Why the Experts Don?t Tell the Truth About Stock Investing

By Rob Bennett

Valuation-Informed Indexing offers long-term investors both higher returns and less risk than what they can expect while following a Buy-and-Hold strategy. It sounds good, of course. The trouble is — It sounds too good.

Many investors are skeptical of Valuation-Informed Indexing on grounds that it sounds too good to be true. Higher returns and lower risk both? If there really were a way to pull that off, everyone would be doing it. No?

I think that?s right. Eventually, everyone will be doing it.

For now, though, you need to dig to learn what works in stock investing. Most of the people generally viewed as experts in this field very, very, very much do not want average investors to learn what works.

There are nine reasons:

1 ) The Experts Themselves Don?t Possess a Clear Understanding of the Realities. Every expert I have spoken to accepts that valuations affect long-term returns. But I have not yet spoken to one who fully appreciates all the implications that follow. Valuation-Informed Indexing is something new. Those who learn about this idea today are getting in on the ground floor;

2 ) The Shift From Buy-and-Hold to Valuation-Informed Indexing Is a Big One. Buy-and-Hold was rooted in breakthrough insights. The experts are properly proud of their association with the good that was done through promotion of the now discredited model and feel disloyal to point out that it has been discredited. My sense is that it is going to take another stock crash before a large percentage of experts will be willing to give up on Buy-and-Hold;

3 ) Investing Is a Conservative Field. When you are telling people what to do with their money, you need to exercise caution. Buy-and-Hold seems like the more conservative strategy because it has been around so much longer. Experts in this field are reluctant to stick their necks out by promoting new ideas, no matter how exciting;

4 ) There?s a Fear of Lawsuits. The mistakes made by the Buy-and-Holders were not deliberate. The reality is that our understanding of how stock investing works is today primitive and that the Buy-and-Holders advanced the ball in many important ways. Still, mistakes were made and those mistakes are likely going to cause millions of people to suffer failed retirements. Can those who promoted Buy-and-Hold be held financially liable? No one knows the answer to this question. Many would prefer that the question not even be brought to the table. So there is little enthusiasm among experts for seeing the failings of Buy-and-Hold publicly examined;

5 ) The Flaws in the Buy-and-Hold Model Have Been Public Knowledge for a Long Time. We learned that valuations affect long-term returns in 1981. The ideal time for the experts to have begun backing away from Buy-and-Hold would have been soon thereafter. But in practical terms there was little danger associated with following a Buy-and-Hold strategy until the mid-1990s (valuations were extremely low in the early 1980s). So the easy path for an industry that had already spent millions promoting Buy-and-Hold was to rationalize continued promotion efforts. Now that so much time has passed, and now that Buy-and-Hold has brought on an economic crisis, the decision to hold off letting investors know looks bad;

6 ) The Mistakes Made by the Buy-and-Holders Were Basic Mistakes. The reason why we have been told that there is no need to change our stock allocations when prices rise to insanely dangerous levels is that Buy-and-Hold is rooted in a belief that stocks can never be insanely overvalued. Anyone who has been paying even a little bit of attention has known for a long time now that this belief is seriously wide of the mark. It?s embarrassing for the experts to acknowledge that the mistakes they have made are such obvious ones;

7 ) Acknowledging Mistakes Is Not Viewed As Good Marketing in This Field. No one understands investing well today. But investors want their ?experts? to know it all. So most of those who put themselves forward as experts act as if they possess more confidence in their ideas than they do in fact possess. To say ?oopsie!? after promoting Buy-and-Hold for 30 years would help us put this failed idea behind us. But the experts giving thought to doing this worry about what it would mean re their personal career prospects;

8 ) Many Investors Become Angry When Told That Buy-and-Hold Does Not Work. Many investors are living in denial today. Many experts view it as their job to tell their clients what they want to hear rather than what they need to hear; and

9 ) Both Experts and Ordinary Investors Are Today Suffering from Cognitive Dissonance. We humans do not ?know? all the things we ?know.? We accept some information bits, we reject others. The huge bull market persuaded many of us of the merits of Buy-and-Hold and the intellectual case against it is something that many of us are finding it a struggle to acknowledge.

We need to have a national debate on the Big Fail of Buy-and-Hold and of the need to move to acceptance of the Valuation-Informed Indexing model. Some of these issues are so big that they can only be addressed on a society-wide basis.

Rob Bennett created the first retirement calculator that contains a valuation adjustment. His bio is here.

( Photo courtesy of Francisco Diez )

13 Responses to Why the Experts Don?t Tell the Truth About Stock Investing

  1. Rob – A couple of points.

    #1 – there are always two sides to every trade. Somebody profits when the “buy and hold” investor loses. Those profits have a tendency to be disproportionate because there are so many lazy people who will NEVER pay attention on the other side of the trade. There are some very wealthy traders (like Goldman Sachs as a whole) who are very happy stealing money from these people.

    #2 – Valuation models vary in complexity and “accuracy.” In theory it was obvious that the market was over-valued in 1997-2000. I (like you) was completely out of equities in 1998 (only a few years early). Obviously, not everybody saw it that way. If they had, we would have had that crash sooner than 2001.

    #3 – People play the stock market because they like the thrill ride … at least as long as it is going up. We have an alternative strategy at my firm that delivers very stable 6-8% rates of return in any kind of market. It is darn right boring … yet clients (who should know better) are always asking if we can goose the strategy for a little more “pop.” When the market is up 10% in a month (as it is right now), they lament that missed out. Of course, over the past three months they are are net positive while the market is off 5% … but that isn’t as much “fun.”

    #4 – While your model is interesting, it doesn’t answer the question of “What do you do with your money when you’re not in equities?” Bonds? Eventually, that will be jumping from the frying pan into the fire.

  2. Thanks for stopping by, John. You’ve asked a number of important questions. I’ll give relatively brief responses here. But to do your questions justice I really would needs to write four separate column entries.

    there are always two sides to every trade. Somebody profits when the ?buy and hold? investor loses.

    I of course understand what you are saying here and there is an important sense in which it is true. However, I also believe that there is an important sense in which this is not so. Stock investing is not a zero-sum game. We alllose when as a society we all come to invest ineffectively.

    I believe that the primary cause of the economic crisis was the insane bull market of the late 1990s. The market was overvalued by $12 trillion in January 2000. Even John Bogle acknowledges that Reversion to the Mean is an “Iron Law” of stock investing. So we knew then that $12 trillion of spending was going to disappear from our consumer economy sometime over the course of the next 10 or 15 years. The loss of that $12 trillion meant that consumers had less to spend, which meant that businesses had lower profits, which meant that workers lost their jobs. We collectively CHOSE to have this economic crisis. And we are now paying a big price for having done so. Even our political system is showing strain as a consequence!

    It is true that of the two people participating in a trade there is one winner and one loser. But what this conventional take misses is that there is also a SOCIAL dimension to the stock investing project. When we permit stocks to become overvalued, we make our free market economic system dysfunctional. Think what it means to say that stocks are priced at three times fair value. It mean that each investor is thinking that his portfolio is worth three times what it really is worth. How can anyone engage in sound financial planning in those circumstances? No one knows how much wealth he has accumulated. People are making decisions about buying cars and going on vacations with no idea of whether their choices make sense or not because they do not have an accurate understanding of where they stand.

    My view is that overvaluation is a social evil, like pollution. BOTH sides to all transactions (actually, all citizens) should oppose overvaluation. It is an inefficiency that eats away at the productivity of the work we all do.

    The Valuation-Informed Indexing Model is designed to make overvaluation impossible. The idea is to make investors aware that stocks offer a poor value proposition when they are overvalued and thereby cause them to want to sell some of their stocks at such times. Those sales bring prices back to fair value. So long as people are aware of the effect of overvaluation, market prices are self-correcting. The mistake we made in the Buy-and-Hold Era was encouraging people to think that there is no need to time the market (that it is okay to stay at the same stock allocation even when prices rise to insanely dangerous levels).


  3. Obviously, not everybody saw it that way.

    This is a true statement about the most important question.

    I don’t see the question of whether stocks were overvalued as being simply a matter of opinion. There are objective tests that can be applied that showed that stocks were insanely overvalued. This should have been common knowledge. Had it been, we would not be in the mess we are in today.

    It was NOT common knowledge. That much is certainly so. My view is that that is the problem we need to solve.

    How do we get people to pay more attention to valuations?

    I believe that the key is moving away from the Buy-and-Hold Model. The reason why few paid much attention to valuations during the Buy-and-Hold years is that valuations do not matter under the Buy-and-Hold Model. Buy-and-Holders stay with the same stock allocation at all times. So discussions of valuations are an irrelevancy to them.

    To get people to care about valuations, we all need to be promoting a model in which valuations are the key consideration in determining your stock allocation. Then we would see articles every day in all the papers and at all the web sites. Valuations matter so people need to be following an investing model that acknowledges that they matter.

    People will have different views on valuations even when such a model becomes dominant. That’s fine. It’s healthy to have people expressing different viewpoints. The key is that everyone understand that it is critical to change your stock allocation when valuations change dramatically. The thing we want to avoid is the situation we created with Buy-and-Hold, where lots of people think it is okay to go with the same stock allocation at all valuation levels.


  4. We have an alternative strategy at my firm that delivers very stable 6-8% rates of return in any kind of market. It is darn right boring ? yet clients (who should know better) are always asking if we can goose the strategy for a little more ?pop.?


    It is this phenomenon that is the primary risk of stock investing, in my view.

    Stock investing is easy intellectually. It is hard emotionally. We need to change the focus of investment advice to focus more on the emotional aspects of the project. These are the parts that people have a hard time with.

    We cannot change human nature, of course. This emotional reality will always be with us. But in other area of life we at least struggle to overcome our negative emotions. We all would like to eat six pieces of chocolate cake after dinner each night. But doctors and nutritionists warn us of the dangers of doing so. We all wanted to pretend that the insane overvaluation of the late 1990s might not hurt us so much this time. The experts should have been telling us otherwise, that we absolutely had to lower our allocations.

    They didn’t do that. They dropped the ball. They need to be held accountable for that. I don’t mean in a nasty, mean way. But they certainly need to acknowledge that they are not as “expert” as they have claimed to be, that they have made mistakes. And they need to adopt practices to insure that they do not repeat these mistakes.

    It’s human to make mistakes. But it is critically important that we begin learning from our mistakes in the investing field. I’m not seeing this today. There was a fellow who, after the crash, asked the editors of Money Magazine “What would it take for you guys to change your advice?” That hits it on the head for me. We need to see more humility and openness to new idea among the “experts” in this field.

    The bottom line is that the investing advice that became popular during the Buy-and-Hold Era has not produced good results. We need to go back to the drawing board, figure out what went wrong, and come up with something better. The single biggest flaw, in my assessment, is that we have not focused on the emotional side of the investing experience enough. Buy-and-Hold assumes investor rationality and that gets thing very much on the wrong track. Most of us are NOT naturally rational. But we can work at it. And true experts can provide us tools to lead us in the right direction.


  5. Rob – I thnk you hit the nail on the head with getting people to realize that valuations really do matter. That’s at the root of manias. People come to believe that the long term trend–what ever it’s determined to be by the “experts”–is all that matters. In any mania, objectivity goes right out the window and the greater fool theory (finding a greater fool than yourself to buy the investment at an even more insane price) takes over.

    The same thing happened in the real estate market. Objective valuations means little when there’s over confidence that prices will always rise. Now the reason for that over confidence…would be the subject of a very long, very interesting post.

  6. What do you do with your money when you?re not in equities?? Bonds?

    There is no one answer to this one, John. I like to hear different people offer different thoughts.

    My favorite counter to stocks is Treasury Inflation-Protected Securities (TIPS). Stocks are risky and TIPS are super-safe. So I feel they complement each other well.

    In 2000, the most likely 10-year annualized return for stocks was a negative 1 percent real. TIPS were paying 4 percent real. That’s a difference of 5 percent points of return for each of 10 years running. So those who put their money in stocks were thereby giving up 50 percent of their initial portfolio value, half of the accumulated savings of a lifetime.

    And what were 90 percent of the “experts” in this field recommending? A high stock allocation!

    Something is wrong with this picture. We need to hear some new ideas.


  7. “Now the reason for that over confidence?would be the subject of a very long, very interesting post.”

    Humans are self-deceivers. That’s the story.

    I eat too many chocolate chip cookies. I have been doing it my entire life. I know it hurts me. But I still do it.

    Investors buy overvalued stocks. They have been doing it for the entire history of the market. It ruins them every time. But they still do it.

    The only answer is to focus on this side of the question more. We cannot change human nature. But we can aim to influence it a bit. We can provide people with more tools to help them see the effects of overvaluation. There are lots of things along those lines that can be done.

    The big problem today is that things have reached a point where the very words that we use make it hard for us to understand the realities. What is it people are doing when they buy overvalued stocks? They are engaging in Get Rich Quick thinking. They are hoping that it will all be different this time, that this will be the first time that buying overvalued stocks pays off. But I had a post one time where I referred to Buy-and-Hold as “Get Rich Quick investing” and a fellow said: “I don’t think I have ever heard Buy-and-Hold referred to as Get Rich Quick investing before!”

    He’s right. You don’t hear that much. I think that’s the problem.

    We all need to work up the willpower to resist that natural urge to buy stocks even when they are overvalued. But we are weak creatures and we need help. And the recognized experts are not providing it. You buy Money Magazine and it tells you to Buy-and-Hold. You pick up the Wall Street Journal and it says to Buy-and-Hold. Most of the big blogs recommend Buy-and-Hold.

    A basic rule of advertising is that people believe something they hear repeated thousands of times. For decades now we have been repeating the message that there is no need to time the market and that Buy-and-Hold is a good way to go. We need to start repeating the opposite message, that investors must ALWAYS take valuations into account when setting their stock allocations.

    If we repeat the message often enough, people will get it. But we need to make a decision as a society that we do not like the economic crises that result from failing to do this and that we are all going to work together to make this happen.

    It’s like putting a man on the moon. Some people say that it cannot be done. It certainly is so that if we all sit around saying “it cannot be done” that it cannot be done. We are the humans and the humans are the ones with the power to change things. If we choose to do this, it can be done. We need to stop complaining about the economic crisis and get about the business of DOING SOMETHING about it.

    We’re all going to feel a whole big bunch better about a whole lot of things once we take that step. Right now everyone is blaming someone else. When we start taking constructive action, we will all feel more optimistic and more hopeful and more full of charity for others and more full of good cheer.

    It’s a light-switch that needs to be flipped. We are all going to wake up one morning thinking “this sinking feeling is a drag, let’s get to work!” That’s what makes it happen. It’s up to the humans.

    That’s us! It’s a cool thing that we possess this power to do wonderful things in this mixed-up world of ours. I think that doing this sort of thing is what it is all about. We all are presented with opportunities to do wonderful things from time to time, and, when we take advantage of them, it makes life worth living.

    I think that we are going to learn from our mistakes and that after the next crash we are going to work up the courage to begin doing the things that are going to take us to the greatest period of economic growth we have yet seen. It’s always darkest before the dawn.


  8. Rob,

    You have a refreshing message.

    As it pertains to John’s question about what to invest in when NOT investing in equities, you mentioned TIPS. It is our understanding TIPs are correlated to the Consumer Price Index. We don’t have a tremendous amount of respect for that index as it has been monkeyed with to obscure reality just like the unemployment figures have been manipulated…and the gov’t has the audacity to point their crooked fingers at Enron :-).

    John Williams of shadowstats.com has an interesting website that brings the reality of this intentional obfuscation into the light. It is not difficult to see the advantages of such manipulation by those who were ultimately responsible for engineering it. It saves corporations and the government billions of dollars in COLAs associated with pensions and social in-security payments. Employers often use the Consumer Price Index when considering salaries which has helped tremendously in suppressing wages and defrauding laborers.

    We would be interested in your comments on the integrity of the Consumer Price Index and also your view on where precious metals fit into your portfolio allocation and whether this allocation would’ve changed in your portfolio model since the year 2000.


  9. You have a refreshing message.

    Thanks for your kind words, Steven and Debra.

    I understand your concern re the Consumer Price Index. I know that there are many smart and good people who share this concern. My personal take is that there are no perfect solutions and that I am happy if I can find a way to hold on to most of my money until a time comes when stocks are priced more reasonably. So I don’t worry about this aspect of things too much.

    It could be that I am wrong, however. I am glad to have people like you pointing out the other side of the story. We all have limited experiences and others are often able to see things that we cannot.

    As for precious metals, I own a small amount of gold that was purchased in the late 1990s and which has done well. I see precious metals doing well when people lose confidence in their economic and political leaders.

    My personal hope is that we will be able to find enough responsible people to work together so that we will be able to restore confidence in our system. If we fail to do this, my view is that ultimately we are all cooked, even the owners of precious metals. So I don’t put much of my money in metals. I certainly respect the people who do, however, and I have to applaud them for their foresight.

    Personally, I am a stock guy — I want stocks back! That’s my dream — stocks selling at prices at which a middle-class person stands a realistic chance of seeing a decent long-term return. Is that too much to ask in this crazy, mixed-up world of ours?


  10. Mr Bennett:

    You mentioned gold as an investment, in these times of high PE for the stock market, and said you have some gold yourself.

    Do you hold it as an individual stock, as an ETF, direct investment in a miner, or actually hold physical gold in coin or in bullion form?

    What would you recommend as the best way for someone seeking exposure to precious metals to ‘buy in’?

    Thanks in advance.

  11. What would you recommend as the best way for someone seeking exposure to precious metals to ?buy in??

    Thanks for stopping by, Looking4Alpha.

    I own my gold in the form of gold coins.

    But I am not a good person to which to direct this question. It was years ago when I purchased those coins and I have not studied gold since then.


  12. My personal hope is that we will be able to find enough responsible people to work together so that we will be able to restore confidence in our system.


    Our current monetary system certainly isn’t trusted and there are a couple of reasons for this broken trust and lost confidence in our system. The first reason is a lack of transparency. The second reason is that there is no competing system.

    We basically have a money cartel in the relationship between the Congress, the Federal Reserve, and the U.S. Treasury. There is no REAL oversight or accountability. There have been bills in Congress to audit the federal reserve (a private banking corporation), but they’ve been effectively stripped of any meaningful language. We hear that there may also be a bill coming soon to audit the gold in Fort Knox and at the Federal Reserve in New York City, but we suspect that bill will also get gutted in one form or another. This could cause some alarm with the central banks of other nations who allow some of their gold to be held there for the purpose of balancing payments between their countries. If they believe their gold has been sold, without their consent, it could cause a run on the dollar.

    The U.S. dollar is basically the common stock of USA Inc. If the rest of the world loses confidence in USA Inc and no longer chooses to fund our debt and they start unloading their dollar reserves, Americans will finally wake up and the current system will be abandoned and competing systems of monetary exchange will be privately engaged. It won’t matter whether the competing systems are legal or not. The system that provides the most transparency and is the most competitive will be the one favored and the one most profitable.

    In our view, we don’t need to restore confidence in our current system, but would rather prefer to see competing private systems enter the monetary fray and let the end user (you and I) decide which one will be used. Competition and transparency will provide the natural oversight the Congress and Treasury have repeatedly failed to deliver on.

    We need look no further than the U.S. Post Office to see what a little needed competition (fedex, ups, etc.) can do.

  13. In our view, we don?t need to restore confidence in our current system, but would rather see competing private systems enter the monetary fray and let the end user (you and I) decide which one will be used.

    I’m grateful to you for sharing your thoughts, Steven and Debra.

    My view is that we need a national debate on all these issues. I think that pretty much everyone agrees that things are not working perfectly today. So I think we should just acknowledge that we are going to need to explore some new ideas. We should get things out on the table, examine pros and cons and over time try to come to a consensus as to where to take things.

    I certainly do not claim to know all the answers. I think we need thousands of people participating in such discussions, big-name experts and everyday people and all in-between.

    I got pulled into all this very much against my will. I just happened to form a discussion-board community and we happened to talk about safe withdrawal rates (it’s a retirement concept). I explained why the numbers in the conventional studies are wrong and a lot of people showed an interest in learning more and that turned into this big huge thing that been going on at scores of boards and blogs for over eight years now. It’s all just 100 percent crazy! I think that we have learned some important points along the way and I make an effort to share what we have learned when I can. But I don’t want people to think that that makes me some Grand Poobah That Knows All the Answers.

    I am confident that you know more than me re the issues that you focus on and that there are others who know more than me on lots of other issues. We all just need to be working together and sharing what we know with each other and moving forward together. It should be so simple! There is something complicating it. There is something messing things up. That much has become very clear to me over the past eight years. I hope that we are all able to figure out what that something is and to do something about it before it causes everything to burn to the ground.

    Anyway, it really does cheer me to hear a few people expressing some interest in hearing about what I have learned and I think it is great that there are people like you out there exploring other angles and sharing what you have learned for the benefit of us all as well. I remain optimistic that we will all work things out. Not because of some evidence I have come across. Because I don’t see any other good choice! If we let the frustrations discourage us too much, it will be the discouragement that will do us in! So we all need to make an effort to remain light of hear and full of good cheer (which I think you guys pulls off well), in my view.


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