A Rich Life

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

“Wade Pfau Over and Over and Over Makes Clear That He Views Me as the Teacher and Himself as the Student in the 16 Months of E-Mail Correspondence in Which We Developed Together Our Breakthrough Research Showing Millions of Middle-Class Investors How to Reduce the Risk of Stock Investing by 70 Percent”

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Set forth below is the text of a comment that I recently put to this site’s blog:

At about nine minutes into this video you made, Rob, you claim credit for “at least 50% of the work that Wade Pfau put into his published research.” Do you suppose he agreed with your assessment?”

Do you suppose he agrees with your assessment?

Nothing could be more clear, Banned.

Here is the article at which I provide links to the blog entries reporting on the 16 months of e-mail correspondence in which we developed together our breakthrough research showing millions of middle-class investors how to reduce the risk of stock investing by 70 percent:

http://arichlife.passionsaving.com/the-buy-and-hold-crisis/corruption-in-the-investing-advice-field-the-wade-pfau-story/

Wade over and over and over makes clear that he views me as the teacher and himself as the student.

I obviously do not intend any dig at Wade with those words. Wade made a huge contribution and I have said publicly that his contribution merits a Nobel prize in Economics. I just happened to be placed in circumstances that permitted me to gain a jump of several years over him and that of course came through in the work we did together.

When Wade felt safe posting honestly, he had no problem saying such things. It was only after you Goons (with the implicit support of my good friend Jack Bogle) made clear that you would destroy his career if he continued to post honestly that Wade ever came forward with any comments 100 percent the opposite of the viewpoints he expressed over and over and over again during the 16 months in which he believed that there would be no penalties imposed on him for the “crime” of saying what he truly believed about safe withdrawal rates and many other critically important investment-related topics.

Rob

Robert Savickas, GWU Associate Finance Professor: “I Thought That Buy-and-Hold Had Been Challenged a Long Time Ago and Many Academics Don’t Believe It”

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I have been sending e-mails to numerous people, letting them know about my article reporting on The Silencing of Academic Researcher Wade Pfau by The Buy-and-Hold Mafia.

Set forth below is the text of the response I received from Robert Savickas, an Associate Professor of Finance at the George Washington University School of Business:

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Hi Rob,

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I looked at the article.  I thought that buy and hold had been challenged a long time ago and many academics don’t believe it.  I have actively traded myself (and daytraded) with relative success and so have some of my other “academic” colleagues.  The efficient market hypothesis (EMH) has also been challenged a bunch of times.  I have problems with both buy-and-hold and EMH myself, but for reasons other than what you mention.
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Also, the phrase ““For years, the investment industry has tried to scare clients into staying fully invested in the stock market at all times, no matter how high stocks go,” I  think is not quite accurate.  I think we often emphasize that it is important to buy low and sell high.  I always tell my students that even if you are a long-term investor and have decided your portfolio, nobody forces you to enter all the positions at once: you have to time the market and buy the stocks at their lows (technical analysis helps identify temporary lows and highs).  Same with exiting your positions; sell at the temporary highs.   I thought it was well known in academic and non-academic circles that you can’t buy without any regard for price…
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Robert
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I wrote back:

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Robert:

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Thanks much for your response.
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I certainly agree that Buy-and-Hold has been challenged and that many academics don’t believe in it. The question (in my mind) is whether they give sufficient voice to their doubts to protect the millions of middle-class people who have been led to believe that there is academic research supporting this strategy (there is not, but I have spoken to thousands of middle-class people who believe that there is).
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My personal concern is less with the bad investing results that follow from promotion of Buy-and-Hold and more with the economic crisis that came about as a result of the huge losses suffered by millions of investors and the loss of buying power we saw in our economic system as a result. We see articles on the internet about the economic crisis all the time and it has even led to political unrest in the form of the Tea Party and Occupy Wall Street movements. Wouldn’t this problem be solved if we just permitted (And even encouraged) honest posting about the 30 years of academic research (Shiller published his paper showing that valuations affect long-term returns in 1981) showing that a Buy-and-Hold strategy can never work in the long run? If investors knew that stocks offer a poor long-term value proposition once prices reach insanely dangerous levels, we would never see another bull market. Price would self-regulate because investors would sell at high prices and continue selling until prices returned to fair-market levels. If we never saw another bull market, we would never see another bear market or another one of the economic crises that inevitably follow in their wake. That works for me!
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Anyway, those are my thoughts. It helps me to hear what other smart and good people think about these matters. I am grateful for your willingness to send a few words my way.
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Please take good care.
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Rob

“Wade Pfau Has a Ph.D. in Economics from Princeton. Wade Spent Months Trying to Find a Study Showing That Long-Term Timing Is Not Required. He Never Found One. He Was Amazed. He Kept Thinking that He Had Done Something Wrong. But He Looked and He Looked and He Looked and He Never Found Such a Study.”

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Set forth below is the text of a comment that I recently put to the discussion of a blog entry at this site:

I am grateful to you for putting forward something that deals with substantive issues, Banned. We work out our differences by dealing with substantive issues.

There is a contradiction in the words used to introduce the table set forth at the link. First, it says: “By owning the entire market (all of the asset classes), susceptibility to changes in market variations is minimized.” Then it says: “Large variations over a short period of time, but tends to be stable when viewed over the long term.”

The first statement cannot possibly be true if the second statement is true (and the second statement IS true). These are not my words. These are the words of the Bogleheads, the primary advocates of Buy-and-Hold. And these words show why Buy-and-Hold can never work for even a single long-term investor.

The second statement is a wonderful summation of the 140 years of U.S. stock market history available to us. Year to year variations in returns are indeed INSANE. And long-term variations are indeed minimal. We are in complete agreement re this statement.

Where we differ is re its MEANING. You take this statement as signifying support for a Buy-and-Hold strategy. I take it as a warning NOT to follow a Buy-and-Hold strategy.

If returns are stable over the long term and if that stable return is a good one (it is), you want to be heavily invested in stocks as a rule. We agree re that point.

If returns are wildly variable in the short term, you want to be heavily invested in stocks during the short-term periods when returns are very, very good but you do NOT want to be heavily invested in stocks when returns are very, very bad. You want to avoid taking the huge hit that comes from being invested in stocks during price crashes. Avoiding crashes will increase your return DRAMATICALLY while also diminishing your risk DRAMATICALLY. The lifetime benefit is counter-intutively high. You would need to work the numbers to see how huge a difference this makes.

That’s Valuation-Informed Indexing, Banned. The only difference between Buy-and-Hold and VII is that with VII you lower your stock allocation at times of price crashes (those times when the short-term variation works against you) and increase it at times of huge price jumps (those times when the short-term variation works to your benefit). That’s the entire deal.

Now –

Buy-and-Holders would have to be insane not to want to take advantage of return predictability if it existed. They obviously do not believe that these times of short-term variability (in both directions) can be predicted. I obviously do. That’s the only issue in dispute.

This is where I say the Buy-and-Holders have never put forward a single sliver of evidence supporting their position. This was Wade Pfau’s most important finding. This is why Wade says that the research that he and I did together belongs in the Journal of Finance, the most important journal in the field.

Wade has a Ph.D. in Economics from Princeton. He makes a living doing investment research. If there is anyone alive who is able to determine whether there is a study showing that long-term timing is not required, Wade is that person. Wade spent months trying to find such a study. He never found one. He was amazed. He kept thinking that he had done something wrong. He must have missed it! But he looked and he looked and he looked and he never found any such study.

He wanted to be sure. So he went to the Bogleheads Forum to see if anyone there knew of one. No one did. Not John Bogle. Not Bill Bernstein. Not Larry Swedrow. Not Rick Ferri. Not Taylor Larimore. None of these people have ever seen a single study supporting the core principle upon which the Buy-and-Hold strategy is built.

If these people never heard of a study, there is no study, Banned. There is zero reason for any rational person to believe that long-term timing (paying attention to price) is not absolutely required for anyone hoping to have a realistic chance of long-term investing success.

Now — to the first statement that appears before the presentation of the table!

The first statement says: “”By owning the entire market (all of the asset classes), susceptibility to changes in market variations is minimized.”

No! This is false!

The research that Wade and I did shows that the far bigger factor is the valuation level that applies when the asset is purchased. Just paying attention to valuations alone takes 70 percent of the risk out of stock investing. Owning a large number of asset classes does virtually nothing to minimize risk compared to the simple act of taking valuations into consideration when setting your stock allocation. Buy-and-Holders do not minimize risk by going with a pure Get Rich Quick approach. They MAXIMIZE it! Just as common sense tells us must be so!

There never can be any justification for failing to take price into account when buying something, Banned. It cannot be. It is a logical impossibility.

If you want to say that Buy-and-Holders sincerely believe that it is not necessary to take price into account, I can go along with that statement. But I cannot go along with a statement that there is research supporting such a statement. Wade checked this very, very, very carefully. There is no such research. There never will be any. The idea that it is not necessary to take price into account when buying stocks is dangerous and false and wrong and absurd.

Buy-and-Hold was a mistake.

It was a mistake made by good and smart people who were trying to help us. But it was a mistake all the same.

That mistake caused our economic crisis. That mistake needs to be fixed.

I wish you all good things.

Rob

“I Don’t Understand Why You Say That Those Who Used P/E10 to Predict Long-Term Returns Would At One Time Have Been ‘Off.’ Wade Checked the Entire 140 Years of Stock Market History Available to Us and Never Found a Time When They Were ‘Off’.”

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I have been letting numerous people know about my article reporting on The Silencing of Academic Researcher Wade Pfau by The Buy-and-Hold Mafia.

Yesterday’s blog entry reported my on correspondence with Economics Professor Valeriy Zakamulin. Set forth below is the text of my response to the e-mail by Valeriy detailed in the earlier blog entry:
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Valeriy:

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I understand that you believe that stock returns are to some extent predictable. I would be grateful if you could describe the THEORY of how stock prices are set that justifies this belief.
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Buy-and-Hold is rooted in a belief in the Efficient Market Theory. If the Efficient Market Theory were valid, Buy-and-Hold would indeed be the ideal strategy. It does indeed follow from the theory. If stock prices changes are determined by economic and political developments that cannot be identified in advance, risk is a constant and the best choice for the investor is always to remain at the same stock allocation. I do not share the Buy-and-Holder’s belief in the Efficient Market Theory. But I do acknowledge that the strategy follows logically from a belief in the model.
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Valuation-Informed Indexing is rooted in a belief that investors carry within them both a belief that Get Rich Quick can work in the short run and that only common sense can work in the long run. So investors believe that stock prices can go wildly off the mark for periods of time of up to 10 years but that prices always return to fair value over time as investors become alarmed that a widespread reversion to a common-sense belief in how markets work is going to cause a crash and an economic crisis. We have a different foundational belief from the Buy-and-Holders and so we follow a different asset allocation strategy.
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Is there a theory that supports the idea that stock prices are to some extent predictable both in the short-term and in the long-run? If the market were efficient, this would not be so because prices would follow a random-walk pattern. I don’t think it follows from the theory I believe in either because I don’t see why investors would permit prices to get so out of hand if they thought they were predictable in the short term. If investors believed this, wouldn’t they exploit their knowledge of where prices were headed? If the thing that made prices predictable was valuations, wouldn’t the exploitation of the inefficiency cause the mispricing to disappear? Perhaps you believe that it is something other than valuations that makes price changes somewhat predictable both in the short-term and in the long-term.
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The significance of Shiller’s 1981 paper is that it discredited the Efficient Market Theory. Once we knew that the model that supports the Buy-and-Hold strategy was invalid, we knew that the strategy was dangerous. Everyone agrees that price matters in purchases of every possible good or service except for stocks. The only reason why some thought at one time that Buy-and-Hold might work is that they bought in to the Efficient Market Theory. So the big step was the publication of that 1981 research. That was what set us on the right track (or at least what could have done so).
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Shiller certainly did expand on his foundational insight in subsequent work. And of course many others have confirmed his findings and expanded on them. I point to the 1981 research because it removed the foundation belief that caused people for a time to accept that Buy-and-Hold (an exceedingly counter-intutive idea) might make sense.
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I of course don’t believe that everyone “got it” as soon as Shiller published his 1981 research. Few “got it.” In fact, it is still a small number that entirely gets it today. The research is out there, though. There is nothing today that stops us all from getting it other than the Social Taboo that restricts us from talking openly and frankly and expansively about Shiller’s findings. The Social Taboo is the cause of all our troubles in this field, in my assessment. The Social Taboo was formed in 1981 and then grew in strength in subsequent years as the mountain of evidence supporting Shiller’s findings grew taller and taller.
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I don’t see how an investor can know in advance his real return on CDs or corporate bonds. The inflation rate affects the real return. How can you know the inflation rate in advance? If you don’t know your real return, you are taking on risk, more risk than was being taken on by investors who bought stocks at a time when their worst-case scenario return was solid.
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I don’t agree that investors switched to CDs because they thought they knew what real return they would obtain from them. I believe they switched for emotional reasons. They were afraid of stocks. Investors had permitted stock prices to rise to insanely dangerous levels and the price crash that inevitably followed scared them. We are living through a similar set of circumstances today. Buy-and-Hold is the most emotional strategy imaginable. It teaches investors that it is okay to ignore price, which makes investors uneasy because they do not follow this “strategy” in their purchases of any other good or service. The huge losses that inevitably follow confirm their misgivings and they swear off the asset class just at the time when it becomes priced to deliver amazing long-term returns. Those who fall for the Buy-and-Hold marketing mumbo jumbo get hurt on both ends: They buy stocks when they offer a horrible long-term value proposition and then they sell them when they offer a fantastic long-term value proposition. We should be discouraging investor emotion, not exploiting it to the fullest extent. Get RIch Quick strategies provide short-term profits for the industry but the huge losses they cause for the investors who follow them cause so much economic damage that even the industry would be better off if we permitted the experts in this field to give more emotionally balanced advice, in my belief.
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I don’t understand why you say that those who used P/E10 to predict long-term returns would at one time have been “off.” Wade checked the entire 140 years of stock market history available to us and never found a time when things were “off.” The model always works as it is supposed to. I haven’t looked at what would have happened if you looked only at 20 years but it certainly makes sense that those numbers would indeed be off. Looking at 20 years wouldn’t tell you anything of any value. That’s not even close to being a long-enough time-period to help you understand how stock investing works. Bull markets can last 20 years. So the 20-year time period you were looking at might have been an intensely emotional time.
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You might be trying to use the P/E10 values to make precise return predictions. They do not do that. P/E10 tells you how risky stocks are at a given time. So you can use it to identify a range of possible returns and to assign rough probabilities to different points along the spectrum of possibilities. But please remember that in the short term it is emotion that dominates and that emotion cannot be precisely predicted with the tools we have available to us today. Even a time-period 10 years or 20 years out is in part affected by the short-term factors that apply to it. So a precise prediction is not possible.
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Rob

Economics Professor Valeriy Zakamulin: “I Do Believe That Stock Returns Are to Some Extent Predictable, Both in the Short- and Long-Term. But I Do Not Accept that Stock Returns Are Highly Predictable. My Model Predicted Better Than the Shiller P/E10 Model Post-1960.”

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I have been letting lots of people know about my article reporting on The Silencing of Academic Researcher Wade Pfau by The Buy-and-Hold Mafia.

Yesterday’s blog entry reported on my correspondence with Economics Professor Valeriy Zakamulin. Set forth below is the text of Valeriy’s response to the e-mail of mine detailed in the earlier blog entry:

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Rob:

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First of all, you forget that I do believe that the stock returns are to some extent predictable, both in the short- and long-term. But I do not accept that the stock returns are highly predictable. Just read my paper about the secular mean reversion and long-run predictability of stock returns. In this paper I actually show that my model predicted better than the Shiller’s PE10 model post-1960.

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Second, when it comes to the fixed interest rate securities like CDs and bonds, you need to understand that for an investor who holds them till maturity the return is positive and known in advance. Hence, in this case CDs and bonds are completely risk-free. If you bought a CD or a bond in 1980-82, this security would provided you 12-15% annual fixed return till maturity. That is why many investors switched to fixed income securities at that time.

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Third, Shiller in 1981 wrote a paper about excessive stock volatility (compared to some particular rational model). As far as I know he wrote a paper (co-authored by Campbell?) about his model that uses PE ratio only in 1998. In this paper they warned about a huge overvaluation in the stock market.

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Finally my comment on the following: I would not be inclined to set my bond allocation by “the current secular trend in the bond market.” I would compare the long-term value proposition available from bonds with the long-term value proposition available from other asset classes and go with the asset class offering the better deal. My view is that all investors should be seeking the asset classes that offer the best returns at the lowest risk.

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I believe this is a huge mistake if we agree that the stock and bond returns are predictable. If you believed that stocks would provide you with 6.5% annual average return (computed using 140 years of data) and use this estimate to invest in 2000 for about 10 years, you would be way off your expectations. If, on the other hand, in 2000 you used last 20 years to compute the average stock return and supposed that during the next 10 years the stocks provided the same average return, again you would be way off your expectations. The same examples can be constructed for the bond investing. A more wiser approach to stock and bond investing is to take into account the model that use the predictability of stock and bond returns.

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Valeri

Economics Professor Valeriy Zakamulin: “If Stocks Are No Longer Risky, They Should Provide the Same Return As Money Markets.” Rob Bennett: “You Are Touching on the White-Hot Core of the Dispute.”

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I have been contacting numerous people to let them know about my article reporting on The Silencing of Academic Researcher Wade Pfau by The Buy-and-Hold Mafia.

Yesterday’s blog entry reported on the correspondence with Economics Professor Valeriy Zakamulin. Set forth below is the text of the e-mail sent to me by Valeriy in response to the e-mail of mine detailed in the earlier blog entry:

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Rob:

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My comment on the following: “My view is that we are on the verge of a huge breakthrough. We now know how to assess risk effectively (look at the P/E10 value!). Once we know how to assess risk effectively, we know how to eliminate risk. There is no reason why stocks need to be a risky asset class. We made them a risky asset class for many years because of our ignorance of the realities. “

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You see, the basic postulate in finance, and it is completely rational, is that “no reward without risk”. Since stocks are risky, then they need to provide a higher (expected) rate of return than money markets. This is what we actually see looking back at the history, namely, stocks provided higher returns than bonds and money markets. Without any risk, if stocks are no longer risky, they should provide the same return as money markets. What is the point to invest in stocks in this case?

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Valeri

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I replied:

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Valeri:

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You are touching on the white-hot core of the dispute with this one.
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I don’t agree that the thing that stock investors are being paid for is a willingness to take on risk. I believe that this idea became popular in the days before index funds. Then there really was risk — the investor was sharing in the fortunes or lack thereof of the company in which he bought shares of ownership. Indexing changes all that. When you buy an index fund, you are buying a share in the productivity of the U.S. economy. That economy has been sufficiently productive to produce an annual return of 6.5 percent real for 140 years now. So in all likelihood that’s roughly what you are going to get (provided you don’t overpay or underpay for your shares). The number could change a small bit in either direction. But with an advanced economy dramatic changes in either direction are unlikely. The investor is being paid for the use of his money, which is put to productive uses. His money is essentially being rented and his return is the rental fee. You give up control over the money for a period of time and in return you get an annual return of 6.5 percent real, plus or minus whatever adjustment is needed to reflect the fact that the shares were overpriced or underpriced at the time you made the purchase.
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It’s true that, when investors come to realize that index funds purchased in a valuation-informed way are not significantly more risky than Certificates of Deposit (CDs), the disparity in return on stocks and on CDs will need to tighten. But this doesn’t necessarily mean that the return on stocks will drop; the tightening can be achieved by a rise in the return on CDs. The return on stocks is set by the productivity of the U.S. economy. The return on CDs is set by the need of the banks offering them for sale to offer a return high enough to attract the investors needed to purchase their offerings. Here it is the PERCEIVED risk (NOT the actual risk) of stocks that matters. Stocks have never in history been as risky as they were in 2000 (when prices are at three times fair value, prices are certain to fall hard in coming years). So, according to the conventional theory, stocks should have been offering amazing returns at the time to compensate for the insane level of risk being taken on by investors. The reality is that the most likely annualized return 10-year return on U.S. stocks at the time (as determined by a regression analysis of the historical return data) was a negative 1 percent real (See The Stock-Return Predictor). TIPS and IBonds and CDs were at the time offering a return of 4 percent real. That’s a differential of 5 points real of return each year for 10 years running, a total penalty for the stock investor of 50 percent of his starting-point portfolio value. Where’s the compensation for buying stocks at the riskiest time to own them in U.S. history?
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The reason why we had an equity risk PENALTY at the time is that the PERCEIVED risk of stocks was low. Buy-and-Hold was being pushed relentlessly at the time and millions of investors had become convinced that there was no need to consider price when setting their stock allocations. In fact, many investors had come to believe that the only possible risk in stock investing was the risk associated with a lowering of one’s stock allocation! Investors act on perceived risk, not real risk. In 1982, when risk was nil (prices cannot drop lower when they are already at one-half of fair value and the investor obtains a return of 6.5 percent real when prices remain at fair-value levels), the most likely annualized 10-year return was 15 percent real. There was no need to compensate stock investors for taking on actual risk at this time. But there was a great need to compensate them for taking on perceived risk. Perceived risk is always greatest when real risk is lowest (because it is low prices that cause investors to fear stocks).
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If we educate investors to the realities and stock valuations stabilize, the risks of stock ownership will drop to levels not much higher than the risks of owning CDs. Banks will no longer be able to sell CDs providing returns far below the returns available from stocks in an environment in which stocks are no longer perceived as carrying much more in the way of risk (the appeal of CDs today is their low perceived risk). So they will have to increase the returns paid by CDs. They of course can do this since the money obtained by selling CDs can be put to equally productive uses as the money obtained by offering shares of stock. Banks indeed HAVE paid high returns on CDs at times like the late 1990s when the perceived risk of stocks was so low that there was no other way to market the CDs. The reason why CD rates are so low today is that the perceived risk of stocks in the minds of many investors is high and these investors are willing to accept low returns to escape that perceived risk.
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It is true that on an overall basis the historical record shows a higher return for stocks and more risk for stocks. This is why many have come to believe that stocks pay higher returns BECAUSE of the higher risk attached to them. But index funds have only been available since 1976. We are still in the early stages of thinking through how this entirely new asset class operates. And the historical record does NOT support the conventional view of risk when you compare risk and return offered at particular times. At particular times, there is a negative correlation. High prices mean high risk and low returns. Low prices mean low risk and high returns.
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Again, these are merely the sincere views of a non-expert who has spent a lot of time trying to understand conflicts and weaknesses in the conventional understanding of stock investing. I believe what I am saying here. But I am just one guy who never studied investing in school and who never managed a fund and I of course could be partly or entirely wrong.
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I thank you again for your willingness to engage in a back-and-forth discussion that I find highly stimulating.
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Rob

“Investors Should ALWAYS Aim to Keep Their Risk Profile Right. Whether the Economic Outlook Is Bright Doesn’t Matter — That Is Cooked Into the Price, So It Doesn’t Need a Separate Analysis.”

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I have been writing many people to let them know about my article reporting on The Silencing of Academic Researcher Wade Pfau by the Buy-and-Hold Mafia.

Yesterday’s blog entry reported on my correspondence with Economics Professor Valeriy Zakamulin. Set forth below is the text of my reply to the e-mail detailed in the earlier blog entry:
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Valeriy:

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Re the first point — You’ll get a different result if you factor in whether the fair-value P/E10 number appears on the way up or the way down. When we see a P/E10 of 15 on the way up, the P/E10 that applies 10 years later is always a good bit higher. When we see a P/E10 of 15 on the way down, the P/E10 10 years later is always lower. It’s not the number alone that matters. You need to take into consideration what type of investor emotion it is that produced the number. It’s no failing of P/E10 that it doesn’t produce good predictions from a fair-value start for those who do not take investor emotions into consideration. That’s a failing on the part of those performing the analysis. P/E10 always works for those willing to consider both numbers and emotions, both of which are critical aspects of the stock investing story.
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Re your second point — I believe that investors should ALWAYS aim to keep their risk profile right. That’s the key to success. Whether the economic outlook is bright doesn’t matter — that is cooked into the price anyway so it doesn’t need a separate analysis. This all comes down to risk management, in my assessment. The P/E10 value is telling us how risky stocks are. If all investors aimed to keep their risk profiles constant (they would if only we would tell them how to do it), stock prices would always self-correct and all would be well. Fama was right that the market WANTS to be efficient. What makes it inefficient is the Social Taboo that says that we must not tell people about the dangers of going with high stock allocations at times of insanely high P/E10 values. We want to be rational. But we cannot pull it off without access to good information and those of us who understand the realities dare not provide good information in light of the intense social pressures imposed on us not to speak too clearly about these matters.
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My view is that we are on the verge of a huge breakthrough. We now know how to assess risk effectively (look at the P/E10 value!). Once we know how to assess risk effectively, we know how to eliminate risk. There is no reason why stocks need to be a risky asset class. We made them a risky asset class for many years because of our ignorance of the realities. But we have overcome our ignorance over the past 50 years. Now we just need to give ourselves permission to talk through and think through all that we have learned and to share the insights we have developed with all interested parties without apology or hesitation.
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I don’t think that a wise use of P/E10 ever calls for getting entirely out of stocks. It never predicts short-term results and short-term results matter. P/E10 is a risk-management tool. Should investors have lowered their stock allocations in 1996? Absolutely. Should they have gone to zero stock allocations? No. The aim should have been to keep their risk profiles roughly stable. So an investor who properly went with an 80 percent stock allocation in 1982 might properly have gone with a 20 percent stock allocation from 1996 forward. But not zero.
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Please note that those who dropped to 20 percent stocks in 1996 are ahead of the game today. And they will be even more ahead of the game after the next crash. And the differential will grow and grow over the decades of compounding to come. Wade’s research shows this:
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Please understand that I am only stating my sincere views. I obviously do not know it all. I have been wrong about important things in the past and it could be that it is happening again. I am telling you what I believe because you are asking good questions and I love to be able to share this stuff, which I view as being very important. But I am not trying to say that I know it al. We need to have everyone sharing his or her sincere views if we are to hope that as a society we can advance in our understanding of this stuff. I am certainly grateful for the challenges to my thinking that you have advanced in our e-mail communications. They force me to think and to reconsider points where I may have made mistakes. But you need to know that I am biased. I cannot help it.
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Rob

Economics Professor Valeriy Zakamulin: “If the Bubble Occurs, It Is Rational to Participate In It”

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I’ve been e-mailing lots of people to let them know about my article reporting on The Silencing of Academic Researcher Wade Pfau by the Buy-and-Hold Mafia.

Yesterday’s blog entry reported on my correspondence with Economics Professor Valeriy Zakamulin. Set forth below is the text of an e-mail sent by Valeriy in response to the e-mail of mine detailed in the earlier blog entry:

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Rob:

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First of all I would like to comment the following:

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The right way to think about this (in my view!) is that P/E10 tells you the extent of risk in the market. It never identifies the precise return that will apply in 10 years. It always identifies the range of possible returns (the range is 6 points in either direction — when prices are at fair-value levels, the range is from an annualized 10-year return of 0 on the down side to an annualized return of 12 percent real on the up side) and assigns rough probabilities to an actual outcome falling at any point on the range of possibilities (the most likely 10-year outcome starting from a time of fair-value prices is an annualized return of 6 percent real).
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What I am telling in this context is that if the PE10 ratio is way too high or way too low, then the precision of your forecast (the range of possible outcomes as measured for example by plus minus one standard deviation) is rather good. If the PE10 ratio is close to its long-run mean, then the range of possible outcomes is too wide to be useful for forecasting.

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My comment on the following: If we tell people how stock investing works, we will never see such extreme P/E10 values again. Once we get the word out, stock prices become self-regulating. If people understand that they MUST change their stock allocations in response to big price swings, each swing upward will bring on sales and those sales will pull prices back to fair-value levels again. There can never be another bull market or another bear market once we permit open discussion of Shiller’s findings. 

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First of all, it seems to me that we agree that people are not fully rational. Second, it will not be correct to say that it is rational that the PE10 ratio should always be about 15. In a rational expectation model the value of PE (hence PE10) depends on some, sometimes unobservable, parameters. For example, the investor’s risk aversion, the derivative of which is the market price of risk. Third, I do believe that the Shiller’s work did its job, now many people understand that it is not rational to have a PE10 value of 44. Forth, despite this, even in a rational expectation framework if the bubble occurs, it is rational to participate in it. As an example, image that you are in 1993 and you see a bubble in the stock market, yet the economic outlook is very bright, the investors’ optimism is high, and it looks like the bull market will continue for a long time. Will you get out of the stocks and miss the bull market till 2001? I doubt.

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Valeriy

George Rossolatos, Author of the the Disruptive Semiotics Blog: “I’ve Familiar with this ‘Script’. It Is Part of a Trilogy That Might Be Called ‘Double-Binds in a Spiraling Funfare'”

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I’ve been sending numerous e-mails letting people know of my article on The Silencing of Academic Researcher Wade Pfau by the Buy-and-Hold Mafia. Set forth below are reports on five responses.

1) Wm. Denis Huber, part of the Core Faculty at Capella University, wrote: “What are you asking me? What do you mean ‘if it pulls you in’?”

I responded: “I am not seeking any particular acton from you or any of the others I have contacted. I am a journalist. I view this as a scandal. People need to know what works in investing and this information is being held from them. I am banned at numerous boards and blogs because I told people the truth about what the recent research in this field says and Buy-and-Hold advocates don’t want people to find out about it. I think people need to know, especially given the evidence that it was the heavy promotion of Buy-and-Hold strategies that caused the economic crisis, which has hurt us all in a very serious way. By “pulls you in,” I just mean if the article holds your interest. If it does, you might tell a friend about it. That might help. I want to see people educated about these issues. My profession is a profession that favors the spread of information, I don’t believe that intimidation tactics should be used to stop academic researchers from doing the research they view as important. I know that it sounds shocking to many for me to speak bluntly, but I view this as a massive act of financial fraud. Anyway, I am grateful if you are able to give the article a read. I certainly wish you well in all your future endeavors.”

2) George Rossolatos, Author of the Disruptive Semiotics blog, wrote: “I’m familiar with this ‘script’. It is part of a trilogy (maybe more parts) that might be called ‘Double-binds in a spiraling funfare’.” I responded: “Thanks for being able to appreciate the lighter side of it all. Take care, man.”

3) Dalvinder Singh, a Professor at Warwick School of Law, wrote: “Can you send me the paper and bio as a word document?” I of course did so.

4) Jack Mintz, Director of the School of Public Policy at the University of Calgary, wrote: “Thanks for the note. There is a good literature on alternative investment strategies and gains from it so I would be surprised at someone not getting tenure or promotion for working in this area. Always possible for a journal to reject papers in an area forcing someone to choose other journals (I have seen before). But there are outlets. Anyway, Hard to get involved without knowing far more about quality of work, overall teaching and research quality, etc. Academic decisions are complex.”

I responded: “Wade’s paper was indeed published in a credible peer-reviewed journal. And you are of course right that there has been other work along the same lines published in peer-reviewed journals. Wade’s work follows from Shiller’s work, which of course was published over 30 years ago. So please don’t think that I am trying to say that work discrediting Buy-and-Hold is not available. I wouldn’t have the views on stock investing that I have today had I not seen such work. So it’s out there. The problem is more that there are amazing steps taken to discourage such work and thus MOST people do not know about it or do not place much confidence in it because they hear about it so rarely. My aim is to launch a national discussion of the Shiller model (Valuation-Informed Indexing) and of Wade’s research showing the exciting practical implications of Shiller’s model. I want people to know that there are good reasons to reject Buy-and-Hold strategies. It is of course fine if people follow such strategies after hearing about the alternatives. But I want people to know that there are alternatives.

“My personal experience is that I cannot post at any major investing board or blog because I am the person who ten years ago discovered the errors in the Old School safe withdrawal rate studies and I have thus been a marked man in the eyes of the Buy-and-Holders ever since. Many of my fellow bloggers have seen what has happened to me and are thus highly reluctant to point out the dangers of Buy-and-Hold themselves. We need that to change to get good discussions started. I like and respect the Buy-and-Holders and I certainly want to hear their side expressed. But I also want those on the other side to feel free to express their sincere views without fear of inappropriate negative consequences being visited on them. Both sides need to speak openly and freely and without fear for the debate to be truly productive.

“Please don’t think that I am trying to be argumentative here. Your comments are perfectly fair and helpful. I sent a response to them because I wanted to be clear that I am NOT saying that there is zero literature available on this. There IS literature. There is more all the time. That’s one of the positive signs. It is my belief that we are going to see big changes following the next crash. I believe there is a pent-up desire for an open discussion of what really works in stock investing. The problem today is that so many people have so much invested (not just financially but emotionally as well) in Buy-and-Hold that it hurts them to hear the concept challenged and people have reacted irrationally. Anyway, thanks much for taking time out of your day to read my words. My warmest wishes to you.”

5) Michel Habib wrote: “Thank you, Rob. I must say I do not work on that. I wish you the best of luck.”

Harvard Law School Professor Alain Lempereur: “It Is Not Easy to Work on This Kind of Topic. I Can Testify Too.”

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I have been sending e-mails to numerous people letting them know about my article reporting on The Silencing of Academic Researcher Wade Pfau by the Buy-and-Hold Mafia. Set forth below are reports on five responses.

1) Alain Lempereur, Director of Graduate Programs in Coexistence and Conflict at Harvard Law School, wrote: “Thank you for sharing this with me. I read the piece last week. It is not easy to work on this kind of topic. I can testify too. I was in a business school before…”

I responded: “Thanks for taking the time to read the article and thanks for your response. It certainly has not been an easy 10 years. But I do think we are starting to see some light at the end of the tunnel. I have to point people to the bad stuff to help them make sense of the story. But I also try to emphasize that the good here outweighs the bad by at least 10 to 1. An argument can be made that the good and the bad are connected. People are upset because it hits them that they have wasted opportunities. That’s why things get on the wrong track. But it is because the opportunities are so great that the emotional pain is so intense. As people become better able to take advantage of the opportunities, the good will come to dominate. I bet that the people who replaced cars with horses ran into this sort of problem. We just don’t hear about the foot-draggers today. The bad stuff is forgotten in time and the good stuff gets better and better and better. Or so I tell myself, in any event. Don’t let the bad guys get you down, man.”

2) Rifat Yilmaz wrote: “What do you want me to do with this?”

I responded: “There’s no particular call to action. I learned about the problem by posting honestly about stock investing on the internet. I was amazed to see what Buy-and-Holders did to block discussions (I also interacted with many investors who wanted to learn the realities). I believe that it was the promotion of Buy-and-Hold that caused the economic crisis. The numbers show that. We are all affected by this economic crisis and we all will be affected in more serious ways when it gets worse. I feel that it is urgent to get the message out and the ordinary means of doing so have all been blocked for me. My thought is that we all should do what we can. Perhaps you can share the link with some friends when they express concerns about where the economy is headed. That would certainly help. My belief is that it is only by getting other people involved that we can work up the courage as a society to deal with the problem. The Buy-and-Holders are smart and good and hard-working people. They are in intense emotional pain. The good news is that, if we melt their hearts, we can all begin working together to take things in a very positive direction indeed. We know things today about how stock investing works that no generation that came before us knew! I hope that all makes at least a tiny bit of sense. Please stay positive, please get involved to whatever small extent seems practical in your circumstances and please wish us all luck as we continue as a society down this highly promising but more-than-a-little-scary path that we are on today.”

3) Shelley Marshall, a Senior Lecturer at Monash University, wrote: “Thanks for sharing, Rob. I’ll look forward to reading your paper.”

I responded: “Thanks for your response. I just wanted to be sure that you understood that the paper that I worked on with Wade has already been published in a peer-reviewed journal. It is here: http://mpra.ub.uni-muenchen.de/29448/ It is written in that dry style that academics favor (Not me! We journalists play it a very different way!). But the implications are far-reaching indeed. The graphic on Page 11 suggests that an investor can reduce risk by 70 percent by taking valuations into consideration when setting his or her stock allocation. My best wishes to you.”

4) Vikram D. Amar, Associate Dean for Academic Affairs at the University of California Davis School of Law,  wrote: “Thanks. This is not really up my alley but I wish you the best.”

5) Michal Gilad, wrote: “I am a little confused. What is the purpose of the review? This is by no means my area of specialty.”

I responded: Thanks for your response. I understand that it is not your area of specialty. In some respects that is a positive. People in this field feel limited in what they can say. Their careers are at stake. I am not seeking any particular response from you. I am letting various people know about this. The economic crisis affects us all in a big way. We all need to be thinking about how as a society we can overcome it. We all can help in different ways. Perhaps you have friends who are interested in the subject and you can share the link with them. Each of us can make a small difference and in the end lots of small differences can added together make a big difference. I hope that makes at least a little bit of sense.”