Five Reasons Why We Don?t Want to Know How to Invest Effectively

Beyond Buy-and-Hold #24

Wade Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies in Tokyo, Japan, recently published preliminary research at his web site showing that: ?Valuation-Informed Indexing provides more wealth for 102 of the 110 rolling 30-year periods? in the historical record.

This is exciting news. We all now have available to us a far more effective way to invest than we have ever had available to us before. And several bloggers have been helping us spread the news. The Free From Broke blog ran a Guest Blog Entry that I wrote titled A Better and Less Risky Way to Invest in Stocks. And MapleMoney ran one titled The Five Big Benefits of Valuation-Informed Indexing. And the Carnival on Passive Investing at the My Personal Finance Journey blog awarded its ?Editor?s Pick? to the ?A Better and Less Risky Way to Invest in Stocks? article. So we are beginning to make some progress in our efforts to fill in middle-class investors re what really works in stock investing.

However, the reality remains that there are not today hundreds of discussion boards and blogs promoting Valuation-Informed Indexing as there are hundreds promoting Buy-and-Hold. Huh? There are people pushing the dangerous stuff and failing to even let their readers know about the good stuff?

You know what University of Chicago Economics Professor Eugene Fama would say about that, don?t you? He would say that it?s not rational, it?s not logical, it?s not efficient. Given that it?s not rational or logical or efficient, he would conclude that it?s not possible.

Possible or not, it?s the reality. We see the reality every day on our computer screens. We know that there is a better way to invest available to us and yet we rarely talk about it. Why? Do we not want to know how stock investing works?

That?s it!

We humans are to a large extent irrational creatures. Contrary to Fama?s theorizing, it turns out that humans are entirely capable not wanting to know the realities of stock investing. Here are five reasons why:

1) We are ashamed. If Buy-and-Hold is as bad as the historical data and the academic research says it is, Buy-and-Hold was almost certainly the primary cause of the economic crisis. Most of us followed some form of Buy-and-Hold in the 1990s. We caused the crash. Who wants to acknowledge having done such a thing?

2) We are confused. There really was a time when the academic research indicated that Buy-and-Hold was the perfect strategy. Millions of us have come to believe that timing isn?t required or even that timing is a bad idea. Research showing that this is not so is hard to accept. Given our genuine confusion, we remain reluctant to learn about the strategies that follow from the research of the past three decades and seek solace in a comforting belief that perhaps Buy-and-Hold will turn out to be not so bad after all.

3) We are emotionally invested. Have you noticed how, when you make a major purchase (say, the purchase of a new computer), you ask lots of hard questions up to the time you put money on the table. However, once the transaction is completed, you take off the skeptic?s hat and become a booster of the product you bought. Why? Now it?s your computer. People who would have been happy to learn about the dangers of Buy-and-Hold in the days before they adopted the strategy as their own are not so keen on learning about the topic 30 years after making it their investing strategy.

4) We are financially hurting. When you lose money in the stock market, you don?t lose only dollar bills. You lose out on the life opportunities that would have been available to you had you invested more effectively. There are Buy-and-Holders who will not be able to send their daughters to college because of the mistake they made when choosing an investing strategy. And there are Buy-and-Holders who will not be able to start the business they wanted to start. And there are Buy-and-Holders who will not be able to retire early. That sort of thing hurts. A common human response to hurt is to go into denial of the realities.

5) We are embarrassed. There are many married couples comprised of one spouse who believed that Buy-and-Hold would work and one spouse who was skeptical. In many cases, the skeptic deferred to the believer after noting the heavy push in favor of Buy-and-Hold that was being made by the stock-selling experts. The spouse who persuaded his wife to go along with Buy-and-Hold does not today feel excited to learn that he was taken. Neither does the worker who persuaded his office mate to follow this approach,. Neither does the friend who persuaded his friend. Or the neighbor who persuaded his neighbor. Or the discussion-board poster who persuaded his fellow community members.

There’s a reason why bear markets stretch out so long. The words ?I? and ?was? and ?wrong? are the three hardest words to pronounce in the entire English language.

It?s one thing for an academic researcher to produce research showing that Buy-and-Hold never works. it?s something very different for investors to reach a point where they are capable of reading it with clear and open and learning-thirsty minds.

Rob Bennett created a stock valuation calculator that performs a regression analysis on the historical stock-return data to reveal the most likely 10-year return starting from any valuation level. His bio is here.

Rob Bennett created a stock valuation calculatorr that performs a regression analysis on the historical stock-return data to reveal the most likely 10-year return starting from any valuation level. His bio is here.