A Rich Life

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

Mike “Mish” Shedlock: “The Bull Market Was Caused by Loose Money”

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I sent an e-mail to Mike Shedlock on April 10 asking him to take a look at my Google Knol entitled The Bull Market Caused the Economic Crisis. Mike is a registered investment advisor representative for SitkaPacific Capital Management. He writes the Mish’s Global Economic Trend Analysis blog.

Mike responded on April 11, saying: “Loose money is at the root of every bubble. The bull market was caused by loose money.”

Set forth below is the text of the e-mail that I sent to Mike on April 12. I will report on Mike’s response in tomorrow’s blog entry.

Mike:

Thanks for taking a look and for letting me know your thoughts.

I don’t want to be argumentative. But you are the third person who I respect who said something along those lines to me in the past three days and so I wanted to let you know my reaction. I fully understand the logic behind your comment. But my thought is that perhaps people are coming at the “loose money” angle from the wrong direction. By “loose money” I presume that you mean that the Fed handled monetary policy improperly. Could it be that the most basic problem is more simple than that?

Stockholders are able to vote themselves raises whenever they please just by bidding stock prices up. We bid stock prices up to three times fair value in January 2000. That translates into $12 trillion of overvaluation. Is that a loose money problem all its own, a much bigger one than the one that results from anything the Fed does? As a society we incurred $12 trillion in debt that had to be repaid by future investors (the investors of today!) regardless of anything the Fed did.

It’s important to identify the true cause of the problem because different causes point to different solutions. If the Fed is the problem, we need to reform the Fed. If the human inclination to bid up stock prices is the problem, we need to teach people new ways of thinking about how stock investing works. For example, we could provide people tools showing them that stocks offer a poor long-term value proposition when selling at high prices and encouraging them to sell once stocks reach such price levels. We wouldn’t need to reform the Fed to do that. We wouldn’t need to take any political action at all. We would just need to change the messages about stock investing that people hear.

Rob

Clusterfuck Nation: “To Discuss Buy-&-Hold In Relation to Financial Businesses Is Pure Abstraction”

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I recently wrote to James Howard Kuntsler, author of the Clusterfuck Nation blog and of the book The Long Emergency to ask that he take a look at my Google Knol entitled The Bull Market Caused the Economic Crisis.

In response to my assertion that “much of the public responded negatively to President Obama’s health reform initiative largely because of a resentment that our political leaders are failing to address the more serious problem,” Jim responded by saying “that’s an astute observation.”

In response to my assertion that  “The question ‘How precisely did the bankers do this to us?’ has never been answered by those seeking to make the bankers the fall guys,” Jim responded by saying “This does not persuade me. The mischief within-and-without the banks is well known, e.g. the Magnetar case and the GS case… as well as the bailouts, the ZIRP carry trade, the Repo 105 shenanigans, the FASB rule 157, AIG’s  swaps division, etc etc etc. Essentially, what the bankers did was divert the deployment of capital from productive activity to rackets, swindles, and frauds. One could also say that oil cheapening through the 90s caused the bull market. (Energy inputs to the economy.) It seems to me that you are talking about markets in purely technical trading terms without application to the question of whether our business activity produces real things of value.  To discuss “buy-and-hold” in relation to financial businesses is pure abstraction.”

I told Jim that “I’m grateful for your feedback.” I added that: “I still believe what I believe. But I am going to make an effort to reflect on your feedback and the feedback that I hear from others and perhaps over time I will be pulled closer to your views. In any event, your being willing to take the time to let me know your thinking on all this was obviously a kindness on your part.”

My E-Mail to Kathleen Burns Kinsbury at KBKWealthConnection.com

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Set forth below is the text of an e-mail that I sent to Kathleen BurnsKinsbury, at www.KBKWealthConnection.com, on March 11:

Kathleen:

My name is Rob Bennett. I am the author of the “A Rich Life” blog (http:arichlife.passionsaving.com). I saw your comment at the “Psy-Fi Blog” (my personal favorite) and followed the link to your site.

My sense is that you take a holistic approach to financial planning. It’s very much my belief that we need to see a big shift in that direction. So I wanted to make contact with you and let you know about an article that I recently wrote that might hold some interest for you.

Here is a link to an article that I wrote for “The Integrative Advisor” entitled “Humble Money Experts Are the Best Money Experts”:

http://www.aiflp.org/pdfs/IntegrativeAdviserNo0203.pdf

Please let me know if you have any reactions or questions.

I wish you the best of luck with your future endeavors in any event!

Rob
http:arichlife.passionsaving.com

My E-Mail to Andrew Smithers, Co-Author of Valuing Wall Street

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Set forth below is the text of an e-mail that I sent to Andrew Smithers, co-author of Valuing Wall Street, on March 3, 2010.

Andrew:

My name is Rob Bennett. I am the author of the “A Rich Life” blog (http://arichlife.passionsaving.com) and have long been a big fan of your work. Your article at the “Free Exchange” blog entitled “Lucas Roundtable: The EMH Must Be Discarded,”

http://www.economist.com/blogs/freeexchange/2009/08/lucas_roundtable_the_emh_must

is in my assessment one of the clearest and most powerful investing articles ever written. It is perfect!

I would be grateful if you would take a look at a Google Knol that I recently posted entitled “Why Buy-and-Hold Investing Can Never Work.” I am leading an effort to have the internet opened to honest posting on the Big Fail of the Buy-and-Hold Model (numerous discussion boards and blogs have banned honest posting on the flaws of Buy-and-Hold because it upsets those who have confidence in this model to learn of its weaknesses). I would be grateful for any feedback on the Knol that you might be able to offer.

Good luck in all your future endeavors!

Rob
http:arichlife.passionsaving.com

My E-Mail to Greg Howard, Author of the Blog at MondayHope.com

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I sent an e-mail to Greg Howard, author of the blog at www.MondayHope.com, on March 10. The text of the e-mail is set forth below:

Greg:

My name is Rob Bennett. I am the author of the “A Rich Life” blog (http://arichlife.passionsaving.com). I found your web site today through Twitter.

I would be grateful if you would take a look at a Google Knol that I have posted entitled “Why Buy-and-Hold Investing Can Never Work”.

I have been trying for eight years to bring the matters discussed in this Knol to the attention of middle-class investors. Many have expressed great interest but I have run into brick walls when site owners or “experts” who have endorsed Buy-and-Hold have shut the discussions down. I believe that people need to be able to ask questions to learn what they need to learn for us all to survive this economic crisis.

I have come to believe that the answer lies in getting the word out about this issue to the Tea Party movement. Ordinary middle-class people care about these issues in a way that those who make money promoting Buy-and-Hold strategies do not, in my experience. If you believe that the message that I am putting forward in the Knol has merit and that my idea of spreading this message to members of the Tea Party movement is a good idea, I would be grateful for any suggestions or help you can offer in getting me on the right track in doing so.

Thanks for any help you can offer. Best of luck with your blog and other endeavors!

Rob
http://arichlife.passionsaving.com

“It [My Claim That Long-Term Timing Works] Is Consistent with Shiller’s Analysis & Could Be True”

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Rajiv Sethi, a professor of economics at Barnard College, Columbia University, said in a blog entry update dated February 17, 2010, that: “Rob Bennett makes the claim that market timing based on aggregate P/E ratios can be a far more effective strategy than passive investing over long horizons (ten years or more.) I am not in a position to evaluate this claim empirically but it is consistent with Shiller’s analysis and I can see how it could be true.”

Schroeder (a regular at the Goon Central board) put a comment to that blog entry that night describing a case in which he believes that Buy-and-Hold produced better results than Valuation-Informed Indexing. I disputed this point, arguing that Schroeder’s illustration was cherry-picked after-the-fact and that The Investor’s Scenario Surfer shows that Valuation-Informed Indexing produces better long-term results in roughly nine out of 10 of the possible returns sequences. I asserted that a strategy that produces good results in only one out of 10 of the possible scenarios is a high-risk strategy and that, thus, it cannot be said that Buy-and-Hold is providing good risk-adjusted returns even in those few cases in which it yields better nominal results than Valuation-Informed Indexing.

Sethi offered the following comments in response to my post:

“Rob, I don’t think that randomly generated returns (regardless of the distribution you are using) can provide a convincing test of your claim. What you would need to do is to use historical data (as Schroeder has done) with multiple starting points and horizons. But even this is not enough: the P/E thresholds you choose for switching portfolio composition must be such as to generate on average over time the same asset allocation as the buy and hold strategy. In other words, you can’t pick the critical P/E thresholds (12/20) and the asset allocations (25/50/75) independently: they have to be selected jointly to match the buy and hold asset allocation over long horizons.”

I posted a lengthy response, which I encourage you to read by following the link set forth above.

I am grateful to Sethi for sharing his thoughts with us. I believe that he has pushed the ball forward a bit. That Schroeder individual I am not so sure about (I’m joking — there have been numerous cases in which Schroeder has offered constructive comments and this is one of them, in my assessment).

“Fixed Income Should Equal Age, BUT Adjusted Up or Down Depending on Valuations”

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Tom Behlmer, a financial planner in Nevada City, CA, wrote me a kind note the other day:

“Rob:

“Great website.

“I have counseled my clients to allocate a percentage to equities based upon market valuations. Fixed income should equal age, BUT adjusted up or down depending on valuations.

“It is amazing that so much material has been written about safe withdrawal rates, but valuations have been ignored in much of what has been written. Ed Easterling wrote a wonderful piece on withdrawal rates and valuations.

“I feel like I found a kindred spirit.

“Fascinating web site. I assume the risk evaluator is based on 10 years of average earnings?”

Here is my response:

Tom:

“Thank you for your kind words.

“Yes, it is indeed amazing that valuations have generally been ignored in the calculation of safe withdrawal rates. I attribute this largely to cognitive dissonance. Many researchers understand that valuations play a critical role. But it becomes clear quickly that including valuations in the analysis produces very different results. I think this holds people back. There is a social stigma today that stops people from discussing these issues frankly and plainly and clearly.

“The valuation metric for the Risk Evaluator is P/E10. That’s the price of the S&P index over the average of the past 10 years of earnings. If you have an interest in looking at the statistical research that supports the calculator, please take a look at John Walter Russell’s site, www.Early-Retirement-Planning-Insights. John was the co-developer of the calculator and he was the Numbers Guy in our partnership (John died recently).

“I have a section on the home page of the “A Rich Life” blog at which I quote people who have said kind things about the site. I would like to use your words in a link there and link to a blog entry where I would report what you have said if that is okay with you. Could you please let me know if you have an objection? [Note — Tom gave his permission]

“Please let me know if you have further questions. It is encouraging to hear that there are financial planners out there who are giving their clients good valuation-informed advice (I knew that there were such people, but unfortunately we don’t hear about them often enough).”

Rob

Programming Note: The blog will next appear on Monday, January 4, 2010.

Critique: Does Long-Term Market Timing Really Work?

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Shadox at the Money and Such blog recently posted a blog entry entitled Critique: Does Long-Term Market Timing Really Work?

Juicy Excerpt: I tend to be skeptical of theories that are built on the assumption that everyone else is subject to mass delusion, hypnosis or hysteria, yet we seem to be the only ones retaining our sanity and keeping our wits. It just doesn’t feel right.

Michael Harr argued in a comment that Valuation-Informed Indexing reduces risk but does not yield great returns.

Juicy Excerpt: There is no published study that I’ve seen to date that supports a superior return from Rob’s strategy that I liken to dynamic asset allocation. However, there is a load of evidence that it reduces the risk in a portfolio.

“Just How Bad Would Things Have to Get
Before You Guys Changed Your Advice?”

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Set forth below is the text of an e-mail that I sent on December 18, 2008, to an editor at Money magazine in response to a recent article. I have not received a response.

Pat:

My name is Rob Bennett. I am the publisher of the www.PassionSaving.com web site and the founder of the Retire Early discussion-board community. I have also been a long-time contributor to a number of indexing discussion boards at which the issues raised in your article “Is It All Over for Stocks?”

http://money.cnn.com/2008/12/17/pf/end_of_stocks.moneymag/index.htm

have been discussed for close to seven years now as part of a series of discussions referred to as “The Great Safe Withdrawal Rate Debate.” We have learned amazing things during these discussions.

You hit on exactly the right point in the early paragraphs of your article. When you quote the man who asked “Just how bad would things have to get before you guys changed your advice?” you get right to the core. That’s it. The reality is that the conventional investing advice of the past 30 years is horrible advice. It was obviously well-intentioned and it was obviously developed by smart people doing their best to come up with sound advice. It is also obviously so that this advice is wrong-headed in a fundamental sense. We need to change what we say about investing. We need to begin giving better advice. We need a national debate to get us there. Money magazine obviously could be of huge help in getting us to where we need to be.

The dominant model today is Passive Investing. This model argues that there is no need for investors to time the market; in fact, it argues strongly that timing is a bad idea. The reality is that timing is essential. Without timing. long term investors cannot succeed in their efforts to reach their financial goals.

The error was in failing to distinguish short-term timing and long-term timing. There is indeed much evidence that short-term timing does not work; the advice to avoid short-term timing is good advice. The terrible error was the rush to the conclusion that long-term timing also is a bad idea. Long-term timing is changing your stock allocation to protect your portfolio at times when stock prices rise to insanely dangerous levels. Long-term timing is ESSENTIAL for the long-term investor.

I have a calculator at my web site called “The Stock-Return Predictor.”

http://www.passionsaving.com/stock-valuation.html

The calculator uses the historical stock-return data to reveal to investors the range of possible 10-year returns on stocks and the probabilities of various outcomes. If you plug in the P/E10 level that applied in January 2000 (“44”), you will see that the most likely 10-year annualized return for stocks purchased at that time was a negative 1 percent real. In contrast, Treasury Inflation-Protected Securities (TIPS) were paying a 4 percent real return with a government guarantee attached. There is no sane argument that can be made that a negative 1 percent is a better long-term return than a positive 4 percent. Yet the vast majority of investing “experts” was urging investors to invest heavily in stocks. This is the horror of Passive Investing.

The purported goal of Passive Investing is to “Stay the Course.” The problem is that Passive Investing advocates urge investors to stick to the same stock allocation at all valuation levels and this means taking on wildly different risk profiles at different times — that’s not staying the course, that’s permitting your plan to be sent wildly off course for no good reason. Investors need to be told how to Stay the Course in a meaningful way. They need to be told when changes in their stock allocations are needed to keep their risk profiles roughly constant.

I call this new strategy “Valuation-Informed Indexing.” There are numerous articles about it at my web site.:

http://www.passionsaving.com/Index-Investing-and-valuations.html

I’ve also recently recorded numerous podcasts exploring the need for a transition from the Passive Investing model to a new model that calls for changes in allocation in response to dramatic price swings (I call the new model “Rational Investing”):

http://www.passionsaving.com/personal-finance-podcasts.html

The change (including consideration of valuations in one’s allocation decision-making process) is a profound one. It changes every aspect of the investing project. The difference is that investors who understand that valuations affect long-term results see a market that always performs in accord with how their model says it should perform while Passive Investors see a market that never (except for short time periods, like the time from 1995 through 2000) performs in accord with how their model says it should perform. The key to successful long-term investing is confidence. Those who keep their risk profile roughly constant gain confidence over time. Those who fail to do so inevitably find themselves in circumstances in which their confidence falters because the message being delivered by the real world is not in accord with what their model leads them to expect.

I believe that we need to make a shift from Passive Investing to a model that urges that investors always take valuations into account. I believe that this is the only way to restore investor confidence in the stock market. It has not been possible to get an airing of these ideas for so long as prices remained at insanely dangerous levels. Now that prices have returned to reasonable levels, I am seeing signs that it might be possible to get a national debate initiated.

If you have an interest in these ideas, please ask any questions and let me know what you view as the strong and weak points. I would thrill me to see Money magazine set off the spark that gets this much-needed national debate on how investing really works in the real world started. I am a journalist speaking to a fellow journalist. I hope that you will not think it arrogant of me to let you know that I believe that you grabbed a tiger by the tail with the questions you brought to the table in your article. I have studied these matters in great depth on a daily basis for close to seven years now and have discovered things that I would have thought impossible in the days before I became involved in all this. I hope we will be able to work together to bring these ideas to the attention of a much larger readership than has been exposed to them thus far.

Thanks for listening. Congratulations on the writing of one of those truly important articles that we only get the opportunity to craft one or two times in the course of a lifetime. There is a chance here for the entire community of investors to take an extremely dark set of circumstances and turn it into something that will do a lot of good for a lot of people in the long run. These are absurdly bold claims. I wouldn’t put them forward if I were not confident that I could back them up and ultimately persuade you of their merit.

Rob

Community Reactions to My FIRECalc
Correspondence with Jonathan Clements

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In my blog entry for June 22, 2006, I set forth the text of an e-mail that I sent to Wall Street Journal Columnist Jonathan Clements urging him not to put forward further endorsements of Bill Sholar’s “highly misleading” (William Bernstein’s phrase) FIRECalc retirement planning tool. The blog entry for June 23 set forth the text of a response e-mail by Clements defending FIRECalc from my criticisms. The blog entry for June 24 set forth the text of my response e-mail.

Set forth below is the text of some Financial Freedom Community reactions to the correspondence between Clements and me re my criticisms of the FIRECalc tool (Wanderer’s comment was not made in direct reference to the correspondence with Clements, but I included it as it was made in the same time-period as the other comments and addresses a topic raised frequently during The Great Safe Withdrawal Rate Debate, the long-running saga for which the Clements correspondence serves as the most recent chapter):

Arrete: “My guess is that they are laughing their buns off at the Wall Street Journal.”

Gurdison: “My guess is that Clements deleted the message before reaching the end of the first paragraph.”

GW: “Similar crank letters are commonly sent to scientists, usually describing ‘revolutionary’ ideas that the writer cannot get accepted because they are suppressed by the establishment.”

Ogrecat: “I have noticed that hocus [hocus is the screen-name that I use when posting on discussion boards] sounds a lot like the anti-evolution crowd.”

Mel Lindauer (co-author of The Bogleheads Guide to Investing): “I’ve had my fill of those long-winded posts that include distortions, unsubstantiated claims, misquotes and comments taken out of context.”

Yakers: “It looks like the best that can be done is for someone like Jason (a disruptive poster at the Vanguard Diehards board) to post a reference to the sites that explain Hocus, kind of like the web references that debunk Kiyosaki [the reference is to Robert Kiyosaki, author of Rich Dad, Poor Dad], in each thread that Hocus posts in and leave it at that.”

Wanderer: “Hocus’ investing choices have had pretty good results over the last X years. My hat’s off to him.”

Krankor53: “The objective should be to achieve the flattest possible distribution of outcomes over the historical starting points. My preference would be to do this by using a lower allocation of stocks vs fixed.”

BigMoneyJim: “FIRECalc et al are historical simulations with no claims about the future.”

Brewer12345: “The response from Clements is priceless, especially where he points out that the safe withdrawal rate has to be substantially higher than 2.4% (the yield on TIPS), vs hosuc’s [this is how some Greaney defenders spell my screen-name in their posts] suggestion that it is presently 2.5%.”

John Walter Russell (publisher of the analytically valid safe withdrawal rate research at www.Early-Retirement-Planning-Insights.com): “FIRECalc does tell us what happened historically. The danger is how people use this information going forward.”

Daryll44: “I have heard many rip Rob (that’s a reference to me), but truthfully I don’t know what the counter argument is…. Is there a counter-argument?”

Earnabuck: “Greaney did his thing based upon historical market action. Yes, he stated that it was the past, but he proceeded to put out the number as relevant to today. Much discussion and planning were done based upon that number.”

Syke: “Maybe Earnabuck is hocus.”

ResNullius: “Threats are meaningless unless backed up with action.”

WorkWayLess: “Intercst [that’s John Greaney’s screen-name], this sounds like slander to me. IIRC [if I recall correctly], you never made any physical threats against him. Civil suit judgment = new income stream for Intercst?”

Daverx: “His site [Greaney’s www.RetireEarlyHomePage.com] is the best on the web.”

Gnobility: “John’s a’ight fyask me.” [The reference is to Greaney]

John Greaney (author of the conventional methodology study published at www.RetireEarlyHomePage.com): “The fact that you are willing to expose full-blown, first-person Hocomania to influential financial columnists certainly makes your debunking a lot easier.”

Tashina: “If you do a M* [Morningstar–home of the Vanguard Diehards board] search on the term FIRECalc, of the latest eight search results, two are from jwr [John Walter Russell] and three are from Hocus. One is even Hocus bringing up FIRECalc himself when someone asks for useful financial sites.”

Bill Sholar (Creator of FIRECalc and owner of the Early Retirement Forum): “Sorry Guest, you are banned from posting or sending personal messages on this forum…. Your IP address is on the abusive poster list.” (These words appear on my computer screen when I direct my internet browser to the Early Retirement Forum web site.)