Beyond Buy-and-Hold #14
I am the world?s #1 Boglehead.
I am also the world?s leading critic of Buy-and-Hold, the investing strategy advocated by Bogle.
It?s entirely possible to be both at the same time. The big-picture perspective is that Bogle is going someday to be known as the figure that led middle-class investing out of the dark ages. The Bogle Revolution is an extremely powerful force, one that will one day permit us all to obtain far higher returns at far less risk and one that may even do much to stabilize our free market economy.
But —
Before we get to that wonderful place where we all long to be, Bogle will need to face the music re the mistakes he made in his initial version of the Buy-and-Hold strategy, mistakes that were the primary cause of the economic crisis and that are likely to cause millions of failed retirements in days to come.
My strong sense is that even Bogle himself does not appreciate the implications of his most powerful insight — the need for investors to switch from a short-term perspective to a long-term one. I recall seeing Bogle interviewed one time in which a question was put to him as to how he thought stocks were going to do over the next year or so and his first reaction was to laugh. Perfect! The question really is silly. Short-term returns are unpredictable, long term returns are highly predictable. So why would anyone focus his energies on trying to guess what is going to happen in the short-term? It is indeed to laugh.
Or to cry.
Even in the financial markets, habit is an irresistible force
The reality here is that most investing analysis to this day is focused on the short-term. Bogle has been advising people for decades to take a long-term focus and they just do not get it.
It?s not that they are dumb. People are not dumb. It?s that stock investors have been focusing on the short-term for a long, long time. Yes, they get it that Bogle (and all other Buy-and-Holders) say that that?s wrong. But there is no force with a greater influence on human behavior than habit. It will take many years, perhaps decades, before we will all be able to truly focus on the long term in the real world. Bogle?s big idea represents so big a change that we have not been able to fully incorporate it into our thinking in the few decades since Bogle founded Vanguard in the 1970s.
We?ll be reaping the benefits of Bogle?s genius for decades to come. That?s the uplifting side of the story.
The Bogle Revolution, Take Two
There?s a dark side to today?s story too. You need to know about that side too.
The dark side is — Bogle himself doesn?t fully get it!
Bogle says the words ?invest for the long term? all the time. He means it. What he doesn?t get is how big a change this represents. What he doesn?t get is on how fundamental a level this idea changes the nature of the investing project.
Please read the column that I wrote titled Stocks Are a Lot Less Risky Than You Think to gain a sense of what I am getting at here. John Walter Russell, the former owner of the Early Retirement Investing Insights site (John died in October 2009 and the site was transferred to me), once did a statistical analysis to determine how predictable the 20-year stock return is for those who invest in indexes and who check valuation levels before making their allocation decisions. He found that those following a Valuation-Informed Indexing strategy can put their money into stocks knowing at the time they make a purchase 78 percent of what they need to know to identify the annualized return they will receive at Year 20.
That?s not a risky asset class! Bond investors are not able to know in advance 78 percent of what they need to know to identify their 20-year real return. Stocks are now less risky than bonds for those willing to follow valuation-informed strategies. That?s never been so before. This is a big, big change. We have Bogle (and Russell!) to thank for this.
But Bogle doesn?t get it. Bogle properly urges investors to give up their short-term focus and to adopt a long-term one. But he is too close to all this to see how important a change he is advocating. When it does hit him (and other Buy-and-Hold advocates), we are going to see some wonderful things happen in this field.
Bogle doesn?t miss these things because he is dumb. Have you ever climbed a mountain and noted how more and more and more of the view you are going to take in when you get to the top gradually comes into focus? Bogle was the pioneer. He saw farther than anyone else of his time, but there are limits to how far into the future any human can see.
Bogle was too influenced by the limitations of the investing worldview he was taught when he was learning the ABCs to be able to see how far his own revolution would someday take things. We now are getting close to the days when lots of us (including Bogle, I very much hope!) will be taking the next big leap forward.
Once again, it?s back to history to find our way forward
Valuation-Informed Indexing is the opposite of Buy-and-Hold. It posits that investors must take valuations into account when setting their stock allocations while Buy-and-Hold posits that it is okay (or — heaven help us all! — even a good idea) not to do so. But by no stretch of the imagination does Valuation-Informed Indexing repudiate the core Bogle insights.
Valuation-Informed Indexing is the fulfillment of Bogle?s initial vision. It is what Buy-and-Hold would have been from the first day had Bogle known in the early 1970s what the best-informed investors know today (the academic research showing that Buy-and-Hold cannot work was not published until 1981 and its implications are of course not widely acknowledged even today).
Buy-and-Hold was the initial draft, Valuation-Informed Indexing is Version 2.0, the embodiment of Bogle?s revolutionary idea (to focus on the long-term) that actually works. There would be no Valuation-Informed Indexing without the huge contributions of our good and trusty (and humanly flawed) friend John C. Bogle.
Rob Bennett often writes about basic money management strategies. His bio is bio is here.
Rob, you say that the stock market is overvalued and has been overvalued since at least 1996.
I would posit that it’s possible the average valuation for the stock market increased, thanks in large part to Bogle’s indexing innovations, due to the massive increase in capital that poured into the market.
I would posit that it?s possible the average valuation for the stock market increased, thanks in large part to Bogle?s indexing innovations, due to the massive increase in capital that poured into the market.
Thanks for commenting, Robert. You are asking a highly intelligent question with a lot of interesting angles. I hope that there will be a few who will give some thought to the idea you are putting on the table here.
Can you say what you believe the average valuation level has increased to?
Do you agree that an increase in the average valuation level would mean a permanent decrease in the long-term return for stocks from what it has always been in the past?
The reason I ask the first question is that the answer to this one would reveal whether there was any time from 1996 through 2008 when stocks represented a strong value proposition in comparison to the super-safe asset classes (TIPS, IBonds, CDs). It is possible that the average valuation level increased a bit. I have doubts that it could have increased enough to have made stocks appealing during those years. The difference between the value proposition for the super-safe asset classes and stocks (using the historical fair value numbers) was not a small difference for most of those years.
The reason I ask the second question is that the answer to that one reveals the price we all would need to pay for having pushed the average value P/E10 dramatically up, if indeed we have done so. Say that the long-term return for stocks has been permanently cut in half, from 6.5 percent real to 3.25 percent real. Were those few years of bull markets worth if they caused a permanent reduction in the return offered by what has historically always been the best long-term asset class?
My personal guess is that people will tire of low returns from stocks, abandon them, and thereby push the valuation level back to what it has always been in the past. That will mean huge additional losses for Buy-and-Holders. But it will also mean that the long-term return for stocks from that point forward will return again to what it has been throughout the history of the U.S. market.
But I could be wrong!
Rob
I always enjoy reading your stuff but do believe that you made a bit of a leap with your comment, “Bogle will need to face the music re the mistakes he made in his initial version of the Buy-and-Hold strategy, mistakes that were the primary cause of the economic crisis . . .”
To blame Bogle for the current economic crisis with no facts nor arguments to back that assertion up is purely slinging mud, for slinging’s sake.
To blame Bogle for the current economic crisis with no facts nor arguments to back that assertion up is purely slinging mud, for slinging?s sake.
Thanks for sharing your thought re this one, Spokane Al.
Please don’t think that I say something like this lightly. Bogle is one of my heroes. So it pains me to say this. The reality, though, is that if Shiller is right that valuations affect long-term returns, then Buy-and-Hold is not just a flawed strategy, it is the most dangerous strategy ever developed by the human mind. I do NOT believe that Bogle sat down one day with the intent of coming up with the most dangerous strategy ever developed by the human mind. He went by what we knew about stock investing at the time, which was not too much, and therefore made some mistakes which have become more and more and more costly as time has gone by.
I don’t blame Bogle (or any of the other Buy-and-Holders) even a tiny bit for the mistake he made. We all make mistakes. That’s all just part of the wonderful game. What I blame him for is his stubborn refusal to ACKNOWLEDGE the mistake or even to acknowledge the POSSIBILITY that he made a mistake. It is because the Buy-and-Holders cannot even acknowledge the possibility of their having made a mistake that things keep getting worse and worse and worse and worse. At some point this madness has to stop, and I think it is fair to say that it is not ever going to stop until those of us who know about the mistake start speaking up more clearly and more boldly and more plainly than we have in the past.
Say that you made a big mistake in the work you do, Al. Would you want your best friend to tell you about it? I would want that from my best friend. I have written a lot of articles about investing. I worry that I may have made mistakes in some of them and that those mistakes may hurt the people I am trying to help. One of the things that I like about the internet is that, if I make a mistake, there are people who will see it and perhaps be kind enough to send me an e-mail or post a comment at my blog. Then I can correct the mistake and set things right and all is well again.
That’s the way that I believe that things should happen with Bogle (and all Buy-and-Holders — I certainly do not mean to suggest that he is the only one who made this mistake, he just happens to have the biggest name). I would like to be working with Bogle to fix his mistake and to set things right. I have been saying for several years now that we need to have a national debate on all the things that we have learned about investing from the academic research over the past 30 years but that we have not been able to talk about because the Buy-and-Holders have not been able to acknowledge the possibility of their having made a mistake.
As part of that debate, I would like to see a series of cover stories in Money magazine with the title “I Was Wrong” in which a different leader in the field would write an article each month saying what he got wrong and how he learned that he got it wrong and what we all can learn from the experience. One month would feature Bogle, and the next Bernstein, and then Buffett and then Scott Burns and on and on. I would be happy to participate. I have made mistakes. I think it would be helpful if one of those articles focused on mistakes that Rob Bennett has made and what can be learned from them. I think Shiller has made mistakes. We could learn by hearing about those.
The Bogle mistake is in the process of causing the collapse of our economic system. We know the rough cost of the mistake. It is in excess of $12 trillion. Millions of people have lost their jobs. Tens of thousands of businesses have failed. We are seeing strains in our political system; people are losing confidence in their leaders as they see the effects of this mistake spread and spread. We have to come to terms with this matter. We have a serious problem on our hands and we need to make an effort to deal with it as serious people.
The point here is NOT to make Bogle or any other Buy-and-Holder feel bad. The point is to let them off the hook. The best thing to do when you have made a mistake is to acknowledge it. Why? Because that puts it behind you. It’s like magic. You say the words “I” and “Was” and “Wrong” and all the bad stuff is behind you and now you are positioned to move forward learning all sorts of new and wonderful things.
I ask Bogle to acknowledge his mistake not to hurt his feelings. I do it because I respect him and admire him and I want to see him making constructive and positive and helpful contributions again. I ask Bogle to acknowledge his mistake because I think of him as a friend and because that is what I would want my friend John Bogle doing for me if the tables were turned.
Here is a link to an article at my site titled “The True Cause of the Current Financial Crisis Is Buy-and-Hold Investing” that gives background on Bogle’s mistake, how it caused the crisis, and why we need to launch a national debate on the realities of stock investing if we are to restore confidence in our economic and political systems:
http://www.passionsaving.com/cause-current-financial-crisis.html
I am grateful for the frankness of your comment, Al. I hope that we can persuade many others to be equally frank. There are no different sides re this one. We all live in the same economic and political system. We are want to see them succeed. We all are on the same side. We all should be working together in a spirit of mutual respect and affection. The tricky part is getting from where we are today to where we all want to be in the future and I believe that your willingness to put forward a frank expression of your take helps us do so.
Rob
My guesstimate is that the current average is about 33% higher than the previously calculated historic average. So that brings the average P/E10 to around 20.
Yes, if the valuation levels are higher, then unless companies are more profitable than in the past, it stands to reason that percentage returns will be lower going forward. One could argue that most companies are more profitable. Vast layers of middle management and support staff have literally disappeared.
I believe the market was significantly undervalued in late 2008 – early 2009.
My guesstimate is that the current average is about 33% higher than the previously calculated historic average. So that brings the average P/E10 to around 20.
Thanks for responding, Robert.
I am very grateful for your comments. They add a much-needed balance to the discussion. I am, of course obligated to present my own views just as I hold them but it makes me feel better if people reading the column can also gain access to other points of view on the questions examined here, especially when they are as well-informed as yours are.
Rob