A Rich Life

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

The Rob Bennett Challenge
to Passive Investing Enthusiasts

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I’m some guy who posts stuff on the internet.

Some people think that I should learn my place. Some people think that I should stop talking back to my betters.

I can’t do that. I think of my fellow community members as my friends. When you learn things that can help out your friends in a big way, you let them know. I will continue to report the safe withdrawal rate accurately. I will continue to post honestly on what the historical stock-return data says about the effect of valuations on long-term returns.

I’ll continue to get flak for doing so too. I think that much is more than fair to say.

The fellow who runs the Clever Dude blog came up with a great solution to the abusive posting problem a few weeks back. There were some abusive posters posting comments on a guest blog entry that I wrote for that blog and the guy who runs it said: “I’d like to invite any and all of you to submit guest posts as well (go to my Contact page) to counter Rob’s article or to write about any other topic you like.”

That’s the right stuff. Civil and reasonable humans work out their differences by talking them over, not by participating in never-ending smear campaigns. I followed by putting forward a similar invitation of my own. I said: “I extend the same offer re space at my blog. I would love to see people contributing guest blogs that offer ideas counter to my investing views. I of course have strongly held views and I of course am obligated to state my sincere views. So I see the biggest weakness of the Financial Freedom Blog [now the A Rich Life blog] being the lack of balance in perspectives being shared. I get some comments putting forward other points of view, but not enough of them. So if Schroeder or others would like to make some points in a guest blog, I very much encourage them to send me some words.”

There have been no takers. None of the Passive Investing enthusiasts who have terrorized the Retire Early and Indexing communities over the past six years have written up any words explaining their case in civil and reasoned language. Surprise! Surprise!

I say “Surprise! Surprise!” because I have made similar offers on a number of earlier occasions. I asked Greaney to participate in a debate of the safe-withdrawal-rate topic at the Motley Fool board in which only he and I would post and members of his Goon Squad would not be permitted to disrupt. No dice. I offered to appear on a radio show with Greaney at which he would argue in support of the Old School SWR studies and I would argue in support of the New School SWR studies. No dice. I included in an article that I posted to the web site several years back an offer to provide space for Greaney or Sholar or any of the other “defenders” of the Old School studies to make their case. No dice.

I want dice!

I want dice because it is important to be fair and balanced. I say that the demonstrably false claims advanced in the Old School studies are likely going to cause millions of busted retirements in days to come. That’s a startling claim. If it is true, I have absolutely no choice but to advance it. To fail to try to get the word out to millions of people whose retirements are likely to fail would be an unforgivable dereliction of my responsibilities to the community. On the other hand, if there is something wrong with the claim, I have a responsibility to let people know that and to correct my words. So I should be doing all that I can both to publicize the flaws of the Old School studies and to learn of any flaws in the New School concept (the New School argues that it is impossible to calculate the SWR accurately without including an adjustment for the valuation level that applies on the start date of the retirement).

How are we all to learn whether the “defenders” of the Old School studies have any justification for not calling for the correction of them unless they tell us what it is? I believe that the reason why they have not offered any justification is that there is no possible justification. Still, I don’t think it hurts to open this blog space to anyone willing to take a stab at defending the Old School methodology. Hence — the Rob Bennett Challenge to Passive Investing Enthusiasts.

I hereby challenge any defender of the Old School studies to write up a blog entry explaining why he or she thinks it is a good idea not to include an adjustment for the effect of valuations in an SWR study. Send it to me (please note the “Contact Rob” tab at the left-hand side of this page) and I will schedule it for posting at the A Rich Life blog.

We’ve gone well beyond discussion of the flaws of the Old School SWR studies in recent years. So I would like to make the Challenge broad enough to cover more than the topic that kicked off The Great Debate. I believe that the truly core issue is the Passive Investing issue. Does it make sense to urge investors to stick with a stock allocation elected when prices were reasonable when prices have reached dangerously overvalued levels? I say “no way!” If you say “yes, way!” please give some thought to writing up some words and passing them along for posting where your fellow community members can read them and learn from them.

I will not comment on any blog entries submitted within the text of the blog entries themselves. I may or may not comment in a subsequent blog entry posted under my own name. I won’t offer the first comment to any blog entry posted as part of The Rob Bennett Challenge. If others comment, I may or may not offer my views in response to those comments, as I would re comments posted in reaction to my own blog entries.

I’m not expecting to receive any blog entries in response to the challenge. I would love to be surprised.

There’s no deadline. I’m happy to see your reasoned defense of either the Old School SWR studies or the Passive Investing concept whenever time opens up in your schedule for you to do us all the favor of writing one up.

As Clint Eastwood nearly said:

Ya feeling challenged today, Goon?
Well, are ya?

Note: I am of course with the references to “Goons” having a little fun with those good friends of mine who have been terrorizing the Retire Early and Indexing boards for six years now. Non-Goon submissions are both welcomed and encouraged. They will be pushed to the top of the list! They are preferred!

Today’s Passion: When I’m not caught up in the important business of challenging Goons, I often spend my time coming up with saving advice sayings. My favorites are collected in an article entitled Rob Bennett’s Favorite Saving Advice Sayings.

Passive Investing Has Already Failed

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Passive Investing is an approach in which you stick with the same stock allocation despite wild price swings. It became hugely popular during the wild bull. Its popularity is now in the process of bringing about the largest loss of middle-class wealth in the history of the United States (presuming that stocks perform in the future anything at all as they always have in the past).

The Stock-Return Predictor tells us that, at a time when the P/E10 value is 8 (the value that applied at the beginning of the huge bull), the most likely 10-year annualized real return for stocks is 14.5 percent. At a time when the P/E10 value is 44 (the value that applied at the end of the wild bull), the most likely 10-year annualized real return for stocks is a negative 1 percent. There is no stock allocation that makes sense both at a time when the likely 10-year return is 14.5 percent and at a time when the likely 10-year return is a negative 1 percent. Passive Investing is irrational.

Lots of smart people think it is a great idea. How come?

Say that you began investing in stocks at the time when the P/E10 value was 8. You obviously enjoyed great returns for a number of years. As prices climbed, your common sense told you that you should lower your stock allocation a bit. A voice from your dark side (you greedy cuss!) said “no, hang on, this money for nothing business is too cool!” The Passive Investing enthusiasts told you to pay attention to that voice. You did. You enjoyed more years of great returns.

Passive Investing is addictive. It works. And it works. And it works. And it works.

And then it doesn’t.

That’s how it has always happened. There’s an important sense in which what we are going through today is nothing new.

There’s another sense in which it is new, however. What is new is that this time Passive Investing paid off bigger and for a longer period of time than ever before. We never reached a P/E10 value of 44 before. The number that applied in the month before The Great Crash of 1929 was only 33. We shot way past that bad boy in late 1999.

So Passive Investing worked better this time than ever before, right?

Not right.

Extreme valuations are bad for middle-class investors. Yes, you make lots of money on the up. You then give it back on the down. The end result is not that you break even. The end result is that you are conned into believing that you are wealthier than you are, you make plans for the future based on what you believe your accumulated wealth to be, and then you see those hopes crushed. Middle-class investors are better off if stocks go up a steady 6.5 percent real per year.

Our belief in Passive Investing caused the huge bull. Rational investors would never have permitted valuations to climb so high. Our belief in Passive Investing put our minds in a collective fog. We let things get more carried away than we ever have before.

Most are going to wait until prices crash to term Passive Investing a loser. Not me. The financial losses we are suffering now are just the inevitable result of the crazy price jolts we saw in the late 1990s. The real problem is the craziness that Passive Investing injects into the investing system during up times, not the financial losses that inevitably follow when we are seeking to find our way back to sane price levels.

That’s my take. I don’t need to see the price drops to conclude that Passive Investing hurts humans and other smart, fun-loving mammals. My view is that the losses we suffer in a wild bear are just a natural consequence of the insanity we yield to during a wild bull. The damage has already been done. Passive Investing failed in my eyes when it caused the insanity of the late 1990s.

Please don’t think that I wish these losses on anyone. That’s always the accusation leveled at those who talk straight on stock investing. I want us to learn enough about stock investing to avoid both the insane price jumps of times like the 1990s and the painful aftermath of such eras of insanity. I focus on the cause of the pain rather than the pain itself because it is only by focusing on the cause that we can hope to help people. Bemoaning the price drops accomplishes nothing unless we use that pain to change our behavior during price cimbs.

Passive Investing causes the insanity that does in stock investors. The insanity is behind us; we are now in the early stages of recovery from it. That’s why I say that we do not need to see the price drops to conclude that Passive Investing has failed. This low idea has already accomplished its dirty work.

Today’s Passion: The article entitled Rational Investing vs. Passive Investing offers even more mean-spirited commentary about the most popular investing strategy in the history the world.

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.

I Am Not a Bear

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The most-likely annualized real return for the S&P index over the next 10 years is about 1.3 percent. There’s a less than 1-in-20 chance that we will see a return of worse than a negative 4.7 percent or of greater than a positive 7.3 percent, presuming that stocks perform in the future as they have in the past.

Go out 20 years, and the numbers get a bit better. The range of possible real returns extends from a negative 1.3 percent to a positive 6.7 percent. The most likely real return (the return in the middle of those two extreme outcomes) is 2.7 percent.

The 30-year numbers are a lot more encouraging. At that point, the most likely return is 5.4 percent. The worst outcome is a positive 3.4 percent return. The best is a 7.4 percent return.

My take on the message of the historical stock-return data? To know how much you can afford to invest in stocks, you need to think carefully about how long you can wait to see an appealing return on your money.

Does it make me a bear to report these numbers? I sure don’t think so.

If I said that I thought that returns were going to fall on the high side of the range of possibilities, that would make me a bull. If I said that I thought that returns were going to fall on the low side of the range of possibilities, that would make me a bear. The act of reporting the numbers by itself does not make me a bull or a bear.

Some say otherwise. Some say that it makes me a bear that I report the numbers that so many other investing analysts dare not report.

That shows how out of whack we have permitted our thinking about stocks to get after 20 years of the strongest bull market in U.S. history. We have become so accustomed to hearing a pro-stock slant that the straight story has come to sound bearish to our ears.

That’s not good. The very fact that there are some who refer to me as a bear is evidence of the extent of the overvaluation problem that casts a dark cloud over the financial futures of many of today’s aspiring early retirees.