A Rich Life

The Old Ideas on Saving & Investing Don't Work -- Here's What Does

Carnival of Passive Investing #5 — Behavior Gap Sketches Edition — May 2, 2011

by

Welcome to the May 2, 2011, edition of the Carnival of Passive Investing (#5), a monthly collection of the best and most intelligent Passive Investing strategy articles around the internet. Some people foolishly want to beat the market (want being the key word) but we just want to invest with it.

We have some exciting news to report about next month’s carnival. Rick Ferri, the author of numerous books on Passive Investing, will be selecting the winners of the May Carnival of Passive Investing (#6)!

The purpose of the carnival is two-fold:

  • To provide a forum to showcase articles and research in passive investing strategies (i.e. investing in ETFs, index mutual funds, etc. in such a way that one avoids employing active stock picking). By investing with the market, we are able to beat 70-80% of investment “professionals.”
  • To create a community of passive investment bloggers to connect and share expertise.

The theme for this month’s carnival is: Behavior Gap sketches by Carl Richards. You can take a look at all of Carl’s sketches (he is creating new ones all the time) here. I’ve selected a few of my favorites to add some color and fun and under-the-radar learning experiences to the April 2011 carnival. I like Carl’s work for several reasons. One is that he focuses on the emotional side of the stock investing project and I view mastering the emotional side as the key to long-term success.

Another is that his sketches communicate to us without words. There are too many words written about investing! Seriously, we have heard the words so many times that we tune a lot of them out. Sketches can hit us with a familiar point in a fresh way. That can be a mighty good thing if the sketch is the thing that finally permits an important insight to sink through our thick skulls!


Here are this month’s top three editor’s picks:

1) Jon Elder presents 12 Pillars of Boglehead Wisdom at Free Money Wisdom. John Bogle’s genius is that he keeps it simple. There’s lots of complicated investing advice available to us today. Too much! Most of what is presented to us is noise! The key to success is getting the fundamentals right. Bogle’s 12 Pillars are the core principles of Passive Investing. So you cannot go over them too many times. Hopefully, you reviewed these principles when you first became a Passive Investor. My bet is that if you read Jon’s article today, you will discover some new insight in the same words that will make more sense to you now that you are a few more years along in your investing journey. It’s better to read the stuff that really matters 10 times than to read 10 articles of far less power one time each. Read the 12 pillars and think carefully about what has happened over the past year that has made them ring even more true to you today than they have before.

Juicy Excerpt: I’m a Boglehead.  What’s a Boglehead you ask?  I’m glad you asked!  I could get pretty detailed but it’s simply an investment philosophy.  A Boglehead is against market timing, performance chasing, expensive mutual funds, and putting one’s eggs in a single basket.  At the core of this philosophy is the term “long term.”  I invest for my future, not for short term profits.  The ultimate goal of a Boglehead is to mitigate risk, invest wisely, make a solid return and eventually retire early.  It’s as simple as that.


2) Darwin presents Daytrading Is a Total Scam — Don’t Fall for the Pitch at Darwin’s Money. This article of course highlights why you became a Passive Investor in the first place: You don’t have time for the nonsense! There’s a reason why all the scam approaches never die: They appeal to the Get Rich Quick impulse lurking deep inside us. Read’s Darwin’s piece to remind yourself of why you sought the solace and common sense available through the Passive Investing approach.

Juicy Excerpt: I constantly hear radio spots for getting rich day-trading.  The claims on the commercials are so outrageous, I can’t even believe the FTC allows it.  If you listen to satellite radio at all, you’ll know exactly which ads I’m referring to; they play a repeating cycle virtually every commercial break.


3) FMF presents Index Funds: Not All Equal at Free Money Finance. This article is an except from Never Buy Another Stock Again: The Investing Portfolio That Will Preserve Your Wealth and Your Sanity.

Juicy Excerpt: So, what, then, can investors do to help offset their risk and protect their portfolio from losses? The passivity argument helps keep costs low, but in a nowhere market, it’s not all that useful, and you’re going to need more from your investments as you should. There are a number of possibilities. Some of these are easy. Rebalancing on a yearly basis in one’s 401(k) allocation is a snap—particularly for those who can do so automatically when they enroll in their plan. Establishing a level at which one should sell assets, such as ETFs or other investments, after a certain percentage loss is a bit more difficult, but there are strategies that attempt to go this way to keep losses minimal. (Anyone who immediately exited hot tech funds after it lost 15 percent of its value in 2000 saved themselves a lot of pain. The downside? When there are occurrences like the May 6, 2010 “flash crash,” when popular stocks were suddenly traded briefly at a penny, a level that would have triggered sales for many investors.) Keeping a bit of money in Treasury securities that track rising inflation can help guard some of the portfolio against losses. Other strategies, which will be discussed, involve putting a cap on the losses one will tolerate before shares in index funds or ETFs are sold and allocating funds among a number of different asset classes, more than you’re used to doing in the past. Some of these ideas have their own pitfalls, and there are still plenty trying to come up with a better mousetrap that will solve everyone’s problems with a simple formula. No such formula exists.

Asset Allocation

TFB presents S&P 500 + Extended Market = Total US Stock Marketposted at The Finance Buff, saying “I’d like to move some of my money to this new fund to make my 401k holdings mimic the entire U.S. stock market.”

ETFs

Tom Drake presents Canadian Index ETFs – XIU vs XIC at Canadian Finance Blog, saying “I believe XIC is worth the extra 0.08% MER as it provides much more diversification, including some exposure to small cap stocks.”

Financial Planning

Philip presents Traditional and Roth IRA Income Limits at PT Money: Personal Finance, saying “There are limits (based on your income) that might affect your ability to use one of these accounts (IRAs) to your fullest advantage. Let’s look at each one closely.”

Outlaw presents The Pitfalls of Excess Contributions to Your Retirement Accounts at Outlaw Finance, saying: “Having various retirement plans to pick from gives a person versatility while planning for retirement, however it might also make it easier to make simple errors like going above the total annual contribution limits.”


Investing

Jacob presents My Current Asset Allocation and Net Worth Growth at My Personal Finance Journey , saying “Overall, the 1st quarter of 2011 has gone very well.”

Mutual Funds

Pat S presents Target Date Funds: Are They Right for You? at Compounding Returns, saying “The idea behind these funds is that you choose a date that is close to your expected retirement date, and the fund management automatically adjusts your portfolio allocation as you near retirement.”

Personal Finance

Kevin McKee presents How To Invest When You Are Clueless at Thousandaire, saying “She knew to put the money in her Roth IRA, but she had no idea what to invest in.”

James Nara presents 5 Rules to Help You Manage Your Money Savings at The Secret to Be Happy and Feel Fulfilled, saying “I will help you deal with your first savings in a very systematic way by providing you with 5 rules that you can follow without changing too much of your life style.”


That’s it for this month’s edition of the Carnival of Passive Investing. Bloggers, be sure to submit your passive investing posts for April’s carnival, which will be hosted at The College Investor!

New Wade Pfau Study Shatters Market Timing Myths, Shows That Long-Term Timing ALWAYS Provides Higher Returns at Reduced Risk

by

Wafe Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies in Tokyo, Japan, has published new research showing that, contrary to the incessant marketing campaigns of The Stock-Selling Industry, market timing always works. That is, those who change their stock allocations in response to big price shifts with the aim of keeping their risk profiles roughly constant obtain far higher returns while taking on greatly reduced risks than do those following widely promoted Buy-and-Hold strategies.

Pfau states: “On a risk- adjusted basis, market-timing strategies provide comparable returns as a 100 percent stocks buy- and-hold strategy but with substantially less risk. Meanwhile, market timing provides comparable risks and the same average asset allocation as a 50/50 fixed allocation strategy, but with much higher returns.”

Pfau kindly credits my nine years of work in this field (during which I have argued forcefully that honest posting on safe withdrawal rates and other critically important investment-related topics should be permitted at every investing board and blog on the internet), saying “I am also extremely grateful to Rob Bennett for motivating this topic and contributing his experience and encouragement.”

In a show of his generosity of spirit, he also pays tribute to the leaders of the Bogleheads Forum, who have banned honest discussion of safe withdrawal rates and other important investment-related topics at their site, saying: “Because market-timing strategies are specifically not part of John Bogle’s investment philosophy, the author wishes to thank without implicating users including Adrian Nenu, afan, alec, Alex Frakt, bob90245, cjking, crl848, dmcmahon, DP, grayfox, Les, lostcowboy, market timer, matt, Mel Lindauer, Norbert Schlenker, peter71, pkcrafter, Rodc, SP-diceman, tadamsmar, wearethefall, and yobria.” That sort of comment heals wounds and heaven knows we need wound-healing in the Retire Early and Indexing discussion-board communities today.

The only part that I take issue with is the suggestion (Wade does soften the claim with use of the word “specifically”) that Vanguard Founder John Bogle does not see the merit in long-term market timing. Bogle talks out of both sides of his mouth on this question in nearly every speech he gives. However, the reality remains that Bogle has many times made the case for long-term market timing in clear and compelling terms. I learned about the need to engage in long-term market timing from Bogle’s book and Bogle has said in an interview that he believes Valuation-Informed Indexing can be a good strategy (he did not quite endorse it). It is true, of course, that Bogle often fails to distinguish between short-term market timing (which never works) and long-term market timing (which always works), presumably largely because of the marketing benefits that follow from encouraging investors in their Get Rich Quick fantasies (in fairness to Bogle, I believe that there is a good bit of cognitive dissonance at work here as well).

Pfau explained his purpose in conducting the study in posts he put to the Bogleheads Forum. Stock-selling experts have been telling us for decades that “timing doesn’t work.” And, indeed, many studies have been produced showing that short-term timing (changing your stock allocation because of some expectation of how prices will move in the next year or two) does not work. But how about long-term timing (changing your stock allocation in response to big price shifts with an understanding that doing so may not pay off for as long as 10 years)? Amazingly, Pfau was able to find only one serious study looking at this critically important question. Much of Pfau’s study is aimed at pointing out the flaws in the FIsher and Statman study, which evidenced doubts on the part of the authors about the merits of long-term timing.

It is of course a logical impossibility that long-term timing would not work, given Yale Economics Professor Robert Shiller’s research showing that valuations affect long-term returns. If valuations affect long-term returns, returns should be higher and risks should be reduced at times of low valuations. How could going with a higher stock allocation at times when returns are high and risks are low than one goes with at times when returns are low and risks are high not produce good long-term results? In a rational world, the question Pfau focuses on in his new study would have been analyzed in great depth by many researchers many years ago.

The only explanation for why it has not been is that InvestoWorld is today not generally a rational world. Modern Portfolio Theory (which posits that investors are paid higher returns for taking on more risk, the opposite of what logic says must often be the case if valuations affect long-term returns) has influenced our thinking to such an extent that we do not even know to research the most important questions facing us. As World-Renowned Portfolio Strategist Bob Dylan pointed out in his Idiot Wind Theory (a popular counter to the excessively rationalistic Modern Portfolio Theory), “we’re idiots, babe, it’s a wonder we can even feed ourselves.”

This does indeed appear to be the case. At least that’s what the 140 years of historical data available today for our inspection reveal to the researcher willing to listen to its Forbidden Message.

Pfau charts the nominal wealth accumulation of $1 invested at the start of 1871. The Buy-and-Hold strategy examined is a 100 percent S&P 500 portfolio. The baseline market timing strategy chooses either 100 percent stocks or 100 percent Treasury bills at the start of each year, depending on whether the value of P/E10 is below or above it’s historical average at that time.

The Buy-and-Hold portfolio was worth $95,404 at the end of 139 years. The Valuation-Informed Indexing portfolio was worth $124,147.

Pfau writes: “For every risk measure considered, the market-timing strategies result in less risk and higher risk-adjusted returns than the 100 percent stocks Buy-and-Hold strategy. The highest standard deviation for portfolio returns from market timing is 13.93 percent, compared to 18.02 percent for buy-and-hold. The Sharpe ratios are also larger using two different definitions, showing that market timing provides higher returns on a risk-adjusted basis…. The maximum drawdown, which is the maximum percentage drop in wealth between high points and any subsequent low points in the historical period, is also significantly less for market timing. The maximum drawdown was only 24.16 percent, compared to 60.96 percent for buy-and-hold.”

Noting that the Valuation-Informed Indexing portfolio is able to generate the same returns as the Buy-and-Hold portfolio while being out of stocks half of the time and thus putting itself at what should be a huge disadvantage according to Modern Portfolio Theory, Pfau also compares the Valuation-Informed Indexing portfolio, which has an average stock allocation of 50 percent, with a 50 percent Buy-and-Hold portfolio. In this case, the risks of the two portfolios are roughly equal but the returns for the Valuation-Informed Indexing portfolio are dramatically superior. The Buy-and-Hold portfolio has an end-point (2010)  value of $13,426. The Valuation-Informed Indexing portfolio has an end-point value of $94,866.

The study concludes: “Valuation-based market timing with PE10 has the potential to improve risk-adjusted returns for conservative long-term investors.”

Truly amazing stuff!

We’re idiots, babe. But I think it would be fair to say that those who read this study and spend some time thinking through the implications that follow from it are perhaps a bit less idiots than they were on the day before they took that promising step into the light. Thank you, Wade Pfau!

Please find some room for reporting on this fellow’s work on your front page, New York Times editors! By the close of business today if at all possible!

Associate Professor Wade Pfau Has Contacted Trinity Study Authors re Analytical Errors in Their Safe Withdrawal Rate Study

by

Wafe Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies in Tokyo, Japan, has sent an e-mail to the authors of the famous (infamous?) Trinity study of safe withdrawal rates for retirees asking the authors whether it was their intent when preparing the study to identify the safe withdrawal rate for retirees. Here are his words:

“Okay, I took care of it. I was a little timid about contacting them, as I was publicly critical of their study in the past. But first I apologized to them for that. Then I explained my concerns about 4% for retirees since the mid-1990s. Valuations was a part of my list. I’ve even invited Prof. Walz to give a seminar at my university, as he is in Hong Kong during the spring term. This matter is settled.”

There’s been a debate raging on the internet re this question for nine years now. The debate is referred to as “The Great Safe Withdrawal Rate Debate.”

Numerous discussion boards and blogs have banned honest posting on the safe withdrawal rate matter after seeing the rage (which has at times evidenced itself in death threats, defamation and long-ongoing internet harassment campaigns) evidenced by those who believe in the Buy-and-Hold investing strategy when accurate reports of the safe withdrawal rate are posted. Buy-and-Holders view accurate reporting of the safe withdrawal rate as a threat to the dominant model for understanding how stock investing works.

The reason why the Old School safe withdrawal rate studies do not include an adjustment for valuations is that they are rooted in a belief in the Efficient Market Theory (developed by University of Chicago Economics Professor Eugene Fama), an academic construct that posits that the community of investors always considers all factors bearing on stock prices when setting stock prices and that overvaluation and undervaluation are thus logical impossibilities. Yale University Economics Professor Robert Shiller discredited the Efficient Market Theory (and the Buy-and-Hold strategy rooted in a belief in its principles) with research done in 1981 (and replicated many times in the three decades since) showing that valuations affect long-term returns. If valuations affect long-term returns, both overvaluation and undervaluation are obviously real phenomena.

Pfau has expressed numerous concerns about the Trinity study but does not share my view that the study needs to be corrected.

My view is that the study needs to be corrected because the safe withdrawal rate is the product of a mathematical calculation and it looks very bad when investors hear two wildly different reports as to the results of that mathematical calculation. Common sense tells us that something fishy is going on when different people make such wildly different claims for the result of the same mathematical calculation.

Thus, the friction generated by this “controversy” (there of course is no genuine controversy over what the numbers say — the historical stock-return data is public information and anyone who has ever gone to the trouble to check the data has found that Shiller is right that valuations affect long-term returns, at least in the 140 years of historical data available to us today) cannot go away without a resolution of the question of whether valuations really do affect long-term returns or not. I think it would be wonderful if as a society we could explore all of the amazing breakthrough insights that follow from Shiller’s research (I write weekly about these insights in my “Valuation-Informed Indexing” column at the www.ValueWalk.com site) and that only becomes possible when we open investing boards and blogs to honest posting on safe withdrawal rates and other critically important investment-related topics.

Pfau’s view is that it is possible that the Trinity authors did not intend to identify the safe withdrawal rate. He points out that the study uses the phrase “sustainable withdrawal rate” rather than “safe withdrawal rate.” I do not see the significance of this point given that the two phrases signify the same thing. A sustainable withdrawal rate is a safe withdrawal rate and a safe withdrawal rate is a sustainable withdrawal rate. I presume that “safe withdrawal rate” became the popular term because it is shorter.

Pfau also notes that the Trinity authors properly identify the withdrawal rate that has always survived historically. The problem with this argument is that the thousands of us who have expressed a desire that honest posting be permitted have been saying since May 2002 that the entire “controversy” could be put to rest in seconds if the Buy-and-Holders would be willing to refer to the number generated by the Trinity study (4 percent) as the Historical Surviving Withdrawal Rate (HSWR) rather than the Safe Withdrawal Rate (SWR). The Buy-and-Holders have been unwilling to consider this idea. If it were to become widely known that the Trinity study and the other Old School SWR studies report the HSWR rather than the SWR, the millions of investors who need to know the SWR to plan their retirements would lose interest in those studies. The SWR has great value as a planning tool. The HSWR does not.

John Greaney, the author of the Old School SWR study that appears at the www.RetireEarlyHomePage.com web site, has started a thread at the Motley Fool Retire Early board (honest posting on the subject of early retirement is no longer permitted at the board) suggesting that Pfau may be denied tenure because he has crossed Greaney by asking the authors of the Trinity study a question about their intent in preparing the study. The intimidation tactic is typical of Greaney’s behavior going back to the morning of May 13, 2002, when I put a post to that same board (at a time when honest posting on early retirement was not only permitted but encouraged) pointing out the analytical errors in the Old School studies.

The encouraging news is that, while in the old days, there would within a few hours have been scores of posts put forward by Buy-and-Holders endorsing Greaney’s intimidation tactics, in this case Greaney’s post has gone unanswered. This is how change happens. There’s a famous post by Ghandi in which he observes something to the effect (I am paraphrasing) that “first they ignore you, then they ridicule you, then they attack you, then they say that everyone knew you were right all along.”

I think it would be fair to say that Pfau’s suggestion that perhaps the Trinity authors had never intended to identify the safe withdrawal rate brings us to the “then they say that everyone knew that you were right all along” stage of this particular “battle.” Let’s all pray that the Trinity authors are able to work up the grace and courage to say something in response that pushes the ball even a little bit farther ahead.

Heaven help us all!

“I Have Come to Believe That God Put Me on Earth to Do This Work”

by

Set forth below is the response that I wrote to a question put to me at my Beyond Buy-and-Hold column by Kathryn C at the Kathryn’s Conversations blog:

Rob, do you mean “middle class” or just the average investor? I think you mean the average investor, not middle class. (we’re talking about how sophisticated an investor is here right, not if they are middle or upper class?)

Thanks much for stopping by, Kathyrn.

I understand your question. I use that “middle-class” phrase all the time in everything I write. There’s a logical sense in which you are correct. The advice applies to wealthy investors as well as to middle-class investors.

But here’s the thing: I do not care about wealthy investors!

I have nothing against them as people. I have met many kind and giving and smart rich people. I love rich people. But I do not write for them. If they read my stuff, I am grateful. But it is not rich people that I have in mind when I think about investing and organize my thoughts and craft my sentences.

A word that people often use to characterize my writing is “passionate.” To the extent there really is passion there, it is there because, when I write, I have a reader in mind who I am writing to. That reader is a middle-class person. He’s not poor because poor people generally cannot benefit from the money strategies I write about (I love poor people too, of course — I just do not write for them). And he’s not rich because I’m not worried so much about what happens to the money of the rich (as much as I love them regardless).

Say that a person with $3 million in assets suffers a 50 percent loss from doing dumb stuff with his money. He’s still got $1.5 million. He’s upset. But he’s not busted. He still goes to the beach that year.

Now say that a person with $300,000 in assets suffers a 50 percent loss. That may mean that his or her son or daughter does not get to go to college. He or she may well not go to the beach that year because of the fear he feels over what has happened. This is a very different situation.

I had zero interest in personal finance until I lost a job I loved at age 35. All of the work I have done in the saving and investing fields followed from that experience. I hated the feeing of financial vulnerability. I have made it my life’s work to help other middle-class people never experience those feelings. The full truth is that I have come to believe that God put me on earth to do this work (as crazy and scary as that sounds).

Anyway, I love rich people. I wish them all the best in all their life endeavors. I am happy if some of them care to read my stuff. I love the idea of talking things over with them and kidding around with them and all this sort of thing. But the people I am thinking of when I write my words are middle-class people. It is their money worries and hopes that drive me. I am happy to have anyone benefit from the advice. But my intent is to help middle-class people. That’s where my heart is. And every word that I write starts in the heart. I’m not one of these people who strives to be a purely rational being. Not this boy!

I was born in Northeast Philadelphia. That’s where all this is coming from. The people who live there call it The Great Northeast. No outsider has ever been able to figure out why we call it that. But we still do call it that all the same. You can take the boy out of Northeast Philadelphia but you cannot take the Northeast Philadelphia out of the boy!

Rob

“We Cannot Ignore the Harm Done to Millions by the Mistakes Made by the Authors of the Trinity Study. Doing So Will Cause a Political Explosion”

by

Yesterday’s blog entry set forth some words put forward by researcher Wade Pfau in which he argued that there is no need for the Trinity authors to correct the errors made in their safe withdrawal rate study. Set forth below are the words that I put forward in response to Wade’s argument:

The error that was made was an analytical error.

It was not an analytical error that was made only by the Trinity authors. It was an analytical error that was made by John Bogle. And Bill Bernstein. And the editors of Money magazine. And by thousands and thousands of other good and smart people. It was an analytical error that caused the second worst economic crisis in U.S. history (one that is very much in its early days and likely to become far, far worse in the event that stocks perform in the future anything at all as they always have in the past).

Certainly we want to hear the Trinity authors themselves explain what was going through their minds when they set up the methodology of their study. I have suggested that Money magazine start a new feature where each month someone steps forward and writes an article titled “I Was Wrong” in which he explains what was going through his mind during the Buy-and-Hold days. Bogle should do it the first month. Then we would move on to people like the Trinity authors. I would like to see Shiller do one. Shiller is not perfect. He has made mistakes. I am happy to do one if there are people who want that. I did not understand this all on the first day. I have had to move forward one step at a time just like all the other humans. I think it would be a good thing if you did one, Wade. I think you would acknowledge that you do not today know it all. You would help people if you wrote an article working through the process by which you went from holding a Buy-and-Hold mindset to holding a Valuation-Informed Indexing mindset (or whatever you want to call the new mindset — the terminology is of course not what is important here, the important thing is the attitude).

We all need to become more HUMBLE re the extent of our understanding of how stock investing works.

That is our single most important finding of the past nine years.

The Trinity authors need to become humble enough to be able to say the words “I” and “Was” and “Wrong.” If they are able to do that, there is no limit to the good they can do by doing so. If they are not able to do that, we need to say prayers for them and move on without them. There are many millions of people who have been hurt in very serious ways by the same analytical error that caused the Trinity authors to get the numbers so wildly wrong in their retirement study. Those people matter too.

To the extent that your point is that we should be charitable to the Trinity authors, I am of course with you 100 percent. It was not their intent to make any errors. As you pointed out, their intent was to improve our understanding of retirement planning. And, when you look at this in sweeping historical terms, they did indeed do that. We should of course be grateful for the work they did. But we cannot ignore the harm that was done to millions of aspiring retirees by the mistakes they made. Ignoring that is going to down the road cause a political explosion that may well tear our society apart.

I read an article just this morning about the Donald Trump phenomenon. The guy was saying that Trump is popular because middle-class people are becoming angry about what has happened to them and about the failure of their political leaders to handle matters more effectively. What do you think is going to happen when large numbers of them come to learn that we have had research for 30 years now showing that Buy-and-Hold is the most dangerous Get Rich Quick scheme ever concocted by the mind of mortal man and yet The Stock-Selling Industry continued spending hundreds of millions of dollars promoting it day and night in every possible venue? You don’t see a problem here bigger than the hurt pride of the Trinity authors?

You get it exactly right when you say that the goal should be teaching people what works. That is indeed what I need to be doing and what you need to be doing and what every person involved in this field needs to be doing. How do you propose we go about it?

You have been participating in an SWR thread that has been going around in circles for hundreds of posts. I have participated over the course of nine years in HUNDREDS of such threads. Why do they always go around in circles, Wade?

It’s because the Buy-and-Holders are in great emotional pain. They believed. And they are hurt to find out that they were wrong to believe.

That’s a reality of all this. The intense human pain that the promotion of Buy-and-Hold brought on is every bit as real as the numbers in the historical data. Anyone who is unwilling to deal with that pain lacks the ability to do good work in this field. I say that not as any sort of dig at you or anyone else. I say it because I know it is so. I have learned this through my interactions with tens of thousands of Buy-and-Holders over the past nine years.

I can go this morning to any web site on the internet (except for the ones where I am banned) and report the realities of stock investing. That’s nice. But I can tell you in advance the questions I am going to be asked when I report those realities.

The #1 question I am going to be asked is: “But, Rob, timing doesn’t work, does it?” To say that timing doesn’t work is to say that looking at the price of the stocks you are buying doesn’t work. It’s pure 100 percent foolishness. Yet some of the smartest people in the world believe this. I mean no offense, but I think it would be fair to say that there are certain ways in which you kinda, sorta still believe it. Heaven help us all, but I believe that there may be certain ways in which I kinda, sorta still believe it.

We’re not going to be able to move on until we deal with that question. People believe that timing doesn’t work because they have heard this claim 10 millions times and they have never heard it corrected. Their emotions are telling them that anything said that many times by that many smart people MUST be true. We need to explain how it came to be that they heard this complete nonsense claim millions of times and yet never heard it corrected.

There are a number of elements to the explanation but the biggest factor is cognitive dissonance. The Trinity authors didn’t sit down at their desks one day and say: “You know what might be fun, what if we got the numbers wildly wrong in a retirement study and caused millions of failed retirements?” They believed in Buy-and-Hold. They believed in the Efficient Market Theory. They believed in Modern Portfolio Theory. That’s why the numbers are wrong in the study. That’s why we are living through a global economic crisis today.

The next stop is another 65 percent drop in stock prices. That’s almost certainly going to put us in the Second Great Depression. Large numbers of people are going to become very angry. Some of those people are going to get caught up in their negative emotion and not be even a tiny bit as charitable as I am being in trying to come to a reasoned and fair explanation of why the Trinity authors (and many, many others) got so many things so wildly wrong for so many years. My take is that it is 10 millions times better to bring this to a head today and to handle it in a loving way before things get so bad that others handle it in a non-loving way and cause political frictions the likes of which we haven’t seen since the Civil War.

Of course, I only get one vote, Wade. That’s my vote. I will always reach out the hand of kindness to all Buy-and-Holders. I will always express my gratitude for the wonderful work they have done helping us get to this place where we are today able to invest in ways so much more effective than anyone has ever been able to invest before. If my voice is not strong enough to persuade other good and smart people to join the effort to bring this to a good place, then that’s what the Fates decided re this matter and I just need to accept it.

I’ll keep trying. And I know you will too. I personally believe that we will all get to the other side in one piece. I don’t say that I am 100 percent confident re that one. But that’s my (willfully?) optimistic take. I know that I want to have my name written down as one of those who was on the side saying that it was well worth saying the words “I” and “Was” and “Wrong” to bring on such wonderful breakthroughs and to avoid the human suffering that I believe will follow from continuing to duck these questions.

I sincerely thank you for sharing your thoughts and for thereby prompting me to organize mine a bit for their presentation here. Keep fighting the good fight however you see best to fight it, my good friend!

Rob

“I Think No One Really Knows the Precise Scope That the Trinity Authors Had in Mind….You Don’t Need to Convince the Trinity Authors to Fix Any Errors”

by

Yesterday’s blog entry set forth the text of a comment I made in a recent discussion about safe withdrawal rates with researcher Wade Pfau (Wade says that he does not believe that the authors of the Trinity study meant to identify the safe withdrawal rate (SWR) in their safe withdrawal rate study and that the thousands of financial planners who for many years now have been saying that they did were mistaken to think that and that it’s just tough cookies for the millions of middle-class people who will likely be suffering failed retirements because of the errors made in the Old School SWR studies but not corrected to this day). Set forth below is the text of Wade’s comment in response to mine:

Rob, DRiP Guy kind of won me over with his discussion of scope vs. error at Bogleheads. Well, I think no one really knows the precise scope that the Trinity authors had in mind when they first formulated their study. But if their scope was only to look at how things worked out in the historical data, then there is no error. I mean, I’ve replicated their study and didn’t find errors in their calculations. So there is no error in that regard.

The error comes if people apply those success rates incorrectly to future retirements. I don’t know how the Trinity authors feel about the points you make regarding valuations. Perhaps they agree with DRiP Guy that valuations do not make an important difference, or at least that they do not provide a clear difference that can be correctly acted upon. But I still think there are other reasons to be worried about 4% (fees, international perspective, …) besides just the valuations issue.

This is where I wish the Trinity authors would be more vocal. But even so, the 4% rule is so ingrained into the national consciousness that even if they said something now it would have very little effect.

The duty is for others to come along and explain why they believe that the Trinity study does not provide the whole story about retirement planning in a forward looking manner.

That’s what you are doing. But in doing that, you don’t need to convince the Trinity authors to fix any errors. Just build on their earlier work. Which you did with your retirement evaluator.

As well, as the discussion at Bogleheads is now heading: the whole SWR debate is built on a rather artificial premise that people use a portfolio of risky assets to finance a clearly defined set of planned expenditures. In real life this isn’t how things work,

“Thousands of Experts Who Heard People Calling the Number Generated By the Study the “Safe Withdrawal Rate” Never Corrected the Record — Why?”

by

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.

Rob

Wade Pfau: “Perhaps the Trinity Study Was Not Meant to Be a Safe Withdrawal Rate Study”

by

Set forth below are some words that Wafe Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies in Tokyo, Japan, put recently to the blog entry here titled Everyone in This Field Should Be Urging the Authors of the Studies to Make Corrections:

Rob,

Perhaps the Trinity study was not meant to be a “safe withdrawal rate” study. The word “safe” does not appear in either the original or updated versions. Perhaps the study was only meant to point out that 6-7% withdrawal rates are not safe. So my list of concerns in my updated blog post is meant to point out what I feel are issues that users of the study must consider before jumping to the conclusion that the study provides information about “safe withdrawal rates” for the future. Though I feel they could be more vocal about this matter, the Trinity authors never really gave any indication that forward looking retirees should treat 4% as safe. It’s up to our interpretation as users of their findings.

“Leaders in the Personal Finance Blogosphere Could Issue a Statement Saying They Oppose the Bans”

by

Set forth below are some words that I recently posted at the Get Rich Slowly blog. The blog entry advocated rebalancing. I put up a comment pointing out the dangers of rebalancing. J.D. Roth, owner of the site, then put up a response stating:  “Hey, Rob. Not picking a fight here, but asking a simple question: What investments do you recommend instead? My stock portfolio is up 65% since I moved it to Fidelity in 2009. I’m about to rebalance to have less in stocks, but I’m not going to move everything out. What would you recommend instead?”

What investments do you recommend instead?

You’re not picking a fight, J.D. You’re asking a question that is on the minds of all of your readers. I am grateful to you for asking it and thereby helping us all engage in a little bit more of an effort to figure this investing stuff out together.

There is no one stock allocation that I can suggest everyone adopt. And there is no one non-stock asset class that I can suggest everyone move to when stocks are not a good choice. There are obviously lots of factors that come into play. You would never tell all of your readers to follow one allocation and it is not fair of you or anyone else to think that I might be able to do something like that either.

What I say is that we all should evidence much more skepticism re claims that rebalancing is a good strategy than we have in the past, given the economic crisis we are living through today (which I believe was brought on primarily by the heavy promotion of Buy-and-Hold investing strategies).

Rebalancing is staying at the same stock allocation at all times. Yet there are some valuation levels when stocks offer great returns at low risk and other valuation levels when stocks offer poor returns at insanely high risk. Why would you want to be at the same stock allocation in both sets of circumstances? Rebalancing simply does not make sense. The historical explanation for why it once was considered a good idea is that there was once research suggesting that the market is efficient — rebalancing would be the ideal asset allocation strategy if the market really were efficient).

If you are saying that 65 percent stocks is the allocation that you think makes sense for you at times of moderate valuations, I would say that a stock allocation of perhaps 30 percent makes sense for you today (and 90 percent will make sense when we go to super-low valuation levels). My choice would be to put the money you moved out of stocks into TIPS or IBonds or CDs. That way you will have it to invest in stocks when the likely long-term return on stocks improves (that is, when valuation levels drop).

Please understand that I am not trying to tell you what to do. It is obviously not my place to do that. I’m just a guy who posts on the internet, like you (the difference is that you have been about 500 times more successful than me and please understand that I believe that you deserve your success).

I believe that you are sincere in your Buy-and-Hold convictions, J.D. I also believe that part of the reason why you hold those convictions is that you rarely hear them challenged. That’s because there is a Social Taboo today against saying the sort of things I say about rebalancing and about Buy-and-Hold in general. My hope is that in time (perhaps soon!) you will use your influence in the Personal FInance Blogosphere to overturn that Social Taboo. I am 100 percent confident that we would all be better off as a result.

I don’t know everything there is to know about stock investing. Neither do you. Neither does anyone else. The usual rule that applies when that is the case is that we all post the best thoughts we can with good intent and we all are grateful that the friends we meet on the various blogs are doing that. We learn together. I want to see that Learning Together process take place in investing discussions too. For that to happen, we need to make those who don’t think rebalancing is a good idea as comfortable expressing their thoughts as those who favor rebalancing are comfortable expressing theirs.

I want to help you and all your readers, J.D. I cannot do that with both hands tied behind my back. I respect your views. But I do happen to think you are wrong about this particular point. I’m happy to answer any questions. But I really think it would be a huge plus if some of the leaders in the Personal Finance Blogosphere could get together and issue a statement saying that they oppose the bans that apply today at all of the large discussion boards and at a number of important blogs. To make real progress on these questions, we have to welcome input from all points of the spectrum of opinion.

My bottom-line response to your question is: I don’t want you listening only to me when forming your opinion re rebalancing. I know that, if signals were sent that we want to hear from people who don’t favor rebalancing, we would be hearing from many more people with that viewpoint. I know this because people who hold these views have told me that they are afraid to post. That’s very, very wrong. We all should want to change that, regardless of what particular investing views we happen to hold.

Rob

 

 

“Your Readers Are Hearing Only One Side of the Story and You Pretend to Present Both Sides”

by

Set forth below are some words that I recently posted in response to a comment on the column that I wrote titled Author Banned from 15 Investing Sites. Mike Piper, author of the Oblivious Investor blog, had commented that: “For the record, I never made any tea party comparisons. I suspect you’re thinking of somebody else.”

Mike:

Thanks for stopping by. It makes me happy when I run into you from time to time on Twitter. I am hoping to be able to meet up with you in person at the Financial Bloggers Conference in Chicago in October. I don’t know for sure that you are attending. But I have a vague recollection of seeing something that indicated that you might (perhaps it was that you tweeted something about the conference). Anyway, I often see your name or your blog’s name come up in my travels and that always makes me happy as I have warm feelings about you from the days before the (grrrr…) ban.

Here’s a link to the blog entry I wrote reporting on your e-mail:

http://arichlife.passionsaving.com/2009/08/20/these-people-good-people-have-described-your-comments-as-spammy-obnoxious/

Here are your words:

“These people–good people–have described your comments as “spammy”, “obnoxious”, and “like the guy in a town hall meeting who won’t shut up about something everybody else doesn’t care about.” ”

You sent the e-mail in August 2009. That’s the time-period when Tea Party people were showing up at congressional town hall meetings and asking challenging questions about the health reform law and about the Federal deficit. The people you were referring to were comparing me to Tea Party members and you were citing their comments without criticism.

I don’t take offense to being compared to Tea Party people. I have never attended any Tea Party function. But I am a big Sarah Palin fan and I think there’s a lot of overlap between Palin supporters and Tea Party people. I have a lot of respect for the Tea Party and what it is trying to do.

And I do see a connection between the Tea Party issue and the issue that I raise that we need to open the internet up to honest posting on the dangers of Buy-and-Hold strategies. In both cases, the point being raised is obviously true (we really must do something about the deficit and we really must open the internet up to honest posting on the dangers of Buy-and-Hold). And in both cases there are people on the other side of the issue who sometimes feel a need to engage in tactics that can fairly be described as dirty pool.

There’s a case that can be made by those who support the health care overhaul or who do not want spending cuts to be the focus of the solution to the deficit problem. And there are good and smart people who believe that Buy-and-Hold can work and who have a right and a responsibility to make that case.

But there is no justification for some of the tactics we have seen. Those who oppose the Tea Party hurt themselves when they smear members of the Tea Party for speaking out on issues that matter to them (there have been cases where members of Congress have compared Tea Party people to Nazis). And Buy-and-Holders hurt themselves when they engage in intimidation and deception and board bannings. That sort of thing makes you guys look very, very, very bad in the eyes of many middle-class investors, Mike. I think it is fair to say that, as the economic crisis worsens, there are going to be more and more questions asked by more and more people about the tactics that have been employed to protect from questioning what I think can today fairly be described as the purest and most dangerous Get Rich Quick investing strategy of them all.

I am your friend and I will do whatever is in my power to help make you look not quite as bad as you make yourself look when you ban honest posting on important investing topics at your blog. I cannot change the facts of the matter. The fact is that the academic research has been showing for 30 years now that valuations affect long-term returns and that you still promote Buy-and-Hold strategies at your site to this day.

For so long as you do that while following community norms, you are on solid ground. When you ban comments pointing out in fair and polite and even warm tones the dangers in the strategies you recommend, you cross a line that no blogger who genuinely cares about his readers and the long-term success of his blog should cross.

I think you want your readers to achieve good results. I think it caused you distress to ban me. All that is good. But you did ban me. And that has certainly hurt your readers. They are hearing only one side of the story and you pretend to present them with both sides (nowhere at your blog do you tell your readers that it is only comments supportive of you that may be posted and that those who refer to the 30 years of academic research showing that Buy-and-Hold can never work will be banned).

I will continue to work with you and with all the other bloggers and discussion-board site owners who have banned honest posting on this critically important matter to come up with solutions to our troubles that make more sense than those that have been tried in the past and that have failed us so miserably so many times now. I also am going to continue to keep the needs of my readers and your readers in mind when I do that. I am going to continue to post honestly on what the academic research of the past 30 years says.

I hope that makes some sense to you. If there is ever a time when you or any others in the Personal Finance Blogosphere would like to talk this over with the aim of coming to some more effective solutions than the foolish and dangerous ones that some have adopted in days past, I hope you will contact me and let me know of a desire to be more constructive. I can promise you that the hand of charity will be outstretched to you and to any others who elect to get involved in an effort to try to achieve some good forward movement re this matter.

Please take care, my good friend. And I do hope that we have a chance to talk things over in person in Chicago. Perhaps that will help. I might even be able to hook you up with some Tea Party friends of mine who live there! (That’s a joke.)

Rob