A Rich Life

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

“Do We Like What Comes from Telling Lies to Ourselves re What Our Stock Portfolios are Worth?”

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Set forth below is the text of an e-mail that I sent last week to my friend Brian. Brian and I became friends during my days as a Capitol Hill reporter. We have stayed in touch in the years since. Brian asked: “If everyone (or the vast majority) has lost money,  are we really any poorer?”

Brian:

You’re asking a penetrating question. I wish that everyone would take some time and think this one through. If they did, that would help a lot.

The full reality is that there has been no loss. The money that was “lost” was pretend money. It was cotton candy that has now been blown away in the wind. It never existed in the first place. So of course it was not possible to “lose” it. One cannot lose something that does not exist in the first place.

However, we ARE poorer as a result of our decision to entertain the illusion of being richer for a time:

1) People who believed that the illusory wealth was real started businesses because of that belief and now have seen those businesses fail when the illusory wealth was taken away. The years of effort devoted to building those businesses is lost. That’s a loss for the entire society because those years could have been put to more constructive use;

2) People who believed that the illusory wealth was real spent far larger sums on houses and cars and vacations than they would have had they known that most of the stock market gains of the 1990s were comprised of funny money;

3) People have failed to properly plan for their retirements because they believed that the numbers they saw on the bottom line of their portfolio statements were reasonably accurate;

4) Businesses that would have done better in an environment in which people didn’t think they were as rich as we had come for a time to believe we were failed in earlier years because they were trying to compete with businesses that gained an unfair advantage because of the belief in the funny money. For example, companies selling luxury homes moved ahead of companies selling modest homes because luxury homes seemed to make more sense for a time than they would have had we known the real numbers;

5) Lawmakers have directed huge amounts of money to stimulus projects that would not have been devoted to those projects had we been talking straight with each other about the true level of wealth in our society.

The money that came from the overvaluation of stocks was pretend money. We’ve lost nothing in returning to fair-value prices. But we have caused millions of unfortunate economic choices to take place by telling people for 13 years (1995 through 2008) that they possessed far more in the way of accumulated wealth than they in fact possessed. It’s a tragedy.

The good news is that we could turn it around by making a decision as a society to begin talking straight about how stocks work.  If we did that, the economic growth that would result in the following years would be huge. All of the negatives would be turned into positives. My hope is that this crisis is going to cause so much pain that it will cause people to ask the fundamental questions that need to be asked to get things on a much better track.

It’s a gut check for our society. Do we like what comes from telling lies to ourselves about what our stock portfolios are worth? Or can we reach down deep and transform an unfortunate set of circumstances into something that ends up generating lots of wonderful, wonderful advances in years to come?

Learning how stock investing works is like learning how to cure cancer or how to fly or how to build a computer. There are thousands of implications that affect every aspect of human life that follow from it.

Rob

“It Is the Result of a Mistake, Not a Lie”

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Tuesday’s blog entry set forth the text of an e-mail that I recently sent to the owner of the Frugal Dad blog proposing an arrangement in which we would work together to publicize the findings of the Retire Early and Indexing discussion-board communities from the first seven years of our investing discussions.

Set forth below is the text of a follow-up e-mail that I sent following the posting of a blog entry at the Frugal Dad site entitled Have We Been Sold a Bunch of Lies About Money? I’ll offer commentary in next Tuesday’s blog entry.

Frugal Dad:

This is Rob Bennett. I sent you an e-mail last week re the extensive investing research that I have done. I have not received a response, and so I assume that you do not have an interest in the idea that I advanced. That is of course fine. But your blog entry today is on precisely the topic that I have explored, and so I felt a need to try one more time to get you interested in exploring this question in some depth.

You are not too far off in suggesting that we have been sold a bunch of “lies” re investing. I think that use of the word “lie” is not appropriate. But it is certainly true that we have been misled in terrible ways. I can explain the entire story and provide links backing up my conclusions on just about all of the important points. I very much want to get this story out to a wider audience and I would be thrilled to work with you in doing so if you have any interest in the idea.

What happened is that there was exciting research done in the 1960s and 1970s showing that short-term timing (changing one’s stock allocation in response to price changes with the thought that this would bring good results within a year or two) does not work. Many “experts” interpreted this to mean that ALL forms of timing (both short-term and long-term) do not work. The result was the investing advice that became the conventional wisdom for the past 30 years — always invest heavily in stocks, even when prices go to insanely dangerous levels. This is the worst possible advice that could have been offered. But it is the result of a MISTAKE, not a lie.

We need to fix the mistake. I have found this to be a tough business. Many “experts” are highly reluctant even to consider the possibility that they made such an obvious mistake that caused such great human misery. Still, the evidence is very strong that this is what happened. It is important that the mistake be corrected before too many more investors become so disillusioned with stocks that they take all their money out. Many people are coming to conclusions along the lines of your own, and this could cause stock prices to drop another 50 percent over the next few years. This could lead us to an economic depression. The stakes here are as high as they could possibly be,.

I hope you will not consider me a pest for writing again. I hope that you will give some thought to my idea. Your readers need to learn the realities. The “experts” have indeed let us down. But it is not right to conclude that they are liars and it is not right to conclude that stocks are a bad investment even when purchased at reasonable prices. If you change your stock investing strategy to one in line with the research of the past 20 years, you can obtain the benefits that stocks really do offer while reducing your risk to a fraction of what applies for those following the strategies that became popular during the past 30 years.

If you have doubts about anything that I am saying, please ask questions. I really can tell the whole story, it really is an important story, and it really is a story that you can understand if you spend just a little bit of time getting up to speed on realities that it took me years to uncover.

I am sorry about your losses. If you check my well-documented record, you will see that I have been warning about this stock crash for a long time. I have worked this incredibly hard for a long time. There IS a good deal to be said for the Your Money or Your Life approach (reading that book’s treatment of investing led me to asking the questions that sparked all of my research into these questions) but the YMYL approach has flaws of its own. I have been working with hundreds of people to come up with something a lot better and we have enjoyed a great deal of success in the work we have done. Our one big problem has been on the publicity side. You obviously could be a huge help in that area.

Rob

“I Want to Launch an Effort to
Publicize the Ideas on the Internet”

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Set forth below is the text of a e-mail that I sent to the owner of the Frugal Dad blog on January 14. I did not receive a response.

On January 19, Frugal Dad posted a blog entry entitled Have We Been Sold a Bunch of Lies About Money?  He stated in this blog entry that “My 401(k) has been demolished” and “family members’ 401(k)s have been demolished, even those in target retirement funds that should have been comprised of more conservative options based on their upcoming target retirement date.” He concluded that: “After watching these wild market swings, I’m starting to wonder if I really have the stomach for it” and indicated that he may move to a less risky investing strategy, one not involving the purchase of stocks. I posted a comment to the blog entry and responded to questions put forward by several community members (a few at the end of the thread are abusive, but several earlier in the thread raise reasonable points or ask good questions). I also sent a follow-up e-mail.

I will post the follow-up e-mail as Thursday’s blog entry. I will offer commentary in next Tuesday’s blog entry.

Frugal Dad:

This is Rob Bennett, publisher of the “A Rich Life” blog at www.PassionSaving.com. We exchanged e-mails a ways back in connection with your article re paying off the mortgage (you linked to an article of mine). I hope things are going well with you.

I am looking for a partner to help spread the word re some exciting investing ideas that have been developed in the Retire Early and Indexing discussion-board communities in recent years. Based on what I have seen from following your blog, I think you would be a great person to work with (I am looking for someone with an audience that is large and active but that is not comprised of people primarily interested in investing issues).

The investing strategies that are today conventional wisdom (“timing doesn’t work, “stocks for the long run,” “buy-and-hold,” etc.) have been increasingly discredited by the academic research of the past two decades. There is truth in all these ideas, but not complete truth; there is good in them but there is also danger in them. I have been reporting on these realities for close to seven years now and have produced  a wealth of material related to them (including three unique calculators, over 50 podcasts, scores of articles, and tens of thousands of discussion-board posts). I have communicated with hundreds of middle-class investors who showed great excitement to have found for the first time a description of how investing works that truly makes sense. Unfortunately, these ideas have also met with intense opposition among people who view themselves as “expert” in their understanding of the discredited, conventional ideas. Abusive posting by the defensive group has blocked the efforts of many to learn about these ideas (I call the strategy that I recommend “Valuation-Informed Indexing”) for years now.

There has been a big change in discussions of investing since the big price crash. There is greater interest now than before in new ideas and those inclined to dismiss new  ideas are feeling increasingly defeated by real-world events. I want to launch an effort to publicize the ideas on the internet. If you have an interest, your blog would be a great place to do this. My guess is that your readership is concerned about the recent stock-market developments and would love to hear informed and straight-talk answers to their many questions. But your readership is not comprised of the sort of people who would become defensive on being exposed to some unconventional takes on how stock investing works.

If you think this idea holds any potential, I propose that you explore it a bit by directing a question or two of your own to me. I would respond, using the research that I have done with John Walter Russell (owner of the www.Early-Retirement-Planning-Insights.com site) over the past seven years as the basis for my answers. If you found the discussion helpful to your understanding, you could share what you learned from it with your readers in any of several ways: (1) you could write up articles summarizing the discussions; (2) you could post the actual words of the discussions if you thought that a better approach; (3) you could invite your readers to put forward their own questions and seek responses from me re those questions; or you could follow some other approach of your choosing.

The goal would be to inform your readers of what is happening in the stock market, why it is happening (none of what has happened is the least bit surprising to those familiar with the literature of the past 20 years, much of which unfortunately is rarely discussed in the conventional media), and what they need to be doing to invest more effectively. Ultimately, I hope to see this debate over the future of investing spread to other blogs and other sites. I believe that we need a national debate on the errors that caused the greatest loss of middle-class wealth in the history of the United States. Your “promotion” of my work would obviously bring attention to my site. My belief is that it would also enhance the value of your blog by offering great benefits to your readers and ultimately would gets lots of other people talking about some issues that very much need to be talked about more at this time.

If you have no interest, I of course understand that this is an unusual request and one that you might for perfectly good reasons not see much appeal in; I’d be grateful if you would just send an e- mail saying “no thanks” so that I would know. If you have a limited interest but also have questions, please ask. I have all sorts of resources that I can point to in response to just about any question you can ask. And this project is my baby — I have been preparing for the launching of this initiative by working 10 hour days six days a week re this matter for close to seven years now. I am more than happy and prepared to point you to materials showing the legitimacy of all of the claims that I put forward.

I of course would not expect you to be willing to endorse any of these ideas unless you were confident that there was merit to them. My thought is that you might serve as a go-between for your readers. Your questions are probably to a large extent their questions. If you found my answers convincing, you could forward them (perhaps with your own take attached). If you did not, you could of course elect not to report on them or to report negatively on them.

Please understand that none of the questions that I address are complicated ones. I address the BASICS of investing, the stuff that the typical middle-class worker needs to understand. Unfortunately, it is at the basics level that the conventional advice is most flawed.

I’ll leave you with a few links that will give you a general sense of the issues involved:

1) This is the Podcasts section of my site:

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

2) The Stock-Return Predictor is key to making the Valuation-Informed Indexing approach work:

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

3) Here is a nicely balanced write-up of the Predictor by Felix Salmon that appeared at the Market Movers blog:

http://www.portfolio.com/views/blogs/market-movers/2008/07/08/a-look-at-long-term-stock-valuations#blogComments

4) “Elizabeth’s Story,” which appears at this link, provides a good indication of how these ideas have affected some typical middle-class workers (I can provide many more such stories if they help you make sense of all this):

http://www.passionsaving.com/finding-life-purpose-page-three.html

Rob

“Have We Been Sold a Bunch of Lies?”

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Frugal Dad asks that provocative question in his blog entry for yesterday.

There are lots of people asking that question today. More will be asking it in days to come unless some responsible people step forward to rebuild confidence in the markets by explaining why it is that we have in recent years suffered the greatest loss of middle-class wealth in U.S. history.

My comment is Comment #16.

Juicy Excerpt: We MUST get the word out re this. If people pull their money out of stocks (more are talking about it all the time), we are going to see another huge price drop. That is going to put our economy into a depression. All of this is 100 percent unnecessary. It is all the result of a MISTAKE. We really need to get about the work of getting some serious people involved taking some serious steps. There are many people who know about all of the things I am talking about but who are afraid to speak out because the human misery caused by the Passive Investing concept has been so horrible and it is considered “taboo” to note the errors in this failed approach. I have never seen anything like this!

Podcast #49 — The Road Out

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I’ve added Podcast #49 to the “RobCasts” section of the site. It’s called The Road Out.

Famed investing strategist Carly Simon summed up the Rational Investor’s take re stock-market gloom and doom when she observed that: “I haven’t got time for the pain, I haven’t the need for the pain.”

This Month’s Permanent Portfolio

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The great thing about studying what investors say on discussion boards is that you learn about how things work in practice, not theory.

Investors have been told for 25 years now to follow buy-and-hold strategies. And they say they do. But do they really?

I’ve seen hundreds of comments indicating otherwise. One thing I’ve seen a lot of is a rigid adherence to the idea of buy-and-hold combined with an extremely loose understanding of what it involves in practice.

There are lots of investors out there who in 1999 believed with their entire minds, hearts and souls that owning the S&P500 and the NASDAQ forever was the essence of buy-and-hold. Then the idea became to own just the S&P500 forever. Then it was the S&P and value stocks. Then the S&P and REITS. Then the S&P and small caps. Then the S&P and a global index. Then the S&P and Emerging Markets. The idea seems to be growing of late that maybe it’s best to leave out the S&P altogether and just go with all the other possible slices and dices.

That ain’t buy-and-hold. The idea of buy-and-hold was to stick with a plan long enough to see if it can really pay off. Switching to a different Permanent Portfolio every six months or so doesn’t do the trick.

Investors are kidding themselves. They like the buy-and-hold idea, and for good reason. It is indeed important to stick with a plan long enough to give it a fair test. But the promoters of the buy-and-hold concept did a poor job of pointing out the pressures that those following it will feel to abandon it. As a result, most would-be buy-and-hold investors are unprepared for those pressures and have no idea how to respond to them other than to change their understanding of what constitutes buy-and-hold regularly enough to keep up with their changing desires to own different classes of stocks.

Buy-and-hold is a good idea. But the popular formulation of it is unrealistic. We need a new understanding of how buy-and-hold can work, one that stands a better chance of playing out well in the world of flesh-and-blood investors.

The problem is that buy-and-hold became popular during the longest and strongest bull market in U.S. history. People came to think that you could buy the S&P and forget about it. That of course can never work. When the S&P is selling at reasonable prices, it is a wonderful asset choice. When it is selling at the sorts of prices that apply today, it represents a dubious long-term value proposition.

If we could just say that, we could develop all sorts of strategies for following what are basically buy-and-hold strategies but that are a good bit less rigid than what many of the promoters of the concept have endorsed. Until we develop that freedom, many investors will feel that their hands are tied. It is taboo to change one’s stock allocation or one’s mix of asset classes. But it’s becoming increasingly clear that it is foolhardy not to make some changes in one’s portfolio when the investing environment changes dramatically.

Is it okay to make shifts in the makeup of your portfolio from time to time? Of course. It’s not only okay, it’s pretty much mandatory. None of us knows it all starting out. We learn over time. If we didn’t put what we learned into effect by changing the makeup of our portfolios, there wouldn’t be much point to learning, would there?

We need to be more up front about the changes we make and the reasons why we make them. Many investors have given up on the S&P500 in recent years. For good reason. The S&P is dangerously overvalued. We should learn from our mistaken belief of yesteryear that the S&P would always be as attractive a buy as it was back in the time when it was available at a far more reasonable price.

Buy-and-hold should be a tendency, a goal, a principle. When we make it a dogma, we switch onto the wrong track. We all need to make changes in our portfolio composition and in our stock allocation from time to time. We should discuss those changes openly and thereby learn lessons from the mistakes we made at earlier times.

Today’s Passion: The article entitled Basics of the New Buy-and-Hold provides a groundwork for the development of a new way of implementing this strategy.

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

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

Is there anything bad about stocks?

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

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

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

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

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

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

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

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

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

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

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

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

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

Make sense?

It makes sense to me.

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

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

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

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