Some Experts Are Starting to Tell the Truth About Stock Investing

Beyond Buy-and-Hold #6

By Rob Bennett

Last week we looked at Why the Experts Don?t Tell the Truth About Stock Investing. Let?s flip it! Set forth below are nine reasons for believing that the experts would like to shoot straight if only it didn?t mean saying the three hardest words to pronounce in the entire English language (?I? and ?Was? and ?Wrong?).

1) William Bernstein reported the safe withdrawal rate (SWR) accurately in his book The Four Pillars of Investing. I brag about being the first person to report the SWR accurately, but Bernstein actually beat my May 13, 2002, Motley Fool post by six weeks (I think my brag is a fair one, however, given that I have devoted eight years of my life to letting middle-class investors in on the secret while Bernstein has avoided publicizing the matter). On some level of consciousness I think he would like to see them get out or he wouldn?t have reported on them in his book.

2) Vanguard Founder John Bogle, Mr. Buy-and-Hold himself, has acknowledged that Valuation-Informed Indexing can work. He is not yet willing to put the knife in his Buy-and-Hold baby. But he?s thinking about it!

3) Irrational Exuberance, the book by Yale Economics Professor Robert Shiller in which the Valuation-Informed Indexing model is rooted, was widely praised, even at publications that often promote Buy-and-Hold. Shiller?s ideas will entirely supplant the Buy-and-Hold Model as they catch on. The subtitle of the book is ?The National Bestseller That Revolutionized the Way We Think About the Stock Market.? The book argues that the stock market is a ?Ponzi scheme? at times which stocks are insanely overpriced, as they were for the entire time-period from January 1996 through September 2008. This signals us that opinion leaders touting Buy-and-Hold today may be switching to Valuation-Informed Indexing tomorrow.

4) Rahiv Sethie, an Economics Professor at Columbia University, observed that: ?Rob Bennett makes the claim that market timing based on aggregate P/E ratios can be a far more effective strategy than passive investing over long horizons (ten years or more). I am not in a position to evaluate this claim empirically but it is consistent with Shiller?s analysis and I can see how it could be true.? That?s a big statement coming from so respected a source, given that the claim being made (that market timing works and is required for long-term investing success) challenges the most often-repeated assertion of 90 percent of today?s investing experts. Clearly those in the know do not consider the claim that timing doesn?t work to be anything close to a lock. Things have not gotten so bad that they feel a need to go public with that news just yet. But my guess is that they are talking about future possibilities among themselves.

5) The discussion boards and blogs that have banned honest posting on how stock investing works have almost invariably showed a great deal of reluctance to do so. Even ardent Buy-and-Holders are today experiencing serious doubts.

6) Rob Arnott, the former editor of the Financial Analysts Journal, asked for a show of hands at a conference of investing researchers on how many still believed in the Efficient Market Theory, the intellectual underpinning of the Buy-and-Hold concept. Only a smattering of hands went up. It?s true that nearly every hand in the room went up when he next asked how many still use the discredited theory in their research. But this only shows that the academics feel pressured to pretend to believe in Buy-and-Hold for career advancement purposes, not that they possess personal confidence in it.

7) Dallas Morning News Columnist Scott Burns spilled the beans about why so many in this field have been reluctant to share with middle-class investors what they we have learned from the academic research of the past 30 years: ?It is information most people don?t want to hear.? As the losses endured by those following the discredited strategy pile up, the experts will feel more free to talk openly about the research dating back three decades and showing that Buy-and-Hold can never work for the long-term investor.

8 ) The British Chartered Financial Analyst Institute recently asked its members if they trusted in market efficiency (the fundamental premise of the Buy-and-Hold Model) and discovered that more than two-thirds of respondents do not. It?s not that the experts believe what they are telling us. It?s that they don?t know how to get from where we are, living in an economic crisis caused by 30 years of bad investment advice, to where we all want to be, a world in which we all feel free to discuss the realities of stock investing openly. That one is going to take some political courage!

9) A financial planner based in Maryland, told me that financial planners he knows have behind closed doors started questioning their advocacy of the Buy-and-Hold concept. Money magazine reported on this phenomenon in the cover story to its January 2009 issue, in which it quoted a middle-class investor asking: ?Just how bad would things have to get before you people changed your advice?? Money hasn?t yet spilled the beans. But the fact that it even reported on this question shows that it is at least toying with the idea.

I believe that the next crash will open the floodgates.

Rob Bennett writes on both the pros and cons of index investing. His bio is here.

4 Responses to Some Experts Are Starting to Tell the Truth About Stock Investing

  1. Taleb Nassim’s books were really an eye opener for me on topics of markets and risk associated with it. Mr. Nassim himself never bothers to trade anything risky, including stocks.

  2. Thanks for your comment, Slava.

    I think the risk issue is extremely confusing for most people today. Understanding the research of the past 30 years makes stocks far LESS risky than they have ever been before. But it also shows that for those who fail to take valuations into account when setting their allocations stocks are far MORE risky than we realized.

    So there is no one answer to the question “Are stocks more risky than we thought or not?” They are far more risky for those listening to the conventional advice but far less risky for those reading the research for themselves and not being affected by the spin applied by The Stock-Selling Industry.

    Once we are able to get the word out, stocks will be far less risky for everyone. And we will all be a lot better off.


  3. Can you apply valuation indexing towards your 401k portfolio? What kind of defensive moves can you make? Right now the stock market is artificially high in my opinion and I’d like to avoid a pump and dump scenario and protect my hard-earned cash.

  4. Can you apply valuation indexing towards your 401k portfolio?


    But there is not one thing that I can tell you to do. There are some things that we know and there are some things that we do not know. I can share with you what I think I know. But I cannot tell you the One Right Thing to do. There is some judgment involved. And the things that are right for one person might not be right for another.

    Your opinion that the market is priced high today is supported by the evidence. The best valuation metric we have is P/E10 (the price of a broad index divided by the average of the last 10 years of earnings). This is the metric used by Yale Professor Robert Shiller and by Benjamin Graham (Buffett’s mentor) before him. The fair-value P/E10 level is 14. The last time I checked, the P/E10 level was 20. So, yes, stocks are priced on the high side today.

    The next thing to do is to go to a calculator (“The Stock-Return Predictor”) that I provide at my web site to find out what your 10-year return is likely to be for stocks purchased at a P/E10 level of 20. Here’s a link to the calculator:

    You’ll see that the most likely annualized 10-year return for a broad index fund purchased at today’s prices is 3 percent real. That’s better than what you can get from super-safe asset classes like IBonds or TIPS. So an argument can be made that stocks are an okay investment today (the numbers are better than the numbers that applied before the crash).

    The other side of the story is that stocks are riskier than IBonds or TIPS and you should be compensated for taking on that risk. My rule of thumb is that I want to see a likely return for stocks at least 2 percentage points higher than what I can get from the super-safe asset classes. Otherwise, I conclude that stocks are not worth the trouble. You could probably get something close to a return of 1 percent real from the super-safe asset classes. So we are at about a draw as to whether you should be invested mostly in stocks or in the super-safe asset classes.

    There is one more factor to consider. When stock prices go insanely high, they don’t just wipe out investor portfolios, they bring the entire economy to its knees. Every time we have permitted the P/E10 level to go above 25, we have seen a major economic crisis in the following years (and we have never seen a major economic crisis without first permitting the P/E10 level to rise to 25). So in the late 1990s, when the P/E10 level rose too 44 (far higher than the P/E10 level of 33 that caused the Great Depression), we put ourselves in circumstances where we were likely to see the worst economic crisis in U.S. history. We are now in the process of working our way through the payback for the insane bull market of the late 1990s.

    I believe that you will probably see something close to a 3 percent real return on your money if you buy stocks today and hold them for 10 years. But holding may be very hard if we enter the Second Great Depression sometime over the next few years. If/when that happens, every article in the media will be telling you over and over and over again that no middle-class person should have any money in stocks, that it is wildly irresponsible to own stocks and on and on. That will be the view that sells at that time, as Buy-and-Hold sold during the 1990s.

    Can you hold stocks through another big price crash? That’s the question you need to be asking yourself if you buy stocks today. My guess is that you can hold SOME stocks (say, a 30 percent stock allocation) but that, if you go with a heavy stock allocation today, you are probably going to end up selling when the pressure to do so gets intense. So my thought is that you might want to go with a stock allocation of about 30 percent, give or take a bit for personal circumstances.

    Again, though, you need to think this all through yourself and to talk to lots of other people as well. I am some guy whose “expertise” is that I have figured out how to post stuff on the internet. What the heck do I know? And I believe that there is no such thing as an “expert” in this field (I believe that mankind’s understanding of how stock investing works is too limited today for anyone to be able to make a reasonable claim of “expertise” in this field — those who claim to be Big Shot experts are really just soulless blowhards trying to get their hand in your pocket). So listening just to what I say (or to just what any other one person says) would be foolish.

    I hope that helps a bit, Spendaholic. I am grateful to you for stopping by.


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