Buy-and-Holders) did not take on a crazy amount of risk by doing so. Is that what you are saying?
If it is, I certainly do not agree. I think those investors were nutso. I acknowledge that things have not yet turned out too bad for them. But, if they continue to take on insane levels of risk, sooner or later they are going to get burned. That’s certainly how it has been playing out for 150 years now, which is as far back as we have good records of stock prices. No one can say precisely when a price crash is going to come. So investors can get away with following Buy-and-Hold strategies for a time. But not indefinitely. Prices always sooner or later return to fair-value levels. The market could not continue to function if they didn’t. The core purpose of a market is to set prices properly. The relentless promotion of Get Rich Quick/Buy-and-Hold strategies slows down that process but it does not do away with it.
My advice is that investors always engage in the amount of market timing needed to keep their risk profile constant over time. I would never tell an investor that because he got away with a high-risk strategy for a time that it made sense to continue following it. The aim should be to never take on more risk than one can handle. Those following price-indifferent (Buy-and-Hold) strategies thereby ensure that sooner or later their risk profile will be a wildly inappropriate one for someone with their risk tolerance. For what purpose, you know?
Rob
“ Shiller published a paper in 1996 telling investors that, given the insane CAPE value that applied at the time, stock investors who failed to lower their stock allocation would live to regret that decision in 10 years. As things turned out, today’s CAPE level is even more insane that the one that applied in 1996.”
So what you are saying is that the advice did not work out. I guess it is just dumb luck that got me to $7 million. So what specific investments would YOU if you had $7 million?
You don’t have a stock portfolio valued at $7 million. If your portfolio statement says that your stock portfolio valued at $7 million, you have a stock portfolio with a real and lasting value of $3.5 million (since today’s CAPE value is double the real-value CAPE value). That’s the entire point of Shiller’s Nobel-prize-winning research on irrational exuberance.
I wouldn’t say that it was dumb luck that got you to a temporary $7 million. I would say that it was sound investing that got you to the $3.5 million that is real. And that it was the prohibition on discussion of Shiller’s research that got the other, phony and temporary, $3.5 million, And of course I think you would be better off without the phony and temporary $3,5 million. There’s a good chance that seeing it treated as something real on your portfolio statement will cause you to believe that it is real and thereby give rise to all sorts of bad financial planning choices. You would be better off knowing the real and lasting numbers.
Rob
The value of something is based on what someone is willing to pay you right now. Same goes for your house, car, business, etc. Further, unless you have specifics of my portfolio, how are you even able to comment on future potential or risk?
You can’t use the price that someone is willing to pay as a signal of real value if that person lacks the information he needs to form a reasonable assessment. If there were not a ban on honest posting re the last 40 years of peer-reviewed research in this field, I would agree with you — the values sets by the market would at least be close to the mark. But when people are denied the information they need to form proper assessments, it is just not possible for them to set the value properly. This is why I say that we should open every site to honest posting.
Rob
What information do people not have that isn’t already posted somewhere on the internet? Why should you be able to post what you want wherever, yet you do not allow the same for others?
People should be hearing every day about the dangers of Get Rich Quick/Buy-and-Hold. Given that there’s 41 years of peer-reviewed research showing that market timing always works and is always required, people should be hearing the words “timing always works” AT LEAST as often as they hear the words “it’s possible that there might be circumstances in which timing might not work.” We all have a Get Rich Quick/Buy-and-Hold urge residing within us, If we are going to overcome that urge, we need to be reminded regularly how important it is to overcome it.
How well do you think people would do at losing weight if the Sugar Council banned all discussion of how gaining too much weight causes heart disease and diabetes? Humans have all sorts of weaknesses The only one that I know of where it is forbidden to try to help people cope with the weakness is the weakness we all have for Get Rich Quick/Buy-and-Hold investment strategies. People who hear about the dangers of going pure Get Rich Quick are often persuaded to follow more sensible strategies. Those who never even hear about the last 41 years of peer-reviewed research in this field are often not even aware of the risks they are taking on by failing to take price into consideration when buying stocks.
If we were permitting honest posting re the peer-reviewed research, we obviously wouldn’t have a CAPE value of 35.
Rob