Beyond Buy-and-Hold #64
By Rob Bennett
We go to markets to buy things. We go to casinos to have fun.
Why do we invest in stocks?
We tell ourselves that we invest in stocks to provide for our retirements. We refer to the place at which stocks are bought and sold as a ?market.? I think we are kidding ourselves.
Actions speak louder than words. The behavior we engage in when buying stocks is more akin to the behavior we exhibit in gambling casinos than it is to the behavior we exhibit when buying things.
What is it you are most worried about when participating in the car market or the banana market or the computer market? You want to obtain a good value proposition. You don?t want to overpay.
How many people do you know who worry when they are buying stocks that they are overpaying?
That?s why the stock market is such a mess today. That?s why we are in an economic crisis today.
We flatter ourselves when we suggest that today?s stock market is a true ?market.? That?s not even close to being true. And it?s our fault. For the stock market to become a true market, we all need to start caring about price. I know how much opposition there is to this idea. I?ve been making the case for why we need to build a real stock market for nine years now and I have run into some strong headwinds.
There are places where value doesn?t matter, but the stock market isn?t one of them
You don?t worry about price in a gambling casino. You know the moment you walk in that the value proposition is poor. That?s not the point. You?re there for kicks. Gambling is an emotional thing, not an obtaining-value-for-your-money thing. Like the stock market is for most of us.
How is it that we have gotten so messed up in our thinking about stocks? If you took a poll, the number of people who would say they intend to gamble with their retirement money would be tiny. We all want to obtain value for our investing dollar. So why don?t we do what it takes? Why don?t we look at valuations when setting our stock allocations?
The root problem is that it is only in recent years that we have come to learn how stock investing works. We were living in the dark ages before Shiller published his research in 1981. We are now gradually getting up to speed on the realties. We picked up on so many bad ideas in earlier days that it is taking us some time to appreciate what Shiller?s research is telling us.
How to determine stock values
Are car prices predictable?
They are. If you are buying a used car, you can look up the model and year on Edmunds.com and gain a good idea of how much you will be charged for that car. If the dealer tries to charge more, you know to take a walk.
That?s how stock investing would work if everyone understood Shiller?s research. The P/E10 value tells you how overpriced or underpriced stocks are at the time you are thinking of buying. Knowing whether the price being charged is in the right ballpark or not tells you whether to buy or not and how much. Becoming an effective stock investor is just that easy.
But this idea is so controversial today!
What?s the story?
The story is that, in the days before indexing, stock returns were not predictable. Long-term market timing doesn?t work with individual stocks, only with indexes. Our experience for hundreds of years was with individual stocks. Since our experience has always been that stock returns are unpredictable, we came to believe that that is some sort of law of stock investing.
Shiller showed us what we need to do to take away the risk of stock investing and we ignored him. His solution didn?t match what we thought was the problem. What do we want out of stocks? Higher prices! Shiller doesn?t do anything to encourage higher prices. He shows that price jumps now always cause price drops in years to come. Instead of helping us solve our problem, he did this boring and useless thing of showing how to predict long-term returns and thereby take 80 percent of the risk out of stock investing. What a doofus!
How true markets work
The reason why car prices are predictable is that the car market is a true market. Markets set prices. Look at the price identified by the market as proper and you are on your way. No gambling required.
This stock market identifies the proper price too. It tries to be a real market. All that you need to do to know the real price of stocks is to take the nominal price and add or subtract for the effect of overpricing or underpricing. But how many of us do that?
We don?t do it because we like the surprise element of stock investing. There?s a part of us that enjoys those crazy bull markets and the crazy bear markets that follow from them. We all have an urge to gamble residing in our hearts. Otherwise, casinos could not remain in business.
I enjoy a poker game with the guys. I enjoy a day at the racetrack. I?m not anti-gambling.
I don?t gamble with my retirement money, however. When I invest, I want to know my return before I put my money down on the table. I am a Valuation-Informed Indexer. I shun Buy-and-Hold.
Rob Bennett is known for his unconventional saving advice sayings. His bio is here.
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