A Rich Life

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

“If You Can Change Your Mindset
to See Saving as Buying You a Little Bit of Freedom…”

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The Tight-Fisted Miser blog has posted a review of my book Passion Saving: The Path to Plentiful Free Time and Soul-Satisfying Work.

Juicy Excerpt: This book is more about motivation than nuts and bolts. He distinguishes between what he calls Sacrifice Saving and Passion Saving. If you can change your mindset to see saving as buying you a little bit of freedom rather than something you have to do that you won’t be able to enjoy for many years, then saving will become much easier….. If you have read Your Money or Your Life, you really shouldn’t need this book. If after reading Your Money or Your Life you still need motivation, then this book might work for you.

I am grateful to Andy for writing the review.

He is certainly right that the book is more about motivation than it is about the nuts and bolts of saving. It is for the best if readers know this going in. My belief is that getting motivated to save is pretty much the entire deal. Those who become motivated always are able to handle the nuts and bolts, but those who do not never even care to learn about the nuts and bolts. It’s my belief that there is lots of material available on the nuts and bolts but not too much in-depth material on how those who have never been motivated to save can become strongly motivated.

Andy is also right to see that Your Money or Your Life was a big influence. I don’t agree that those who have read Your Money or Your Life don’t need to read Passion Saving (but then I wouldn’t, would I?). My goal was to take the principles set forth in Your Money or Your Life and show how they can apply to the many types of people who need help saving who are not interested in pursuing the not-for-profit endeavors that are the motivational goal of many of those who used Your Money or Your Life to motivate their saving efforts.

Today’s Passion: My favorite review of Passion Saving is the one done by Audrey at WritersHelper.com.

I Believe In Buy-and-Hold,
I’m Just Not a Fanatic About It

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We all know what’s good about stocks. Stocks provide great long-term returns.

Is there anything bad about stocks?

There is. The bad thing about stocks is the price volatility. You never know where you stand. One day your net worth is $100,000. If the money is in stocks, the number a year from today might be $130,000 or $70,000. You just don’t know. That’s scary.

The thing that determines whether you will become a successful long-term investor or not is how you deal with the fear caused by price volatility. The most common way of dealing with it is through denial. No one literally denies that prices are volatile. But many block this reality out of their minds. They would as soon draw up a will as develop a strategy to deal with price volatility. They act as if they believe that dealing with the problem will cause bad things to happen to them.

There have been three times in the past when stock prices have been where they are today. The average price drop for those three occasions was 67 percent. What are you going to do if the value of your portfolio is cut by two-thirds? Do you have a plan?

Lots of people say “buy-and-hold is my plan.” I don’t think that works. It’s too pat. Your life is going to change in dramatic way if the value of your portfolio is cut by two-thirds; lose that high a percentage of your accumulated wealth of a lifetime and there are going to be fewer options left open to you in all areas of life endeavor. You really are just not going to let that affect you? Are you sure?

Remember, if things go this time as they have gone all the other times, most other middle-class investors will be abandoning stocks when prices drop. It’s easy to practice buy-and-hold when everyone is saying it’s a good idea. It’s not easy when everyone is saying that the best thing is to abandon stocks. That will be what most people will want to hear when most people are abandoning stocks, and most stock “experts” have made it a longstanding practice to tailor their advice to meet the current desires of most of their listeners.

I don’t think you are going to hold if prices drop by 67 percent or by anything close to it. I don’t say that because I think you are weak. I say that because I don’t think any reasonable person would hold onto an asset that had lost 67 percent of its value. People don’t do things like that, and for a perfectly good reason. Doing things like that is nuts. Who the heck can afford to lose 67 percent of his or her life savings? Who the heck can afford to take that sort of hit and not take some kind of action?

Buy-and-hold does not work. It is not realistic.

At least that’s so of the version of buy-and-hold that has been widely promoted for 25 years now

I propose a new approach to buy-and-hold, one with all of the advantages of the now popular approach but without the terrible failing that it cannot work in the real world.

The problem with the conventional approach to buy-and-hold is that it ignores the way the stock market performs. Stocks are not really one asset class. They are two, two, two asset classes in one.

When stock prices reach extreme highs, stocks are a dangerous asset class. There are always huge wipeouts of middle-class wealth when stock prices reach extreme highs. There are no exceptions in the historical record.

When stock prices are normal or low, there’s not much risk. Stock prices might go down a bit from moderate or low prices. But probably not too much. And, if they do go down a good bit, the price drop is not likely to remain in place for long. At least that’s always been the case in the past. Again, there are no exceptions in the historical record.

Here’s my plan for escaping the worst effects of stock-market volatility: Lower your stock allocation when prices reach extreme levels (like those that apply today). That way you are heavily in stocks most of the time and get to enjoy the wonderful long-term returns generally associated with stocks. But you miss out on those huge price drops characteristic only of stock markets for which prices have been permitted to get out of control.

Make sense?

It makes sense to me.

What doesn’t make sense to me is the negative reaction I sometimes hear to this idea. It is my view that that negative reaction is a signal of defensiveness. It is because investors trying to pull off the conventional approach to buy-and-hold don’t really deep in their hearts believe that it can work that it makes them anxious to hear about other strategies, strategies that could help them if they could chill out a bit and think things through without too much emotion getting in the way.

Do I believe in buy-and-hold? Sure. Stocks rarely get to the sorts of price levels that apply today. So it is going to be a rare event when you are going to need to lower your stock allocation to protect yourself from monster price drops. It makes all the sense in the world to hold your stocks through the moderate ups and downs that apply for investors who buy their stocks at reasonable price levels. When the monster price crashs become a live possibility (probability? certainty?), however, I think it makes all the sense in the world to take a little something off the table until our fellow investors come to their senses and pull stocks back to more reasonable price levels.

It’s just an idea, you know? I think it’s a good one. If you don’t, that’s of course fine. We can of course still be friends. I ask that you not get mad at me because I put the idea forward and that you give the idea some thought if your initial impression is that it might make sense.

Today’s Passion: The Investor’s Scenario Surfer lets you test how you would respond to various return patterns without requiring you to put actual money at stake.

Conventional Method of Calculating P/E10 Questioned

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Brad DeLong has questioned the conventional approach to calculating P/E10.

Juicy Excerpt: This is not quite right. This gives you permanent earnings five years ago. To get permanent earnings today you have to grow the average by five years of the trend growth rate of real earnings–which has been 6% per year over the past twenty years. The current value of 28 for the price-to-moving-average-of-lagged-earnings ratio corresponds to a price-to-permanent-earnings ratio today of roughly 21, and to a current r of 4.8% per year.

A community member brought this to John Walter Russell’s attention in a recent Letter to the Editor posted to his site.

Juicy Excerpt: He is trying to tie the numbers down to absolutes, to what would be the “right” price to pay for stocks in a theoretical sense. His research is valuable.

John followed up by writing an article entitled Weighted Earnings.

Juicy Excerpt: The 1.06 weight treats all years equally in terms of the long-term trend line. It estimates the Investment Return of the stock market. The 0.94 weight greatly emphasizes recent earnings. It reveals the Speculative Return.

The technical material is over my head. I am pleased to see this sort of discussion going on. I am strongly convinced that using P/E10 is a major advance over using P/E1, the greatly flawed conventional stock-valuation metric. But I do not believe that we are anywhere close to having reached the end of our explorations of the effect of valuations on long-term returns.

We are in the early innings of this ballgame. We need to see many more investing experts and many more ordinary investors making constuctive contributions to the discussions. No small group of people is going to figure all of this out in a definitive way. Projects of this scope and importance require the input of people coming from a variety of backgrounds and perspectives.

The more that I see these sorts of questions discussed, the better I feel about the long-term future of middle-class investing. Rob Arnott has said that we are now in the early stages of a “revolution” in our understanding of what works in stock investing. I think that’s right, and I think that the question of what valuation metrics do the best job is a question that will be brought front and center as that revolution comes to affect the financial furtures of us all in profound ways.

Today’s Passion: Robert Shiller relied on P/E10 to make his famous stock-market prediction of 1996. Did he turn out to have been mostly right or mostly wrong? That question is examined in the article entitled The Famous Robert Shiller Stock-Market Prediction.

The Author of the Bogleheads Wiki
Statement on SWRs Speaks Out

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A fellow going by the name “SWR Lover” has posted a comment to Tuesday’s blog entry on the Bogleheads wiki statement on safe withdrawal rates (SWRs), saying that he is the author. We of course do not know this for certain to be so. I find it believable. The group that controls what goes into the Bogleheads wiki has strong connections with John Greaney and with the abusive posters who congregate at Goon Central to organize their work destroying Retire Early boards and Indexing boards. One of the regulars there is “Drip Guy,” and the wording of SWR Lover’s post suggests that he could well be “Drip Guy” under another name. Certainly the reasoning employed by SWR Lover is the reasoning that I witnessed often being put forward by Mel Lindauer (co-author of The Bogleheads Guide to Investing) and his “defenders” during his campaign to block honest posting on SWRs at the Vanguard Diehards board. If SWR Lover is not in fact the author of the flawed wiki statement, he is certainly guilty of possessing the same mindset as the author of those hard-headed and hard-hearted words.

First, a word on why you should read what follows. The Old School SWR findings have over the years been cited in tens of thousands if not hundreds of thousands of newspaper articles on retirement planning. It is rare to hear retirement advice today that was not influenced in some way by these studies. That means that you have been influenced by them. We all take in what we hear thousands of times and all of us have been influenced in some way by these claims. If the Old School SWR studies got the numbers wrong (and they did), we are all at risk of suffering busted retirements somewhere along the line as a result. And the false reasoning that led to the errors in the Old School studies led to errors in the investing advice you have heard and accepted as true in many other areas. SWRs matter. It is critical that they be reported accurately. That’s why I often spend time analyzing carefully statements of the sort we saw put forward by SWR Lover last night. His errors are our errors. When we come to understand why SWR Lover has gotten it all wrong, we come to learn where the rest of us have gotten it all wrong too.

Here is what SWR Lover said in his comment to the earlier blog entry:

“Rob,

“I personally wrote the initial article for the Wiki section on SWR. I also purposely included the statement you see there now:

“Original Author, in Wiki: “…one should always be sure to be clear whether the use is in reference to past or projected SWRs, so that unnecessary argument can be prevented.”

“I did that to illustrate there is no need to misunderstand history versus future. Most folks handle that concept quite nicely and naturally without needing to see such a clause, but I thought it added a nice closed loop to that potential argument(!). It certainly does not mean what you ascribe to it:

“RB on his blog: “This statement implicitly (but not explicitly, to be sure) acknowledges that [“old school studies”.. are not [correct].”

“It does not mean that in any way, shape or form. I know what it means, because I wrote it. My intent was to make sure the record is plain as can be, and I think it actually is. (Well, perhaps except for one person. We do what we can, but sometimes there are limits…).”

These are word games. People use SWR studies to plan their retirements. It is important that people planning retirements have access to correct numbers. Otherwise, they are likely to suffer busted retirements. The historical stock-return data shows that the biggest factor affecting the safety of a retirement is the valuation level for stocks that applies on the day the retirement begins. The Old School studies contain no adjustment for this factor. Thus, the Old School studies get the numbers wrong. At times when valuations are extremely high (as they have been for a good time now), they get the numbers wildly wrong. Those are the realities.

The key phrase in SWR Lover’s comment is: “Most folks handle that concept quite nicely and naturally without needing to see such a clause.” There is a sense in which that statement is 100 percent false and there is a sense in which that statement is largely true.

The “concept” he is referring to is the word game. Do most folks view the Old School studies as trickery? Do they know right off the bat that they are exercises in word gaming? Do they get it that we have about as much chance of learning the SWR by using the methodology employed in the Old School studies as we have of getting the SWR right by picking numbers out of a hat?

They do not. There were hundreds of SWR threads that appeared at the Motley Fool board in the days before I first reported what I knew about SWRs (that was on the morning of May 13, 2002). In none of those threads did anyone ever say that he knew that the Old School methodology was just a sick joke and that the numbers were wildly off and that these numbers were in no circumstances to be used to plan a retirement taking place on Planet Earth (William Bernstein has said that anyone giving thought to using one of the Old School studies to plan a retirement would be well-advised to “FuhGedDaBouDit!”). Every member of that discussion-board community thought that the Old School studies were legitimate (even I thought at the time that the studies were the product of honest effort). Those threads remain available today. What I am saying here can be checked. People have planned retirements by making reference to the Old School studies.

There is a sense, though, in which what SWR Lover is saying here really is so. People thought at one time that the methodology used in the Old School studies was analytically valid. Now they know that it is not. But a good number of the people who have learned as a result of our discussions that the Old School studies get the numbers wildly wrong still use the Old School studies to plan their retirements! This also can be verified by looking at the Post Archives of The Great Safe Withdrawal Rate Debate. This also can be checked.

So we have learned two important things. One, we have learned that our thinking on what it takes to plan a retirement effectively is hopelessly confused. We got it all wrong, and we need to go back to the beginning and start again (that’s what The Retirement Risk Evaluator, the world’s first New School SWR calculator, is all about). Two, we have learned that discovering that a methodology gets the numbers wrong does not necessarily hit investors where they live. It might be that people want accurate numbers when analyzing things in other fields (that certainly has always been my experience!). When it comes to investing, though, an entirely different set of rules applies. In the investing field, people love to be deceived. In the investing field, people applaud inaccuracies. In the investing field, people react with shock and anger and hostility to the idea that a false number might be corrected. Stock investing generally does not work according to the rules of reason.

The latter finding is the more important one, in my assessment. It is of critical importance that the Old School studies be corrected, to be sure. But it is of even greater importance that we come to a deeper understanding of why it is that people want to be deceived in the investing advice they read. That’s more important because doing the work it takes to get the numbers right is a waste of time if people are not responsive to what we come up with.

I say above that in earlier days I believed that the Old School studies were the product of honest effort, suggesting that I do not believe that to be the case today. Am I saying that I think that all the authors and promoters of the Old School studies are engaged in fraud? Yes and no. It is fraud to advise people to use numbers you know to be wrong to plan their retirements (and the errors in these studies are so basic that it is more than a little hard to imagine that I am the first person who has noticed them). But it is a very strange and special kind of fraud we are dealing with. Many of the people advocating that others use the Old School studies to plan their retirements are using them themselves to plan their own retirements. This too can be verified by making reference to the Post Archives of our discussions. So this is an act of fraud in which the person engaging in the fraud is himself a victim of the fraud. Holy moly!

Self-deception is the primary problem here. The deception of others is of course a big problem too. But, if we want to help the people whose retirements are at risk, we need to be practical in our approach. And the practical reality is that we need to deal with the self-deception matter to get to first base. When the people telling lies about SWRs (word games are essentially lies, are they not?) realize that they are destroying themselves by using bad numbers to plan their own retirements, they will stop urging others to use bad numbers to plan their retirements. Does that not make sense?

I of course believe that we should continue to do what we can to get the word out about the false SWR claims advanced in the Old School studies. There are hundreds of community members who have responded with great enthusiasm to our findings, showing that the level of self-deception practiced by stock investors varies greatly; some are capable of seeing that it is a bad idea to use wildly wrong numbers when deciding when to hand in a resignation to an employer. Many others are not capable of seeing this, however. Those many others include (not entirely, but to some extent) big names like John Bogle, William Bernstein and Scott Burns. So our most urgent task today is to come to a better understanding of why even powerful minds feel such a strong draw to self-deception when forming ideas about how to invest. That’s a big story in its own right, bigger than the story about the Old School studies getting the numbers wrong, in my estimation.

I referred to SWR Lover’s comments as “repulsive” in my response in the comments section for the earlier blog entry. The reason why I find the word games repulsive is that word games feed right into this self-deception disease that we all seem to suffer from in the area of investing. We very, very, very much want to believe that things that cannot possibly be so about stock investing really are so. I see it as the most important work project of my lifetime to come to a full understanding of why it is that stock investors destroy themselves in this way over and over again (this is the fourth time in history in which valuations have risen to what they are today — the first three trips ended in bone-crushing losses to all who invested heavily in stocks despite what their common sense told them about the risks of doing so at these sorts of price levels). Those who are engaging in word games are doing the opposite of what I am seeking to do. I am trying to make things more clear to people, they are trying to make things less clear. It is in this sense that I view the use of word games in this area as “repulsive.”

I do not view SWR Guy repulsive as a person. I am grateful that he let us know a little bit of what was going on in his mind when he wrote the gibberish that now serves as the Bogleheads wiki statement on SWRs. I contest the ideas put forward by SWR Guy to the strongest extent imaginable. He and I are coming at this from entirely different places. I hope that our personal interactions can be warm ones and civil ones and friendly ones and helpful ones. That’s because I want them to be learning ones. SWR Lover is not just destroying others with his word games. He is destroying himself at the same time. I think if benefits all aspiring early retirees for us to learn what it is that makes it seem in his eyes that that is an appealing thing to do.

Today’s Passion: I argue in an article entitled Does John Greaney Believe His Own Safe Withdrawal Rate Claims? that, if John’s best friend asked him about SWRs, John would probably say the same sorts of things that he says in his study and on our boards.

“For You and Your New School SWR Studies
to Gain a Measure of Credibility…”

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Schroeder posted a comment to yesterday’s blog entry that I believe merits a blog entry of its own in response. His comment came in response to my observation that the Bogleheads wiki statement on safe withdrawal rates (SWRs) contains a link to an Old School SWR calculator but not to the only New School SWR calculator now available on the internet. Here is what he said:

“Actually, there are several links to Old School SWR studies. They have been authored by financial planning professionals and published in peer reviewed journals.

“Rob, you need to do the same. For you and your New School SWR studies to gain a measure of credibility, they need to be embraced by the financial planning community — both by practitioners in the field and journals read by both practitioners and academics.

“Another idea is to partner with someone who does have that credibility. I realize that the partners you have petitioned like Scott Burns and Jonathan Clements have not given you a warm reception. But surely, there must be others, right? How about Robert Shiller? That’s just one name that comes to mind. I’m sure you can think of dozens of other practitioners and academics who will partner with you.”

Schroeder is correct that there are many financial planning professionals who have endorsed the Old School SWR studies. This is an important fact and it is good that we remind those following our discussions of this reality from time to time.

Schroeder misstates the realities of what happened in my discussions with Scott Burns and Jonathan Clements.

Clements said that the Old School studies are “not the last word in SWR analysis,” in his view. That is obviously not an endorsement of the Goon position that posting on the flaws of the Old School studies should be banned at all Retire Early and Indexing boards. If the Old School studies are not the last word, we obviously should be seeking to learn how to enhance our understanding of SWRs.

Clements did not endorse The Retirement Risk Evaluator. But I think it would be fair to say that he endorsed the position of the thousands of community members who have expressed a desire that honest posting on the SWR topic be permitted on our boards. He is saying that we need to learn more. We obviously cannot learn more until the ban on honest posting is lifted.

For community members to be able to interact in an honest and informed way, they obviously need to know how the Risk Evaluator works and what it says. Hence, we need to see links to this tool in places like the Bogleheads wiki statement on SWRs. Clements is saying that we need to continue the learning process and the failure of the people who control what is put in the Bogleheads wiki statement to include a link hinders the learning process in a very serious way. It is the people who control what is put in the Bogleheads wiki statement who are rejecting what Clements has said on SWRs, not me (I of course look forward to the day when Clements goes a step further and endorses the Risk Evaluator).

Burns has written three columns on the New School research done by John Walter Russell. Mel Lindauer (co-author of The Bogleheads Guide to Investing) has compared those articles to the work of a journalist on the crime beat who reports on the actions of a serial killer. I don’t buy it. It is clear to me from the wording of his columns that Scott has reported on the New School findings because he sees great value in them. I am influenced by the fact that Scott has told me in private e-mail correspondence that he believes that John and I are right in what we say about SWRs. So Schroeder’s claim that Burns has not responded warmly to the New School concept (it was Burns who coined the “New School” terminology to make reference to our findings) is obviously more than a little bit off the mark.

The other side of the story is that Scott also has not endorsed the Risk Evaluator and Scott has indeed put forward some unkind words about me. He has described my efforts to get the Old School SWR studies corrected as “catastrophically unproductive.” He has said that “the whole idea that there is a new school of Safe Withdrawal Rates reeks of personal aggrandizement.” Yes, the guy who came up with the term “New School” mocks it. Beat that one in the irony department!

There is not one Scott Burns. There are two. If there were only one, the part of Scott Burns’ brain that understands that valuations affect SWRs and that the Old School numbers are thus wildly off the mark would tell the part that writes the column in the Dallas Morning News that millions of retirements are at risk of going bust and that this is the biggest story of his lifetime and that he had better get to work pumping out some columns.

And there is not one Jonathan Clements. There are two. If there were only one, the part of Jonathan Clements’ brain that understands that the Old School studies are not the last word in SWR analysis would be asking Rob Bennett for the details of the Campaign of Terror that has been used to block honest discussions of the need for improvements in the old SWR studies so that he could write the story up in The Wall Street Journal (now that Clements is no longer employed there, he would instead send an e-mail to one of his friends there tipping them off to the story that I let him know about in an e-mail).

This strange phenomenon in which the human personality is divided into two has not affected only Scott and Jonathan. I wrote a blog entry a little while back about something that happened to Rob Arnott (editor of the Financial Analysts Journal) at a recent conference of the sort of people who spend their working days constructing peer-reviewed SWR studies. He asked the group of 200 “experts” how many of them believed in the Efficient Market Theory. Not one raised his or her hand. He asked how many would be rooting the research they would be preparing when they got back to the office on Monday morning in the premises of the Efficient Market Theory. Nearly every one of the 200 raised his or her hand.

These are the people that Schroeder is telling me to contact for help with my credibility?

In the investing field?

Um — I think I might stick to the track I am on today. There’s lots of wonderful stuff done in the world of academia. There’s also a lot of gibberish produced in that world. My job is to sort out the good from the bad and report to you what I discover. My intent is to continue to do that job to the best of my ability and let my credibility take care of itself. I have a funny hunch that, given that I have discovered through that process that the Old School studies are wildly wrong, it does more for my credibility to report what the New School studies say than it would to endorse the Old School studies.

The reality is that there are scores of peer-reviewed studies that show that valuations affect long-term returns, probably hundreds. There is nothing that I have said about the investing realities that hadn’t been said thousands of times before I came along. And of course there are academics who report the realities. Another recent blog entry reported on a Capital Spectator article noting that: “a new generation of researchers took a fresh look at the random walk in the 1980s and 1990s and the accumulating tide of studies began to turn the academic tide.” More serial killers on the loose!

Valuations have been affecting long-term returns since long before the first Old School SWR study was a gleam in the eyes of the Trinity Study authors. Nothing has changed in recent years but the P/E10 value. When the P/E10 value is 24 (the number that applies today and one of the highest on record), it’s viewed as “rude” to comment on how stocks have performed since the beginning of time. It’s viewed as “kind” to tell people the sorts of fairy tales set forth in the Old School studies.

So be it.

But I’m not in the fairy-tale telling business. I write for people. When I click my words onto the computer screen, I have the image of a real live middle-class man or woman in mind as the person to whom I am directing the thoughts. The people who read my stuff matter to me. They have college educations to fund, retirements to finance, dreams of more fulfilling work that they could pursue if only they had a bit more money. I am going to tell the story straight to those people, smear attacks on my credibility be darned.

I understand Scott’s point that what the historical data says on SWRs is “information most people don’t want to hear.” That doesn’t matter to me. Or at least it doesn’t matter to me enough to make me go along with the idea that telling the story straight is “catastrophically unproductive.” I will post honestly or I will post not. There’s zero give on that one.

So I will continue to do my thing. John Walter Russell will continue to do his thing. Mel Lindauer will continue to do his thing. John Greaney will continue to do his thing. Schroeder will continue to do his thing. Scott Burns will continue to do his thing. Jonathan Clements will continue to do his thing (at a new place since he left the Journal recently). Life will go on, ob-la-di, ob-la-da.

The historical data will continue to say what it says. There is no Smear Campaign that can change that. The authors of the Old School studies got the number wrong, wildly wrong. Their error will cause millions of busted retirements in days to come in the event that stocks perform in the future anything at all as they have always performed in the past. And when we ask them to make corrections, we will hear word games in response. Har-de-har-har.

I write for people with a sincere desire to learn how to save and invest effectively. Thousands of them have expressed a desire that honest posting be permitted on our boards. I urge them to do what it takes to see that desire brought to fruition. It is these people, not the Goons, who built our boards. These people deserve better than they are getting today. A lot better.

I will continue to report accurately what the historical data says re SWRs. Deal with it, Goons.

Today’s Passion: The many community members who would like to see honest posting on SWRs permitted at our boards sound off in an article entitled Community Comments on Using Historical Data to Diminish Retirement Risks.

The Boglehead Wiki Statement on Safe Withdrawal Rates

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The Bogleheads wiki contains the following statement on safe withdrawal rates (SWRs) under the heading “Controversy”:

“Unfortunately, the term ‘Safe Withdrawal Rate’ is necessarily an ambiguous term. This is because initial methods utilized historical data to statically determine what would have been safe given the actual results that past portfolios would have generated with the variables given. The next logical step, of course, was to use that information to predict future SWRs. Either use is technically correct, but one should always be sure to be clear whether the use is in reference to past or projected SWRs, so that unnecessary argument can be prevented.”

Set forth below are my reactions:

1) The statement is a positive development. There was a time when “defenders” of the Passive Investing approach were asserting that the Old School SWR studies are accurate. This statement implicitly (but not explicitly, to be sure) acknowledges that they are not. The SWR is the product of a mathematical calculation. It is obviously not possible for the Old School studies (which include no adjustment for the valuation level that applies at the beginning of the retirement) and the New School studies (which do) to both be accurate. For years, the Goons have asserted that anyone arguing that an adjustment for valuations is needed is “mentally ill.” This statement says that the New School studies are “technically correct.” This is a big advance from the former Goon position and represents an implicit acknowledgment that the Old School studies are analytically invalid (if it is “technically correct” to include a valuation adjustment to calculate the SWR, it is analytically invalid not to include such an adjustment).

2) The statement is logically incoherent. It is obviously not possible for both the Old School studies and the New School studies to be “technically accurate.” Either an adjustment for valuations is required to determine the SWR or it is not. The historical stock-return data shows beyond any reasonable doubt that a valuations adjustment is required. Many experts have confirmed this. For example, William Bernstein, author of The Four Pillars of Investing, has advised any investor giving thought to using one of the Old School studies to plan a retirement to “FuhGedDaBouDit!”

3) The statement is disingenuous. The statement asserts that the New School studies are “technically correct.” Yet the remainder of the wiki article contains references only to Old School studies. Did the Bogleheads that crafted the remainder of the article not bother to read the “Controversy” statement?

4) The statement is unhelpful to its readers. The statement does not include a link to The Retirement Risk Evaluator, the first New School SWR calculator. There is no excuse for the failure to provide such a critical link in a wiki treatment of this topic.

5) The statement is false. It is not so that the SWR phrase is “ambiguous.” The “safe withdrawal rate” is the withdrawal rate that is safe presuming that stocks perform in the future at least somewhat as they always have in the past. I have seen thousands of discussion–board threads in which investors saw references to safe withdrawal rates and were quite naturally led by them to believe that the matter being discussed was what withdrawal rate was safe. The Old School studies identify the withdrawal rate that would be safe in an imaginary world in which valuations have zero effect on stock returns. There is nothing “ambiguous” about the error made in these studies. It is a clear error and an obvious error and a highly significant error.

6) The statement is reckless. The statement appears in a wiki article that contains links (without warnings) to both the Greaney SWR study and to the FIRECalc SWR calculator. I notified Greaney of the errors in his study six years ago. I notified Bill Sholar, author of FIRECalc, of the errors in his calculator not too much later. Neither the Greaney study nor FIRECalc have been corrected in the time since. Both Greaney and Sholar have advocated bans on honest posting on SWRs at discussion boards at which they participate.

7) The statement is silly. It urges that “unnecessary argument” be avoided. I have had a front-row seat to the first six years of The Great Safe Withdrawal Rate Debate. I am not able to recall a single incident in which a poster supporting the idea that honest posting on SWRs be permitted on our boards engaged in any “unnecessary argument.” I witnessed tens of thousands of cases in which “defenders” of the Old School studies engaged in endless rounds of word games and abusive posting. The way to avoid unnecessary argument is for those now “defending” the Old School studies to urge corrections of the errors in them. Once the Old School studies are corrected, there is nothing to argue about.

8 ) The statement provides a false history of the development of our knowledge of how to calculate SWRs. Investing experts have been using the Old School studies to advise aspiring retirees for a good number of years now. The claim has always been that these studies report the SWR, not “what would have been safe” under the convoluted scenario described in the wiki statement. This is so for obvious reasons. An aspiring retiree is not seeking to learn what withdrawal rate “would have been safe” under some convoluted scenario; she is seeking to learn what withdrawal rate is safe for someone beginning a retirement at the time she is planning to begin her retirement. Even Ataloss, one of the lead Goons, has said that, if the Old School studies get the SWR number wrong, they are “worthless” (I view this as an overstatement, but I certainly do not believe that aspiring retirees should be using the Old School studies to determine what withdrawal rate to use in their plans).

9) The statement contains no apology to the thousands of fine community members in the Retire Early and Indexing communities who either participated honestly in our discussions or expressed a desire that honest posting be permitted. Given what these community members have been put through for six years now by the “defenders” of the Old School studies, an apology is obviously appropriate.

10) The statement does not explain the importance of our discovery that the Old School studies are analytically invalid. The Old School studies are the product of a Passive Investing mindset. Passive Investing advocates recommend that investors not adjust their stock allocations when valuations move from reasonable levels to dangerously overpriced levels. The Old School studies posit that the SWR is a constant number. The connection is clear; the idea that the SWR is a constant number follows from the idea that one’s stock allocation need not be adjusted when stocks go through dramatic price changes — the flaw in both claims is a belief that valuations don’t matter. Our finding that the Old School studies are analytically invalid throws serious doubt on all valuation-related claims made by those advocating Passive Investing, not just the Old School SWR claims.

11) The statement contains no discussion of a publicity campaign to warn the retirees taken in by the false claims of the Old School studies. This is our most pressing need today. The point of learning about investing is to help investors to avoid falling into traps. The point of SWR analysis is to prevent retirees from suffering busted retirements. What purpose is served by talking about the “controversy” without outlining the steps that need to be taken for the controversy to lead to positive action?

12) The statement does not explore the implications of our SWR findings. Our finding that the Old School studies get the number wrong served as the beginning of The Great Safe Withdrawal Rate Debate, not as its ending. The Stock-Return Predictor is the product of these discussions. We have been using what we learned about retirement investing from our examination of the flaws in the Old School studies to develop tools and strategies to help investors in the asset accumulation stage for some time now.

13) The statement ignores the Goon phenomenon. It is impossible to discuss The Great Debate in a fair and complete and accurate and balanced way without making reference to the role played by the Goons and by the site administrators, experts, and ordinary investors who have tolerated their presence in our community for so long now.

14) The statement fails to discuss investor emotions. It is clear from our discussions that many of today’s stock investors are emotionally invested in stocks and in all likelihood will remain so for so long as prices remain at sky-high levels. This is a reality of critical importance to any informed understanding of the “controversy” that has evidenced itself in our investing discussions of recent years.

15) The statement offers no recommendations for dealing with the abusive posting that has destroyed or damaged a number of Retire Early and Indexing boards. Again, why not address the practical?

It’s not a perfect statement. The reality remains, however, that it evidences an inching in the right direction. At this rate of progress, honest posting will be permitted at all the boards well before the close of the 23rd Century.

I’m joking! I do see positive signs and I think it is fair to classify this statement as one. We need more, a lot more. But progress is being made over time and it’s every bit as much a mistake to become too pessimistic as it is to become too optimistic. Let’s hope that a good number of our fellow community members are taken aback by this wiki statement and prompted by it to study the SWR matter in a good bit more depth. I see it as being entirely possible that that will happen and in that event the statement will end up pushing things forward. Let us pray!

Today’s Passion: Dallas Morning News Columnist Scott Burns has described my efforts to get the Old School SWR studies corrected as “catastrophically unproductive.” No, honestly!

“An Important Communications Medium of the Future”

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Katy Marquardt has written about the split-off of the Bogleheads community from the Vanguard Diehards community at her U.S. News and World Report blog.

Juicy Excerpt: Concludes Coleman: “The revamped Diehards.org is better organized, easier to navigate and much more intelligently moderated than the older version,” he says. “It’s becoming a true social networking site.”

I put forward a comment filling in some of the background that Murray Coleman “overlooked” in his write-up at IndexUniverse.com (referred to in Katy’s blog entry)

Juicy Excerpt: The internet discussion board is an important communications medium of the future. We learn things on discussion boards that we cannot learn through books or magazine articles or speeches. The magic is that we get to see how real live people apply the theories they learned about in books and magazine articles and speeches.

Threads are ongoing both at the Bogleheads community and at the Vanguard Diehards community. There’s a thread ongoing at Goon Central too but I recently added as a plug-in to this blog an Extreme Dumbnosity Filter and it will not permit me to post the link; you’ll have to dig that one up on your own.

Oh, shoot! — Here it is.

Today’s Passion: Jim Wiandt, publisher of IndexUniverse.com (referred to in Katy’s blog entry), said of the Valuation-Informed Indexing approach that “It’s not like you are proposing some wild new idea!” That’s me — Good Old Moderate-Sounding Non-Stop Troublemaker Rob.

We Don’t Know Enough to Know What We Don’t Know

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We don’t.

We don’t know the meanings of the words. This one kills me. When people offer you investing advice, the odds are good that they don’t know the meanings of the most basic terms at issue.

If a baseball manager didn’t know what a bunt was or what a squeeze play was or what the infield fly rule was, you would fire him. I’ll bet 50 cents that whoever it is you turn to most often for investing advice doesn’t possess a strong grasp of the meaning of most basic investing concepts. I can say that because just about no one does today. Our understanding of how investing works is not yet sufficiently advanced for us to have reached agreement on even the most fundamental points.

Risk is fundamental, right? If you don’t understand risk, you don’t understand investing. Still, the reality is that there is not yet a general consensus on what risk is.

Lots of people say that risk is volatility. Stocks are risky because prices go up and down a lot. Buffett laughs at that idea. He points out that, if risk is volatility, then a stock that goes up in price is more risky than one that remains always at the same price. He’s got a point. But the others just keep insisting that volatility is risk, as if they knew what they were talking about and as if they had not heard what Buffett said. That’s reassuring — not!

What else?

The Great Safe Withdrawal Rate (SWR) Debate is the product of a failure of investing “experts” to distinguish between the concepts of “surviving” and “safe.” Say that you drove drunk two times and got in horrible accidents, but lived. You would not conclude that driving drunk is a safe thing to do. That’s what the Old School SWR studies do. They look for what withdrawal rate barely survived for the two times in history when we got to the price levels that apply today and declare that withdrawal rate “100 percent safe.” Um, that makes sense. If the authors of the studies understood the difference between these two simple concepts, they wouldn’t do that. And they probably do understand the difference when talking about other subjects. When it comes to investing, though, they “forget” the meaning of the words and offer highly dangerous retirement advice.

What else?

Greaney has a study that says that a 74 percent stock allocation is always “optimal.” John Walter Russell checked the historical data and found that that allocation is indeed optimal except for just about all of the other possibilities that can be imagined by the rational human mind. People don’t use the word “optimal” in the investing realm to mean the same thing that it means when used in any other context any more than they use the word “safe” to mean the same thing that it means when used in any other context.

What else?

Investing experts do not know what the word “indexing” means. There are big battles going on about it. Rob Arnott came up with something called “Fundamental Indexing” and John Bogle is saying that it is only Bogle’s idea of indexing that is really indexing and that no other understandings of the term are permitted. As Church Lady has been known to observe from time to time, how convenient!

What else?

People use the phrase “Passive Investing” to refer to indexing all the time. Are they the same thing? It sure doesn’t seem so to me. I love indexing (owning tiny interests in a large number of stocks so that you enjoy great diversification at low cost). Love it, love it, love it. I hate Passive Investing (sticking with the same stock allocation despite wild price swings). Hate it, hate it, hate it. If they are the same thing, how can one guy love one and hate the other? I’m thinking that it just might be possible to index without investing passively, you know?

What else?

Long-term. We’re all investing for the long-term today. So we need to know what it means. But we do not.

The promise that investing in stocks will always work out well in the long term works only for those willing to hold for 30 years. Few of the investors who say that they are investing for the long-term know that. Many think that the long-term is 5 years or 10 years. Guess what happens when those people learn that the results they were expecting to see in the “long-term” ain’t gonna show up when they were expected to show up?

What else?

Buy-and-hold. We don’t know what it means.

Buy-and-hold is effortless during a huge bull, like the one that ended in 2000. We’re now in the huge bear that inevitably follows a huge bull (during a bull, we borrow huge amounts from the returns of future investors to push current-day returns far above those justified by the economic realities). Ball-and-hold is now a very difficult thing, especially for those who were led to believe that it was always easy. The reality is that no one knows what is required to be a buy-and-hold investor yet because the strategy has never yet been tested in a bear market.

What else?

We don’t know what a high valuation level is. Most “experts” use P/E1 to tell us whether stocks are overvalued or not. P/E1 gives many false reads. Those who know what they are talking about use P/E10 or perhaps Tobin’s Q or some other legitimate valuation assessment tool. The majority of people who call themselves “experts” don’t know that they are using a tool that does not work. So they do not really know what valuation level applies at any given time or what its significance is (you cannot make meaningful comparisons of how stocks perform from various valuation levels if your valuation assessment tool is gravely flawed).

It’s not my intent here to put people down. My intent is to let people off the hook. If the experts would stop pretending that they know things they do not know, investors would know to check things out more carefully for themselves. People got proud and careless during the huge bull. Giving investing advice that “worked” during the huge bull was not too difficult a task. Most of us are not up to the job in this new environment.

We need to go back to school. We need to learn the basics. We need to be more cautious in how we state things. We need to learn how to say “I don’t know” and “I was wrong.”

Most of all, we need to develop the intellectual curiosity needed to begin an effort to nail down some of the most basic concepts.

Today’s Passion: The article entitled Investing Basics that Even the Pros Don’t Understand notes that the return you will obtain on your stock investment can be known in advance. Why don’t the big boys they tell us these things?

“The Focus on Active/Passive Is a Distraction”

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There’s good stuff going on at the Vanguard Diehards board lately. Petrocelli offers us a dose of The Common Sense That May Not Be Spoken when he says: “My conclusion after all these years is this: the focus on active/passive is a distraction. The focus should be on buying low-cost funds and diversifying. That’s all. The active/passive distinction can make for some fine pissing contests, but it doesn’t really accomplish a lot in the end.”

That’s good stuff.

I see Passive Investing as the Devil With a Blue Dress On of InvestoWorld. I say “don’t even start up a conversation, you’ll end up in the gutter with a bottle in your hand.” But Passive Investing didn’t get to be so popular just by being evil. There’s got to be some serious good in there or there wouldn’t be so many smart people who have fallen for it. Petro is pointing us to two of the obvious good points when he notes that those who push Passive argue for diversification and for keeping costs down. The other obvious good is that those who push Passive push sticking with a plan for the long term. Those three goods are a very big three goods.

That’s the blue dress part. I believe that God put me on earth to warn you about the devil part. So we better get to that.

Petro is proposing a non-dogmatic approach to Passive Investing. That makes sense. Apply the principles of Passive Investing in a non-dogmatic way and you can enjoy the three goods without falling into the pit. Where I might take issue with Petro a bit is re his possibly too glib suggestion that there are a good number of investors who can pull this off in the real world.

Delete the dogmatic from Passive Investing and you’ve got the one you’ll be proud to bring home to meet your parents. But what are the odds of getting Ms. Passive to go along? Is the Petro vision a fantasy?

I think the Petro vision can be realized. But I think we need to think it through a bit to make it happen.

You can avoid becoming dogmatic about Passive Investing by knowing its limitations. I think that’s the key. In order to make Passive Investing work out in the real world, you need to go in with a peaceful easy feeling, with both feet planted firmly on the ground.

Passive is dangerous in its suggestion that it is okay or acceptable or (heaven help us all!) even a good thing to stick with the same stock allocation when prices go through wild swings. Petro doesn’t care about that rule. He’s a practical guy. He wants what works. So I don’t think he would be opposed to the idea of people hearing why it’s critical that they lower their stock allocations when prices get to the sorts of levels that apply today. So Petro’s vision can work.

People need to be told about the realities, though. We’re born with evil hearts. We all feel temptations to buy into Get Rich Quick schemes. We all possess a desire to hurt ourselves, and unless we are warned about it in no uncertain terms, we will bite into the apple. We need all this stuff spelled out.

We need articles warning us of the dangers of failing to make adjustments in our stock allocations when price changes require it. We need calculators using the historical data to prove the point. All that good stuff. With all that good stuff, I think we can make some changes in the conventional approach to Passive to make it a workable investing strategy.

A generally Passive approach can work. A reformed Passive approach can work. A non-dogmatic Passive approach can work. A valuation-informed Passive approach can work.

A fellow named “Heaths” zeroes in on the good side of Passive a few posts later when he asks: “it seems that you agree that the degree of active is important and more than a distraction. Is that right?” Yes, that’s right. Investors should aim to limit the number of allocation changes they make. And beginning investors should limit the extent to which they engage in stock picking. Those Passive rules are good rules. it is the dogmatic jive talk of The True Believers that causes all the trouble.

Heaths focuses in on an extremely important point a bit later on. He says: “Most investors do not have the skill and/or temperament to actively invest, except perhaps in very modest ways. Because of this most should follow the basic tenets of passive investing: low cost, diversification, and stay-the-course. Some modest active investing might be desirable provided the investor fully understands all of the pros and cons of his investment decisions, but when in doubt most should err toward the passive.”

That’s stated reasonably. It’s not the crazy dogmatism that has made such a mess of so many of our boards over the past six years.

I don’t entirely agree with Heaths, however. I agree that there are important goods in the Passive model and that all investors should be taught about them. I don’t agree that we are not capable of knowing when we need to make changes in our stock allocations, however. All of us have experience paying attention to price when we buy cars and houses and bananas. I am highly skeptical of the claim that we are not capable of doing the same when buying stocks.

It’s true, though, that most of us do not possess this ability today. Heaths nails the current state of play.

You know why? It’s because nobody talks about these realities! When was the last time you heard Bogle give a speech telling us how to know when prices have reached a point where we need to lower our stock allocations? Or Bernstein? Or Burns? Or whoever?

When the Big Shots get down to the business of telling us what we need to know, we will listen. And we will learn. It’s not that we can’t do it right. It’s that the “experts” are so afraid of talking straight about this stuff that they never give us a chance to take the good stuff in.

I know whereof I speak. I have been talking about the effects of valuations on long-term returns on a daily basis for over six years now. Thousands of community members have either expressed gratitude or expressed a desire to learn more. These are ordinary people. These are Normals. These are “most investors.”

We are perfectly capable of learning. What we need today are some “experts” possessing the courage to get about the business of doing some honest and informed and non-dogmatic teaching.

Good job, Petro! Good job, Heaths! Let’s see more of the same!

Today’s Passion: The non-dogmatic Passive Investor is free to do all sorts of things that the dogmatic type dare not even think about. He can pick stocks! No, really. Read all about it in the article entitled Stock Picking for Indexers. Please don’t let any friends of Mel Lindauer know that I wrote that one. I’m in enough trouble as it is.

I Hope You Suffer

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Sometimes I say things in the heat of the moment just to have something to say and, then later, when I read the words back, they make sense! It sometimes really does happen that way. It makes me wonder if there really is a God or something.

Some Goon was sticking his elbows out at me in comments he put to a recent blog entry and I went into my usual riff about how all you need is love and love is the answer and what the world needs now is love, sweet love, blah, blah, blah, blee, blee. blee. Then, for reasons unknown to us mere mortals, the Holy Spirit elected to inspire me to talk about the connection between love and suffering. That balanced the gooey, sticky sweet part and made the riff sound more balanced and real and right.

It’s all about love. It’s all about suffering. Both things are so.

Suffering leads to love. Love leads to suffering.

Hey! I didn’t make the rules. I just report on these unfortunate investing realities as I happen to discover them.

If you keep your heart open to love, you are going to suffer. Anyone who tells you different is not your true friend. Like Otis, I’m a love man. But Otis also wrote “Mr. Pitiful.” Otis knows the score and Otis tells the truth. You need to listen to more than one song if you hope to get anywhere in this world.

I noted in that blog entry that the boards are gradually opening up to the idea of permitting honest posting. My dream! So I should be happy, right?

Well, yeah. Except that this opening up process is the result of lots of people losing a large percentage of their life savings. Which means that financial freedom dreams are being crushed. I am in the business of helping people make their financial freedom dreams come true. So I think it would be fair to say that this little detail is a discouraging note in an otherwise happy song.

Sorry about that.

It’s the way life goes on down here in the Valley of Tears. You get to love through suffering. There is no other way.

When I gave the title “Passion Saving” to my first book, I looked up the word “passion” in the dictionary. One of the definitions was “long suffering.” I thought that was funny. I suppose that the reference is to the passion of Jesus. But then why do they call the crucifixion the “passion” anyway? What’s up with that?

All passion comes from suffering. Romeo and Juliet felt a deep passion because their love was denied. If Juliet’s father had said “that Romeo fellow seems like a nice enough boy, perhaps we can find a place for him in the family business,” she would not have felt things so strongly. Love denied grows. A passionate moment is a moment when something that has long been denied to you is given to you.

We’re suffering now because of the lies we told in the 1990s. I wish that everyone would stop with all the nonsense rationalizations and just say things as we all on a deep level know they are. All the blah-blah has its place. But the first thing that is needed is for us to acknowledge that it is our own lies that caused the problem. We need to grow up. We need to stop making up stories that pull our attention away from The Real Story.

The pain is God’s way of forcing us to do that. He doesn’t set things up this way because He wants to crush us. Bear markets are not God’s vengeance. They are God’s way of showing His love for us. He is saying that He expects better of us, that he knows that we are capable of better.

We are a better people than we pretended to be in the late 1990s. We all should be wishing for a bear market so that we can regain the good qualities that we abandoned during that most unfortunate time. We are capable of honesty. We are capable of compassion. We are capable of intelligence. We are capable of courage.

It is by suffering that we regain the good traits that we temporarily set aside. It is by suffering that we learn again how to love.

And you thought that losing the money you hoped to retire on was a bad thing!

Today’s Passion: The article entitled Learning From Your Mistakes — I Never Should Have Bought That Leo Sayer Album explores the suffering involved in trying to find common ground with a girl who likes disco.