A Rich Life

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

“Suggesting that the Safe Withdrawal Rate Is Low Today Just Adds to the Doom and Gloom”

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FrugalDad’s blog entry for yesterday (“Saving for Retirement: What’s Your Number?”) explored the infamous “4 percent rule” from the Old School safe-withdrawal-rate studies.

Juicy Excerpt: The rule of 4% uses a couple assumptions, some of which are hard to justify in our current market conditions. 

I put forward some comments explaining why I believe that the Old School studies are analytically invalid and why the New School studies are the future of retirement research. I pointed out that The Retirement Risk Evaluator shows that the safe withdrawal rate for retirements beginning at today’s valuations is over 6 percent.

Juicy Excerpt: Suggesting that the number is low today just adds to the doom and gloom, which is the last thing we should be doing today. The reason why we are inclined to overstate the bad news today is that we are reacting to the shock experienced in seeing stocks perform from insane price levels just as we would have expected them to had only the “experts” warned us of the dangers. Emotional extremes beget emotional extremes.

Podcast #72 — When Stock Losses Are True Losses and When They Are Not

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I’ve added Podcast #72 to the “RobCasts” section of the site. It’s called When Stock Losses Are True Losses and When They Are Not.

Losses that bring the P/E10 value back down to fair value are the give-back of gains that never possessed any economic substance. Losses that bring the P/E10 value below fair value are losses of economic substance. You can count on losses in economic being made up. You cannot count on losses of cotton candy gains being made up.

“We Need to Stop Worrying about Who Is an Expert and [Try] Figuring Out What Makes Sense”

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I recently posted a comment to the Get Rich Slowly blog that argues that our current understanding of how stock investing works is too primitive for anyone properly to be thought of as an “expert.” My post is  Comment #51.

Juicy Excerpt: We all need to get back to the basics if we want to figure out how stock investing really works. We need to stop worrying about who is an expert and who isn’t and direct more effort to figuring out what truly makes sense. Expertise that means something will follow.

Podcast #71 — The Bull Market Started in 1975, Not 1982

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I’ve posted Podcast #71 to the “RobCasts” section of the site. It’s called I Was Wrong — The Bull Market Started in 1975, Not 1982.

The big move upward in valuations began in 1982. But stocks pay a return of over 6 percent real in years when the P/E10 level remains the same. Stocks were a fine investment from 1975 all the way through early 2000. We should be encouraging people to own stocks in years when the P/E10 level remains constant, so it is a mistake to suggest that the bull market did not begin until 1982.

Podcast #70 — Reversion to the Mean: We Are Losing Sight of What Bogle Got Right

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I’ve posted Podcast #70 to the “RobCasts” section of the site. It’s called Reversion to the Mean — We Are in Danger of Losing Sight of All that Bogle Got Right.

Bogle made one big mistake. I wish that his “supporters” could accept that and not feel a need to deny all the great stuff he did as a result of trying to “protect” him from coming to terms with the one big mistake.

“Vehement Denial is Common Among both Drunks and Passive Investors”

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A community member named “James” wrote in an e-mail:

“I just listened to your podcast on Buy-and-Hold Cannot Work.  I was referred to it by a friend with whom I have recently been discussing the same concepts.

“What you don’t mention in this podcast is the primary basis for the Stay-the-Course concept.  As I understand it, the idea is that: The market is smarter than any one individual and automatically prices value effects into itself.  Ergo, it’s safe to be passive!

“Quite obviously, this is not correct, but I would be interested in how you refute it.”

Set forth below is my response:

James:

Thanks for your note. You pose an interesting question.

The idea that the market gets the price right is called the Efficient Market Theory. As you note, this is the intellectual framework for the Passive Investing concept. The Efficient Market Theory was at one time believed to be true. However, there has been much evidence accumulating in recent decades that it does not accurately describe how markets work.

Please take a look at these three blog entries:

http://www.passionsaving.com/200805.html#e625

http://www.passionsaving.com/200805.html#e626

http://www.passionsaving.com/200804.html#e599

The Efficient Market Theory is rooted in a premise that investors are all rational actors seeking to maximize their returns. If this were so, the claim that is made — that the market price is close to being right — would indeed follow. The problem is that the premise does not stand up to scrutiny — we are NOT rational actors.

Humans have both a rational side and an emotional side. At times of massive overvaluation, human investors (that’s pretty much all of them!) are highly emotional. They WANT valuations not to matter and are inclined to ignore the wealth of evidence showing that they do. Those acting emotionally are NOT seeking to maximize their returns. They are more interested in being proven right in their investing beliefs than they are in accumulating wealth. The collective decisions of irrational investors do not work to set the market price properly.

Think of an alcoholic. An alcoholic is not rational. He sacrifices his family, his job and his health for the temporary pleasures of drink. At times of massive overvaluation, investors are essentially Stock Drunk. The drunk denies that he has a problem and Passive Investors deny that it is possible for the market price to be wrong. But these denials are themselves part of the problem — vehement denial is common among both drunks and passive investors.

The very fact that the Efficient Market Theory (and the Passive Investing model that goes with it) is so popular is evidence of the problem. Such theories always become popular at times of high valuations. The popularity of such theories fades as prices return to reasonable levels (as they must if the market is to continue to function). The aim of these theories is not to explain how markets work in the real world, but to rationalize an emotional desire to invest heavily in stocks at a time when the long-term value proposition attached to doing so is poor.

I hope that helps a bit. Welcome to the Financial Freedom Community!

Rob

“TIPS Are the Most Predictable
Asset Class I Can Think Of”

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Set forth below is the text of an e-mail that I sent to Colleen, who asked about my thoughts on the market crash and about what she should be invested in at times when valuations are too high to justify a high stock allocation.

Colleen:

Thanks for visiting the site and thanks for writing.

For my thoughts on the market crash, please click on the “A Rich Life” button at the left side of each page of the site. That’s where my blog is located. I’ve been posting every business day. My focus in recent months has been on recording podcasts. So you could also click on the “Robcasts” section and just listen to whatever titles seem of interest. I’ve commented extensively on the price crash in the first 50 podcasts.

I believe that what you are asking is — what should I be invested in as the alternative to stocks at times when stock prices are too high? The conventional recommendation is to go with bonds as the alternative to stocks. My preference is for Treasury Inflation-Protected Securities (TIPS) purchased at times when they are providing a solid long-term return. But I see this as being a judgment call. A case can be made for bonds in some circumstances. To work through the points pro and con TIPS or bonds would take an entire article (I’ll put that on my list for the future).

The analysis is — which option best counters stocks? I like TIPS better because what I am trying to counter is the unpredictability of stocks (TIPS are the most predictable asset class I can think of). However, I haven’t worked this particular question hard enough to have a strong opinion. I tentatively prefer TIPS as my stock counter. But I can see circumstances in which bonds might make sense. It might also be possible to use both as counters.

You’ve asked an interesting question that we have not explored in much depth. You might want to direct your question to John Walter Russell as well. John is my partner in development of the calculators. His site is www.Early-Retirement-Planning-Insights.com. He has a Letters to the Editor section. I know he would be glad to take on your question and I would like to hear what he says about it. My guess is that he might have a better informed take on this particular question tham I am able to offer. You’d be helping other community members by asking him about it as I am sure that there are others who are also wondering about this.

Welcome to the Financial Freedom Community!

Rob

Podcast #68 — 2008 Was a Very Good Year for Stock Investors!

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I’ve posted Podcast #68 to the “RobCasts” section of the site. It’s called 2008 Was a Very Good Year for Stock Investors — Let’s Hope that 2009 Is Not a Repeat!

The price crash was an inevitable result of the insane bull market of the 1990s. So it is not right to think of it as something bad that happened in 2008. The fact that stock prices have returned to reasonable levels is good news. It means that we can begin earning good long-term returns from stocks again.

Podcast #67 — Valuations Don’t Matter, Then They Do, Then They Don’t

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I’ve posted Podcast #67 to the “RobCasts” section of the site. It’s called At First Valuations Don’t Matter At All, Then They Matter Big Bunches, Then They Don’t Matter At All Again.

In the short term, stock prices are determined by investor emotions. In the distant long-term, the market is efficient. From about five years out until about 30 years out, valuations tell the story.