The Three Faces of Wall Street

Beyond Buy-and-Hold #32

Do you remember the movie The Three Faces of Eve?

It?s about a young woman with a split personality. One of her personalities is uptight and repressed and just generally no fun at all; that?s Eve White. Another is full of fun and fire but not exactly the sort you can count on in a sticky situation; that?s Eve Black. The psychologist’s job is to strengthen the third personality (Eve Gray), the one that integrates the two extremes into a moderate, realistic and yet warm and loving and somewhat adventuresome personality.

This movie comes to mind for me when I hear people blame Wall Street for the economic crisis.

Is it Wall Street?s fault?

You could say that. The academic research showing that Buy-and-Hold can never work was published in 1981 and Wall Street continued pushing this Get Rich Quick strategy for another 30 years. Wall Street has not covered itself in glory over the past three decades.

It?s a mistake to pin all the blame on Wall Street, however. It?s also cowardly to do so. Wall Street did what it did in large part because of pressures put on it by its customers — that?s us! If we want to put this economic crisis behind us and begin reaping the benefits of the amazing things we?ve learned about how stock investing really works, we are going to need to acknowledge the role that we played in encouraging Wall Street to go the Get Rich Quick route.

Wall Street is in it to make a buck. That?s fair to say. The job is to figure out a way for Wall Street to make a buck without sending our free market economic system over a cliff.

It?s not hard. Market prices are self-regulating in a world in which investors disdain stocks when they are selling at insane prices because they want to achieve strong returns while taking on only moderate risk.

Wait. What did I just say?

When did ?buy low, sell high? fall out of favor?

Could there ever be a time when investors would not want to achieve strong returns while taking on only moderate risk?

Yes. We just lived through one.

Did Eve Black want to find true love and become able to hold down a job and have kids and contribute something good to this world? Did Eve White want to relax enough to be able to take in a movie or appreciate a joke or perhaps even visit a dance hall on rare occasions?

We humans want to be emotionally balanced and psychologically adjusted to the realities of the world around us. It?s hard, though. The world scares us. Sometimes we act against our self-interests. You could get the idea sometimes that we are our own worst enemies.

The power of Get Rich Quick

Stock investors are their own worst enemies. We love us some Get Rich Quick.

We are Wall Street?s customers. One of the jobs of a business is to keep the customer satisfied. When Wall Street promotes Buy-and-Hold, it is responding to customer demands. It is giving us what we seek — Get Rich Quick in the trappings of science, pornography in a plain brown wrapper so the neighbors won?t know what sort of things we have come to crave.

Wall Street is going to need our help to get its act together.

We are going to have to make it known that it is possible to make a buck offering us accurate and honest and helpful investing advice. When it becomes clear that there is a market for investing advice that really works, the gurus we need to teach us what really works will magically appear.

All humans are like Eve. We all have Get Rich Quick within us. That?s our Eve Black side. And we all have the desire for safety within us that is causing many today to swear off stocks forever. That?s the Eve White side of our personalities, a side no more authentic and balanced than the Eve Black side. We need to become Eve Grays, investors willing to take on calculated risks but unwilling to believe in fantasy worlds where one asset class is always best regardless of the price at which it is being offered for sale.

We turned on our Eve Black smile when Wall Street told its pretty lies in the late 1990s. Now some of us are adopting the stern Eve White visage and condemning the ones who showed us a good time back then. Extremes beget extremes. Peace (and wealth) comes with integration of the fun-loving and responsible sides of our investing personalities.

Rob Bennett believes that Irrational Exuberance is the most important book on investing ever published. Rob?s bio is here.

( Photo by Son of Groucho )

2 Responses to The Three Faces of Wall Street

  1. This may be a real, real dumb question, but in reading your stuff I must ask – what precisely do you mean when you say buy and hold. For example, I believe in asset allocation and rebalance periodically each year to maintain my allocation. By that I end up selling some gainers, and most often rebalance by redirecting additional contributions into asset classes that have fallen below my prescribed allocation criteria.

    Does this make me one of the evil buy and holders and a reason for all the historical errors that you continually point out?

    Just looking for some specificity. Thanks.

  2. You’re asking a super question, Al. Actually, your question is so important that I am going to put it on a list I keep of future column topics.

    Yes, you are evil through and through!

    I’m joking, of course. I don’t think you are evil. I do think that Buy-and-Hold is a MISTAKE and that you are doing yourself a lot of harm by following the investing strategy that you follow. Collectively, all the Buy-and-Holders are doing so much damage to our economic and political systems that it can hardly be measured. It is the widespread promotion of Buy-and-Hold that is the primary cause of the economic crisis that has caused so much suffering.

    In all fields of life endeavor, there are advances over time in our understanding of how things work Take physics. There was a time when most people thought that the sun revolved round the earth. One day, we learned that it is the earth that revolves around the sun. Learning that helped us make all sorts of further advances. Can you imagine where we would be if we had failed to acknowledge the mistake when it came to our attention? That’s where we are today in the stock investing realm.

    The two most important discoveries in the history of stock investing both were uncovered over the past 50 years. They are: (1) that short-term market timing never works; and (2) that long-term market timing always works and is required for long-term success. Buy-and-Hold is today’s dominant model for understanding how stock investing works. It is rooted in that first discovery. That first discovery was a big advance and the Buy-and-Holders should properly be applauded for coming up with it.

    Our troubles came about because at the time the Buy-and-Holders made the first discovery they didn’t know there was going to be a second discovery. They saw research showing that short-term timing never works and they jumped to the conclusion that timing in general doesn’t work or isn’t required. That’s not even a tiny bit true. In later years, we discovered (from academic research) that long-term timing ALWAYS works. But the Buy-and-Holders had already come out with claims that timing doesn’t work. So they have refused to acknowledge the importance of this second huge insight. They continue to this day to tell people that there is no need to time the market or even that timing is a bad idea.

    This is why we have an economic crisis. When stocks become overvalued, they offer poor returns. The natural and obvious thing to do when stocks offer poor returns is to lower your stock allocation. You acknowledge above that this is not what you do. You rebalance, which means to stay at the SAME stock allocation. Millions of your fellow investors follow the same practice. They stayed at the same stock allocation instead of selling as stock prices went up, up, up.

    The result is that the market came to be overvalued by $12 trillion in 2000. That money did not fall out of the sky. It needs to be repaid. We now are in the process of paying that $12 trillion back. It’s going to take a long time. Thousands of businesses have failed. Millions of people are unemployed. All of this is 100 percent unnecessary. There never would have been any $12 trillion debt to pay back had we all just sensibly lowered our stock allocations when prices got so high.

    All that we need to do to bring the insanity to an end is to acknowledge as a society that we did not know everything there is to know about stock investing on the day the Buy-and-Hold Model was developed. Buy-and-Hold was a wonderful advance. You see me thank the Buy-and-Holders for their advances at this column all the time. But Buy-and-Hold was not the last word in stock investing advice. We have learned new things in the years since “A Random Walk Down Wall Street” was published and we need to begin including those new insights in all of our discussions of stock investing.

    I consider all Buy-and-Holders my friends, Al. I consider them friends because they taught me important things about investing. Unfortunately, I cannot say that the feeling is entirely mutual. There are a good number of Buy-and-Holders who don’t like me too much. I wish I could change their minds. But my sense is that the only thing that would change their minds is if I endorsed Buy-and-Hold. And the academic research of the past 30 years shows that Buy-and-Hold is the purest and most dangerous Get Rich Quick scheme ever developed by the mind of mortal man. I don’t say that it was designed to be this — but still.

    I believe strongly that you made a mistake by staying at the same stock allocation when prices went to insanely dangerous levels, Al. I can point you to research showing this to be so. Those who are willing to change their allocations in response to big price swings are able to obtain far higher returns at far less risk and to retire a good number of years sooner. It’s a wonderful thing that we are able to do that today and I of course want to share that exciting news with all of the millions of people who would love to know about about a far better way to invest their retirement money.

    You are of course entitled to think differently. I am not God. I could be wrong. But it hurts me a bit when you suggest that I think you are “evil.” I just think you made a mistake. The way I would put it is that the Buy-and-Hold/Get RIch Quick IDEA is evil because it does so much harm to so many humans. But the people who follow it are just making the same goofy mistakes that all the humans (including Rob Bennett, to be sure!) have been making about all sorts of subjects since the beginning of time. I wish the Buy-and-Holders could lighten up!

    We are flawed creatures. We make mistakes. This happens in the investing area just as in every other area of human endeavor. If the Buy-and-Holders could let that in, I think we could all enjoy some exciting and enriching and fun times together in coming days learning a hundred things about stock investing that no group of people who came before us was ever able to learn. The opportunities available to stock investors today are just out of this world. But we need to take the defensiveness thing down a notch or two to be able to take advantage of them.

    I think Buy-and-Hold was a mistake. It wouldn’t be honest of me to say any different. But I feel respect and affection for all Buy-and-Holders for all they have taught me and millions of others. I believe that there is going to come a day when we are all going to move together to a far better place. When we do, I believe that the Buy-and-Holders will properly be getting the credit for having built the foundation that over time ended up getting us to that wonderful place. And good for them!

    The short answer to your question is: A Buy-and-Holder is someone who does not take into consideration the price at which stocks are selling when setting his stock allocation. A Valuation-Informed Indexer CHANGES his stock allocation in response to dramatic price swings. It’s not necessary to make more than one allocation change every 10 years or so on average. But it is IMPERATIVE that that change be made. If you fail to make that change, you thereby permit your risk profile to get totally out of whack. We all should have been lowering our stock allocations in the late 1990s and it is a national tragedy that most of the “experts” in this field failed in their responsibility to insist that we all do this. Now all that is left to us is to work together to repair the damage we have collectively brought about by failing to call them out on their failure to do their jobs.


Leave a reply