A Rich Life

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

Rob Bennett to Academic Researcher Wade Pfau: “My Understanding of the Theory [Behind Valuation-Informed Indexing] Has Helped Me Avoid Pitfalls That Lots of Others Have Fallen Into”

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Yesterday’s blog entry reported on an e-mail that I sent to Academic Researcher Wade Pfau on August 12, 2011. He sent a response the same day.

Wade congratulated me for obtaining a monthly column at the Financial Highway site. He said that his university subscribed to a service that provided links to media sources using the university name and that my article was picked up by the service. “So everyone here got to see a link to your article in email and our alumni director made a link to it in the alumni group on Facebook.”

He also said that he had received positive comments from a journal on his Fisher and Statman research. He said that things were looking good re future publication. He said: “I might include about the rolling 30-year periods in it rather than keeping it for a separate article.  I’ve been getting so busy and there is not enough time to write all the papers I want to write these days.”

My response, sent later the same day, appears below.

Wade:

It always brings a measure of cheer to my day to receive an e-mail from you. Intelligent discussion of investing is like sunshine to me!

That’s a great story about your university and the e-mail links. The internet works in mysterious ways! It’s so new and different a communications medium that people have not figured it out yet.

One of my dreams is to get one of my calculators picked up at the LifeHacker site. It is a a HUGE site and the calculators are perfect  for it because the site is looking to share knowledge of practical tools. So what happens a week or so ago? LifeHacker picks up one of my saving articles! It brought in lots of traffic and I am of course grateful. But it is strange for things to happen that way. My investing work is 20 times more important than my saving work and my saving work is 20 times more popular. I actually think of my investing work as Anti-Marketing. My saving articles pull people into my site and my investing articles drive them right back out again!

I like the idea of adding the rolling 30-material into the Fisher article. You have two A+ articles there. But you are better off with one A+++ article. The engineer for the Beatles said that his greatest career regret was that he let them release Strawberry Fields Forever/Penny Lane as a single rather than saving it for inclusion on Sgt. Peppers. Sgt. Peppers got plenty of attention on its own. But it would have been even bigger with inclusion of those two songs (and the dropping of two inferior songs). One A+++ article can have more impact than a lifetime of solid B+ material. So don’t make any mess-ups in that article! (That’s a joke.)

There’s a point made in one of the Bogleheads threads in which you  participated that I think might be worthy of some of your consideration. It was one of the critics who put it forward but it was a strong point. He asked: “What is the THEORY that explains why P/E10 would be able to predict returns?” My strong sense is that people don’t spend  enough time thinking that over. I believe that I understand the theory (it is of course possible that I am wrong). My sense is that my understanding of the theory has helped me avoid pitfalls that lots of others have fallen into.

Anyway, you must get that article on the front page of the New York Times before our economic and political system falls! That’s sort of a joke too, but perhaps only 50 percent so. We really do live in times that are both exceedingly scary and exceedingly promising (but perhaps all times seem that way to the poor humans living through them without knowledge of how things turn out on the last page of the story).

Please take care.

Rob

Beyond Buy-and-Hold #85 — The Last 11 Years Have Been Lucky Ones for Stock Investors

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I’ve posted Entry #85 to my weekly Beyond Buy-and-Hold column at the Out of Your Rut site. It’s called The Last 11 Years Have Been Lucky Ones for Stock Investors.

Juicy Excerpt:  Say that we were back in January 1981, the beginning of the 30-year time-period that ended in January 2011. The realistic expectation would be that we would see an annualized 30-year return of something in the neighborhood of 6.5 percent real. That’s the long-term return that has applied for stocks going back as far as we have records. So I plugged that number into the calculator as the 30-year return that would apply for the time period from 1981 through 2010.

Then I plugged in the returns we actually saw appear from 1981 through 1999, the 19-year returns sequence that was set in stone at the beginning of the 11-year time-period we are examining in this article. For the first results column in the calculator, I entered the returns we actually saw from 2000 through 2010. I let the calculator complete the second column, with the aim of bringing the annualized return for the entire 30-year period to 6.5 percent real, the long-term annualized return that has applied for U.S. stocks throughout history.

Assuming an investor had a $10,000 portfolio in 1981 and added $10,000 to his account in each of the 30 years, his portfolio amount at the end of 30 years for the Column One return pattern (the one we saw play out in real life) was $921,287. The Column Two return pattern (the most realistic one that could have been anticipated) generated a final portfolio value of $737,497. That’s a difference of over $180,000 in portfolio value.

Financial Highway Article #8 — The Market Has a Memory

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I’ve posted Entry #8 to my monthly column on Valuation-Informed Indexing at the Financial Highway site. It’s called The Market Has a Memory.

Juicy Excerpt: Shiller has shown with his research that the valuation level that applies today affects the price that will apply for stocks 10 years from today and 15 years from today and 20 years from today. The correlation between valuation levels and long-termstock prices is strong and has been strong for as far back as records have been kept. That’s 1870). That’s a time-period of 140 years.

This is a reality that the Buy-and-Holders cannot explain. If it is daily economic and political events that determine stock prices, why would the valuation level that applies today affect the stock price that applies 10 years from today? It shouldn’t. If the market were efficient, the P/E10 value would be a meaningless number. It is impossible to reconcile Shiller’s findings with Fama’s hypothesis.

VII #82 — The Five Most Important Advances in Our Understanding of How Stock Investing Works

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I’ve posted Entry #82 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called The Five Most Important Advances in Our Understanding of How Stock Investing Works.

Juicy Excerpt: In the days when we thought that the market was efficient, Buy-and-Hold strategies (staying at the same stock allocation at all times) made all the sense in the world. If stock returns cannot be predicted, stocks are equally risky at all times. Thus, it makes sense for an investor to identify the stock allocation best suited to his risk tolerance and maintain it through his investing lifetime.

This logic does not apply in a world in which returns are predictable. In a world in which returns are predictable, the risk associated with stocks changes with changes in valuations (stocks are obviously more risky at times when likely returns are low than they are when likely returns are high). Investors should obviously be aiming to maintain the same risk profile at all times. So in a world in which returns are predictable, Buy-and-Hold is a dangerous and irresponsible strategy.

” My Job Is To Get Everybody Talking To Each Other So That We Begin Reaping the Benefits of the Amazing Stuff We Have Been Learning for 30 Years”

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Set forth below is the text of a comment that I put to a blog entry a the Mint.com site titled Timing the Market Using Stock Valuations:

I’m responding to the comment by Value RIch. He asks about my relationship with Michael Kitces and comments (with at least a small measure of sarcasm, I suspect) that I “must be quite the study to have bested all the leading figures into a whole new investing movement.”

Here’s a link to the home page of my blog:

http://arichlife.passionsaving.com/

The “People are Talking” section (it runs down the left side of the page) contains favorable comments on my work by a combination of 110 experts and ordinary investors. There are comments there by both Michael Kitces and Wade Pfau. And the comments by Michael go back a number of years. I’ve had a relationship with Michael for a long time now. Yes, my work has had a huge influence on his (and Michael’s work has of course in turn had a huge influence on mine).

I of course agree that it is exceedingly strange that I have been able to create “a whole new investing movement.” The full reality is that we are dealing with exceedingly strange circumstances in the investing realm today.

Buy-and-Hold is rooted in the research by Eugene Fama that produced the Efficient Market Hypothesis. Please note that an “hypothesis” is not a fact or a truth, it is really just an informed guess. The thing to do with an hypothesis is to test it. That’s what Yale Economics Professor Robert Shiller did with his 1981 research showing that valuations affect long-term returns. That research discredited the Efficient Market Hypothesis and Buy-and-Hold and showed us the path to something far better. It is really Shiller who is the founder of the movement being discussed here.

If humans were perfect creatures, Buy-and-Hold would have been abandoned on the day Shiller published his research. That didn’t happen. Lots of money had already been spent promoting Buy-and-Hold and people didn’t want to acknowledge the mistakes. Lots of people had already invested their reputations in the promotion of Buy-and-Hold. Lots of people did not immediately grasp the significance of Shiller’s findings. For all sorts of reasons, Buy-and-Hold remained and actually grew more popular during the huge bull market that came in the following years.

The academic research discredited Buy-and-Hold thirty years ago. But the vast majority of the experts in this field hold back from saying things so clearly because it is career suicide to do so. I am a journalist, not a financial planner. So I have for 10 years now been saying things far more clearly than just about anyone else writing about these matters. To that extent it is indeed fair to say that I have started “a whole new investing movement.”

I have great respect and admiration for the Buy-and-Holders. There wouldn’t be any Valuation-Informed Indexing today if not for their many important and powerful and grounds-breaking contributions. But the reality is that Buy-and-Hold died 30 years ago. Shiller himself has said in interviews that he has never told us all he knows about stock investing because he fears that he would be branded as “unprofessional” if he did so. That amazing reality should give you some idea of what we are up against. We all lose when we become unable to hear the sincere insights of the most important figures in this field.

My job is to get the word out about all the wonderful things we have learned intellectually but have held back from discussing publicly for fear that it would hurt the feelings of the Buy-and-Holders for people to learn about their mistakes. We need to be hearing all that Shiller has to teach us and all that Kitces has to teach us and all that Pfau has to teach us and of course also all that people like Bogle and Bernstein and Swedroe and other Buy-and-Holders have to teach us too.

We really are on the threshold of the greatest expansion of our knowledge of how stock investing works ever achieved. It’s a shame that we have let things remain stagnant in this field for 30 years. But the happy side of the story is that we are now in a place where we can enjoy hundreds of powerful insights that have been developed over the course of many years but not shared publicly because for a time it was not politically correct to point out that the Buy-and-Hold model has failed (while laying the groundwork for something better).

I didn’t “best” all the great minds in this field. I learned from them. ALL of them. I have learned many wonderful things from the Buy-and-Holders. I have also learned many wonderful things from the many smart and good people who have done research showing that the Buy-and-Holders did not know all there was to know when they put forward the First Draft of an investing approach rooted in the academic research. My job today is to get everybody talking to each other and learning from each other so that we all begin reaping the benefits of the amazing stuff we have been learning about underground for 30 years now.

Perhaps the best way to say it is to say that the humans worked together to bring about “a whole new investing movement.” I’ve said a lot of things that few or no others have been willing to say clearly. But I ain’t some guy who has been sitting in a room alone thinking grand thoughts. I have had help from hundreds of experts in the field and from thousands of ordinary middle-class investors. There’s plenty of credit to go around here. We all need to get to a point where we start worrying less about who gets credit for the breakthough insights and more about how we get the word out to the millions of middle-class people who need to be hearing about all these insights.

Again, thanks for getting this discussion started, Matthew. It’s hugely important stuff.

Rob

Beyond Buy-and-Hold #75 — If Valuations Matter, It Must Be Possible to Profit From This Reality

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I’ve posted Entry #75 to my weekly Beyond Buy-and-Hold column at the Out of Your Rut site. It’s called If Valuations Matter, It Must Be Possible to Profit from This Reality.

Juicy Excerpt: The next day, the manager releases the team’s best five pitchers on waivers. You are shocked. You tune in to the news that night to hear his explanation. He says: “I strongly believe that pitching matters. That said, I know of no reason to believe that teams with better pitchers win more games. So I am not even a tiny bit concerned that we are losing all our best pitchers. I am convinced that pitching matters a great deal in baseball, but I also am confident that it has no effect on whether you win or lose games.”

VII #78 –Using Accurate Safe Withdrawal Rate Numbers Helps Us Understand Stock Investing Risk

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I’ve posted Entry #78 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Using Accurate Safe Withdrawal Rate Numbers Helps Us Understand Stock Investing Risk.

Juicy Excerpt: Say that the SWR is always 4 percent. Does that sound like a low number or a high number?

It is a remarkably low number. The SWR calculations assume that the portfolio may be reduced to zero over the 30-year time-period. Thus, an asset class providing a zero return for 30 years running would provide a SWR of 3.3 percent. The 4 percent SWR reported in the Old School studies for stocks is only a little better than the SWR that would apply for an asset class offering a return of zero. And yet stocks provide an average long-term return of 6.5 percent real! Why is the SWR for stocks so low?

VII #77 — Do We Need to Have a Dominant Model for Understanding How Stock Investing Works?

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I’ve posted Entry #77 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Do We Need to Have  a Dominant Model for Understanding How Stock Investing Works?

Juicy Excerpt: I believe in Valuation-Informed Indexing. It doesn’t follow that you must. It might work out better for both of us if you do not. The less we agree on, the more we have to discuss, and the more we discuss, the more we are likely to learn.

Buy-and-Hold is dead!

We need quickly to replace it with –

Discussion!

Beyond Buy-and-Hold #71 — Buy-and-Holders Are Good and Smart People

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I’ve posted Entry #71 to my weekly Beyond Buy-and-Hold column at the Out of Your Rut site. It’s called Buy-and-Holders Are Good and Smart People.

Juicy Excerpt: Do you know any field of human endeavor in which the pioneers got it all right on the first try? I can’t think of one. We shouldn’t be surprised that the Buy-and-Holders messed up big time. We should have expected it all along. That’s what usually happens when the humans go about making huge advances in their understanding of some matter of importance. Mess-ups are a part of the process.

I wish we could all start seeing it that way. If we could, we would see the defensiveness that has been holding us back from spreading the word about all of our exciting breakthroughs disappear. If we could just accept that mess-ups are a natural part of the learning process, we could help the Buy-and-Holders come to see that Valuation-Informed Indexing is not so much a refutation of their years of hard work as it is a vindication of them and a fulfillment of them.

Beyond Buy-and-Hold #70 — Why I Don’t Pull Punches in My Discussions With Buy-and-Holders

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I’ve posted Entry #70 to my weekly Beyond Buy-and-Hold column at the Out of Your Rut site. It’s called Why I Don’t Pull Punches in My Discussions With Buy-and-Holders.

Juicy Excerpt: But my goal is to bury Buy-and-Hold 30 feet in the ground, where it can do no further harm to humans and other living things. I would like to see all of the experts in this field endorsing Valuation-Informed Indexing, which I view as the investing strategy of the future. I look forward to the day when The Stock-Selling Industry is spending hundreds of millions of dollars promoting investing strategies that work.

What are the chances that those things are going to happen if I stop speaking out strongly in opposition to Buy-and-Hold or do so less frequently? I think it is safe to say that the chances are pretty darn small. If I follow the advice of my Buy-and-Hold friends, I will be more popular. But I will also be ineffectual! I will not achieve my goals. I can see how that sounds good from their point of view but I am not able to see how it could be seen as a good thing from mine.