The following is a guest post from Rob Bennett, blogger at A Rich Life.
Timing doesn’t work. Everybody knows that.
Right?
Maybe not.
In fact -- certainly not!
The reality is that one form of timing does not work. Another form of timing always works and must be employed to achieve long-term investing success. It’s important to know the difference between the type of timing that doesn’t work and the type that does.
The claim that timing doesn’t work is rooted in studies showing that short-term timing doesn’t work. You are engaging in short-term timing when you change your stock allocation with the expectation of seeing a benefit within six months or a year or two years. The studies showing that this form of timing doesn’t work advanced our understanding of how to invest effectively in a big way.
Unfortunately, too many investing experts have fallen into the lazy habit of saying that timing doesn't work without making the distinction between short-term timing and long-term timing. Long-term timing is when you change your stock allocation in response to big price changes with the understanding that you may not see a benefit for doing so for five or even ten years. The same historical data that shows that short-term timing never works also shows that long-term timing always works.
If you think about it for a few moments, you will see why this must be so. Like all other assets that can be bought or sold, stocks must offer a better long-term value proposition when purchased at good or reasonable prices than when purchased at insanely inflated prices. But the only way to take price into consideration when buying stocks is to go with a higher stock allocation when prices are low or moderate than when prices are high. That’s long-term timing. For long-term timing not to work, stocks would need to offer the same long-term value proposition at all prices. That obviously cannot be so. Long-term timing obviously works.
The strategic implications are huge. Investors who understand that long-term timing works knew to lower their stock allocations when prices went to insanely dangerous levels in the late 1990s. Thus, they protected themselves from the worst effects of the huge price crash. Since long-term timers took less of a hit in the crash, they have more assets to invest now that stocks are again reasonably priced. They’ll be earning the benefits of compounding returns on their larger portfolios for decades to come.
Why does long-term timing work when short-term timing doesn’t? It is primarily emotions that influence changes in stock prices in the short term. Emotions are irrational and therefore unpredictable. In the long term, though, the market must push prices back to reasonable levels if it is to continue to function. In the long run, it is the economic realities that determine stock prices.
It turns out that stocks are not always the best choice for the long run. Purchase stocks at good prices, and you can be assured of a good result in the long term. Purchase stocks at bad prices and the opposite is so.
What you can be sure of is that prices will move in the direction of moderate prices over time (John Bogle calls this “Reversion to the Mean” and describes it as an “iron law” of stock investing). Purchase stocks when they are overpriced and the move to moderate price levels works against you. Purchase stocks when they are underpriced and the move to moderate prices works in your favor.
Timing never works. Except when it does. Which is always!
David Swensen, the investment manager for the Yale Endowment, discusses this in his book "Unconventional Success: A Fundamental Approach to Personal Investment." It appears that he has used this approach rather successfully, helping Yale acheive some pretty good returns over the last decade.
Posted by: Brian S. | April 02, 2009 at 07:55 AM
That's fascinating, Brian. Thanks for letting us know that.
I am trying to publicize this approach and I have run into a good bit of static from Passive Investing dogmatics in response to my efforts. Swenson is a well-respected figure. So being able to say that he supports the basic concept should be a big help.
My sense is that a good number of experts see the need for investors to change their allocations in response to big price changes. Many have been reluctant to speak up because they know that some investors get highly emotional when the value proposition of stocks is questioned at the top of a huge bull market. But I think it would be fair to say that most of us are more open to straight talk on these sorts of questions today than we were prior to the big price crash. So it may be that we have an opportunity opening up to us to make some wonderful advances in our understanding of how investing works in coming days.
Rob
Posted by: Rob Bennett | April 02, 2009 at 08:59 AM
"In the long run, it is the economic realities that determine stock prices."
With $Trillion deficits forecast through the next decade that may not bode well for "economic realities". Pick your poison: rampant inflation and high interest rates due to currency debasement, or deflation due to stagnant economic growth. Both are bad for stocks, unless you are an expert stock picker rather than an investor in funds. I'm no stock picker.
So if someone pulled most of their money out of the market in 1999 and kept it on the sidelines since then, please indicate why you think now is a good time to get back in.
I agree emotion often causes poor financial decision making. And market upheaval causes many to question the conventional wisdom.
Posted by: rwh | April 02, 2009 at 09:42 AM
"please indicate why you think now is a good time to get back in"
The presumption is that the U.S. economy will continue to be productive enough to support an average 6.5 percent real return for stocks. That's the number that has applied for a long time.
You're right that that presumption may not apply, RWH. You're adding an important caveat, in my view.
However, it certainly is so that it is better to be in stocks today than it has been since the mid-1990s. If our economy is finished, those investing in stocks today will not do well but they still will do better than those who bought at much higher prices.
My personal belief is that there is a chance that we are finished. I put the odds at about 20 percent, perhaps 30 percent. If we are not finished (that's my belief and my hope), then the historical data shows that stocks offer a great long-term value proposition at today's prices.
When things look bleak, the payoff for seeing the light on the other side is big.
If the light you see is a product of your fertile imagination -- Yikes!
Rob
Posted by: Rob Bennett | April 02, 2009 at 10:02 AM
This seems to be a glorified rebalancing exercise. You determine your allocation and when it gets out of wack (because one of the allocations is doing exceptionally - or "insanely" - well, you rebalance. That's what Swensen does.
Posted by: Santos | April 02, 2009 at 11:00 AM
"This seems to be a glorified rebalancing exercise."
I don't think that Valuation-Informed Indexing can fairly be characterized as "rebalancing," Santos.
From 1975 through 1995, the historical data supported a stock allocation of about 70 or 80 percent in the typical case.
From 1995 through the first part of 2008, the historical data supported a stock allocation of about 20 or 30 percent in the typical case (because the long-term value proposition is so poor at the prices that applied during that time).
Rebalancing is keeping to the same stock allocation.
Rob
Posted by: Rob Bennett | April 02, 2009 at 11:10 AM
"That's what Swensen does."
I'm not familiar enough with Swensen's views to know whether he just recommends rebalancing (lots of Passive Investing advocates recommend rebalancing) or whether he recommends changing one's stock allocation in response to big price changes.
Just to be clear, I do not recommend rebalancing AT ALL. Rebalancing is sticking to the same stock allocation. It is persuading investors to stick to the same stock allocation when prices went to insane levels that got us into this mess.
I believe that stocks are like every other asset class on the face of Planet Earth -- they offer a better value proposition when priced well than they do when not priced well. I say that investors should not be willing to put too much of their money in stocks when they are not priced reasonably. It has never worked out in the long run. I don't believe that it ever CAN work out in the long run.
I think that Passive Investing (rebalancing is part of the Passive Investing approach) is a disaster. I don't want people to get the idea that I favor rebalancing (I of course understand that the comments here are intended to be helpful ones -- I just don't want to do anything to encourage confusion on this point).
Rob
Posted by: Rob Bennett | April 02, 2009 at 11:16 AM
I have had some strong disagreements in the last couple weeks here with the authors of some posts that took mostly an opposite view to this one. I like being able to say this time that I have nothing else to add, good post.
Posted by: Apex | April 02, 2009 at 11:18 AM
"I like being able to say this time that I have nothing else to add, good post"
Thanks for saying that, Apex. I have taken some hard hits to the head for expressing these views at a number of places in recent years. We all need to hear an encouraging word from time to time.
I learn from the skeptical comments too! There are lots of good and smart people who are skeptical re these ideas.
But it's good to hear every now and again that I am not the only fellow who thinks this approach makes sense!
Rob
Posted by: Rob Bennett | April 02, 2009 at 11:23 AM
My target allocation the last few years (and my plan going forward) has been 60/40 stocks bonds in our retirement portfolio. We have no equities in our non-retirement portfolio, just CDs and treasuries, except about half of each of my teen's college fund is in the state 529 (Vanguard life strategies) and is conservatively invested, the other half is in I-bonds. All through this decade I thought I had missed the boat by purchasing I-bonds in the 90s. Now I'm glad I held on to them.
My plan going forward has been affected by the current bear market. If the S&P 500 rebounds over time I plan to slowly pull our retirement money out of the market. I'm not yet sure what that target will be, but for the sake of discussion, if it hits 1000 I may reduce the portfolio from 60/40 to 50/50. For every 100 point increase I may drop the stock allocation another 10% until it's down to 20/80 or 25/75.
I'm 51 and not particularly confident in the long term picture based on what I see with our projected fiscal situation. But I would like to recoup some of my losses along the way and am hopeful that will happen.
Maybe that makes me a long term market timer?
Posted by: rwh | April 02, 2009 at 11:58 AM
I am very disappointed to see a Robert Bennett guest post on this blog. My recollection of the advice he gives is that it's about as unspecific as Robert Kiyosaki. Mr. Bennett has also managed to get himself banned from several of the popular investment message boards.
Posted by: segfault | April 02, 2009 at 12:22 PM
What segfault said.
Posted by: Meg | April 02, 2009 at 12:44 PM
"I would like to recoup some of my losses along the way and am hopeful that will happen. Maybe that makes me a long term market timer?"
You're saying that you will lower your stock allocation if prices go up. The long-term value proposition diminishes with price increases. So there is a sense in which this makes sense from a long-term timing perspective.
However, I am concerned about the idea of thinking that you can "recoup" losses with price increases. The short-term is entirely unpredictable (it is emotions that control stock price changes in the short term, not economic realities). It's entirely possible that we still have some big price drops yet ahead of us. Given your bleak view of where things are headed in the long term, my guess is that you will not be able to stick with your current allocation if we sustain much more in the way of price drops.
My view is that this is the sort of trap in which Passive Investors often find themselves. If you go with an excessive stock allocation at times of high prices, you sustain intolerable losses and then suffer an emotional desire to "recoup" the losses. The market might go along with that desire, but it also might not. I see risk in the strategy you are following.
The bottom line is that we all have to do what we think best. Please don't think that I am trying to tell you what to do. I certainly do not see myself as any sort of investing expert. I certainly wish you the best. Please understand that I am just spelling out my reaction to your comments to let people know how a Valuation-Informed Indexer thinks about these sorts of questions.
Rob
Posted by: Rob Bennett | April 02, 2009 at 01:16 PM
"Mr. Bennett has also managed to get himself banned from several of the popular investment message boards."
I am the person who discovered the analytical errors in the Old School safe-withdrawal-rate studies. These are the studies that financial planners use to tell us how to structure our retirement plans. The errors in those studies are going to cause millions of busted retirements in the days ahead in the event that stocks perform in the future anything at all as they have always performed in the past. The fact that the Old School studies are in error has been confirmed in recent years by numerous big-name experts. You can review material on this at my site.
There is a fellow who published an Old School study at his web site and who became very upset when I discovered the errors in the Old School studies. He has spent the last seven years of his life following me from board to board and from blog to blog causing trouble for all who seek to participate in civil and reasoned discussions. He has a Goon Squad who helps him out. He has an entire discussion board dedicated solely to the purpose of organizing efforts to terrorize board and blogs. Here is link to an article at my web site which sets forth the text of an e-mail that I sent to my congressman (Rep. Frank Wolf) urging that legislation be adopted protecting us from such vile internet harassment campaigns (the e-mail provides background on the tactics employed by this group to destroy or damage numerous communities):
http://www.passionsaving.com/internet-harassment.html
I hope that those with a sincere interest in learning about the subject matter of the blog post will continue to put forward the questions and comments that help those of us with constructive intent learn together. I urge the site owner to take steps to protect us if we see more harassment posts.
I have seen enough of this stuff to know that it can do great harm to the efforts of sincere posters to engage in friendly and rewarding discussions. I oppose it and will continue to pursue efforts to protect all of us from having to be exposed to such ugliness in our future conversations here and elsewhere on the internet. This sort of thing is degrading both to those who participate in it and to those who experience it. All humans should aim to rise higher than this.
Rob
Posted by: Rob Bennett | April 02, 2009 at 01:32 PM
Well, I stuck with my current allocation throughout most of this decade, including 2008 and the first quarter of 2009 while we had some pretty significant drops. So I don't believe I have let emotion rule my actions. The plan I mentioned above is something I've been thinking about for months now, because I think things are now fundamentally different. I don't believe a $20 trillion national debt is a foundation for a flourishing economy. But I could be wrong.
The market is now up about 20% from the most recent bottom. For the S&P to reach 1000 it will have to go up another 20%, or greater than 40% from its recent low. I don't think cutting my retirement allocation at that point from 60/40 to 50/50 is a move that can be viewed as a knee jerk response based on emotion. And through dollar cost averageing I think my plan depends on what you quoted from Mr. Bogle; my overall portfolio value will revert to the mean.
OTOH, the S&P 500 may never get to 1000 again. In that case neither of us will make any money.
Posted by: rwh | April 02, 2009 at 02:34 PM
The volume of your follow up comments says enough to me. Let the argument stand on its merit and quit taking it personally.
It is still timing and if you time it right you will do well. Otherwise, you will underperform the market. You add risk to potentially capture a higher return while risking a lower return. This is classic risk/reward - there is no free lunch.
Posted by: BobL | April 02, 2009 at 02:47 PM
"I think my plan depends on what you quoted from Mr. Bogle; my overall portfolio value will revert to the mean."
We're at the mean today, rwh. Today's prices are fair-value prices.
It's not your portfolio value that reverts to the mean. It's the valuation level of the market.
That means that when prices were at three times fair value, the long-term direction of the market had to be down and down hard. There's no assurance that things will be going up from where they are today anytime soon. We are already at the place to which the reversion process pushes things. There's no economic reason why prices need to go up or down. And the emotional trend is probably down rather than up.
The question is -- Should people be timing the market to protect themselves from the huge price crashes that always follow when we get to the sorts of price levels we saw in the years before the big crash? I say "yes." Those who lowered their stock allocations when the long-term value proposition was poor (the most likely long-term return on stocks was a negative number at the top of the bubble) have a lot more in the way of assets to invest in stocks now that they again offer a reasonable long-term value proposition.
And those larger portfolios will be paying compounding returns for years to come. You only need to engage in one or two acts of long-term timing every 10 years to obtain far higher returns at far less risk, according to the historical stock-return data dating back to 1870.
Rob
Posted by: Rob Bennett | April 02, 2009 at 03:28 PM
"So I don't believe I have let emotion rule my actions."
I doubt that there is any investor who intentionally lets his emotions rule his investment decisions. My sense is that millions were enticed by the assurances of many of the big-name "experts" that there is no need to time the market when prices go to insanely dangerous levels. Their "expertise" is often in knowing what emotional hot buttons to push to sell stocks when it would be hard to find buyers for them given the long-term value proposition that applies at those sorts of prices.
We went to three times fair value at the top of the bubble. That means that each person buying $1,000 in stocks was trading as asset worth $1,000 (a check written in that amount) for an asset with a long-term value of $350. Millions were engaging in such transactions and thousands of "experts" were egging them on. I'd think it's fair to say that emotions were having some influence on some investors.
I don't say these things to hurt anyone's feelings. We've all been dealt a raw hand. The good news is that we can learn from this and become far more effective investors in the future as a result. I see that as a more constructive course than looking for people to blame for our troubles.
I believe that a lot of the "experts" exploited our emotional vulnerabilities. I also believe that we let them do it to us and that the only real protection available to the middle-class investor is for him or her to learn the realities for himself or herself.
Most of us will be investing in stocks for many years to come. Learning the realities today will pay off big down the road. In many cases, it will pay off big enough to make what we are suffering today worth it in the long run.
Rob
Posted by: Rob Bennett | April 02, 2009 at 03:38 PM
"Here is link to an article at my web site which sets forth the text of an e-mail that I sent to my congressman (Rep. Frank Wolf) urging that legislation be adopted protecting us from such vile internet harassment campaigns..."
If I'm reading this right, the OP has campaigned his congressperson for a federal law protecting Internet trolls from any consequences or retaliation for their actions. That speaks for itself!
Posted by: segfault | April 02, 2009 at 03:47 PM
"Let the argument stand on its merit and quit taking it personally."
I think the middle-class investor very much NEEDS to begin taking this stuff a bit personally, Bob.
I have seen people lose their jobs as a result of the Passive Investing Stock Crash of 2008. I have seen people lose their houses. I have seen people lose their retirements. That's not personal?
When people give bad investing advice, it hurts PERSONS. It is persons that I write for. I care about those people. That's what drives the work I do. It's personal.
If people have genuine questions or comments, whether supportive or skeptical, that's all part of the wonderful game. That's the stuff we all need to see to enjoy a learning experience together.
When people engage in the trash posting that we saw in the above post on which I called the poster out on his sewage tactics, lots of good, honest, sincere people clam up -- they don't want to be the next one on the Hit List, so they don't share their thoughts with us. I care about those people. I want to hear what they have to say.
I have seen thousands of good people done harm by the Goons, Bob. That trash stuff sickens me. I'll stay here and craft the best responses I can for so long as there are people willing to put forward more sincere questions and comments. I won't give 10 seconds of my time to the sewage merchants. If I did not speak out against that sort of stuff, I would not be able to look myself in the mirror the next morning.
If you want porn, go to a porn site. This is a personal finance blog. Those who can't get with the program can watch that the door not hit their butts on the way out so far as I'm concerned. We don't need the business that bad, you know?
I write about investing because I care about investing. I don't exchange porn posts. Anyone who wants that sort of thing from me is asking the wrong guy. I find those sorts of tactics repulsive. I urge the site owner to take the garbage posts down and thereby send a message to the entire community as to what will not be tolerated here.
My sincere take.
Rob
Posted by: Rob Bennett | April 02, 2009 at 03:50 PM
"It is still timing and if you time it right you will do well. Otherwise, you will underperform the market. You add risk to potentially capture a higher return while risking a lower return. This is classic risk/reward - there is no free lunch."
I believe that you are sincere in what you are saying here, Bob. There are millions who believe this, including most of the big-name experts. I also believe that you are wrong.
Taking on more risk does not always bring more reward. There are times when stocks offer a reasonable return for the risk taken on. There are other times when the risk is far too great for the tiny possible reward offered.
There is a calculator at my site called "The Stock-Return Predictor." It performs a regression analysis on the historical stock-return data to tell us the most likely 10-year return on stocks starting from various valuation levels. At the prices that applied in January 2000, the most likely return on a broad stock index was a negative number.
Money markets were paying better than a negative number. And money markets have only a fraction of the risk of stocks. Lowering your stock allocation at any time from 1995 through the first part of 2008 was indeed a "free lunch." It was a smart move and smart moves generally pay off in the long run.
I don't deliberately avoid making smart moves in any other type of life endeavor. Why should I do so when buying stocks? Because the marketing department of some big mutual fund dreamed up a marketing slogan that says that "there is no such thing as a free lunch"? No thanks. I get stuck with the losses that follow from investing pursuant to the marketing slogans. I need to invest in MY best interests, not in the best interests of the marketing departments of the big funds.
We have historical data going back to 1870. Investing in stocks at the prices at which they were selling from 1995 to the first part of 2008 has NEVER ONCE paid off in all that time. Failing to time the market when prices get to those sorts of price levels is a long-shot bet that I cannot afford to take with my retirement money.
Again, I say these things not to hurt people's feelings. I say them because I think that middle-class investors need to begin taking better care of themselves and that the first step is beginning a national debate on the grave flaws of what today passes as investing "wisdom."
Rob
Posted by: Rob Bennett | April 02, 2009 at 04:03 PM
"the OP has campaigned his congressperson for a federal law protecting Internet trolls from any consequences or retaliation for their actions. "
Yuck!
Here is the URL for an article at my site that offers snippets of over 100 members of the Retire Early and Indexing discussion-board communities expressing a desire that honest posting on safe withdrawal rates and other investing topics be PERMITTED at those boards:
http://www.passionsaving.com/investing-discussion-boards.html
Those people matter to me. They should matter to all of us. It's through the efforts of people taking the time out of their day to post constructively that we all learn.
Rob
Posted by: Rob Bennett | April 02, 2009 at 04:08 PM
With the market currently at about 840 you apparently believe this is a good time to buy. Well, I continue to buy. I bought earlier this year when it was under 700. Did you?
And who's to say the market won't go to 600, or 500 or less? The current rally may reverse itself at any time.
So far I've made no changes in my behavior. I reserve the right to begin to cut my losses at what I think is the appropriate time. That won't happen unless the market goes up significantly from here. My changes will be incremental.
I think what you are advocating isn't much different than value investing. Buy low, sell high. But it worked great for Mr. Buffet.
Posted by: rwh | April 02, 2009 at 04:54 PM
"I think what you are advocating isn't much different than value investing"
That's exactly right, rwh. I advocate Valuation-Informed Indexing. It's a combination of the best ideas of Bogle (which provide the simplicity needed by the average investor) with the best ideas of Buffett (which permit the simple approach to work in the real world). My take is that Bogle and Buffett go together like chocolate and peanut butter.
"And who's to say the market won't go to 600, or 500 or less?"
My personal belief is that no one knows.
"I bought earlier this year when it was under 700. Did you?"
I don't talk about my personal portfolio anymore because the Goon posters have put up thousands of false claims about my personal financial circumstances. It's not my aim to help others mislead people about my circumstances and anything I put forward is twisted and misquoted. My hope and belief is that there will come a time when the anger will die down and I will be able to share information about my personal circumstances again.
I think it's great that you bought under 700, rwh. I certainly was saying that stocks offered a strong long-term value proposition when they were selling at those prices.
"I reserve the right to begin to cut my losses at what I think is the appropriate time."
Of course. Please don't think that I am trying to talk you into anything. It's the people who earn the money who get to say how it will be invested. I've got enough trouble figuring out how to make my own investing decisions!
Thanks for the back-and-forth, rwh. You raised a number of good points. I learned something from thinking them over and my bet is that a good number of others did so too.
Rob
Posted by: Rob Bennett | April 02, 2009 at 05:48 PM
"I don't talk about my personal portfolio anymore because the Goon posters have put up thousands of false claims about my personal financial circumstances. It's not my aim to help others mislead people about my circumstances and anything I put forward is twisted and misquoted."
That's the silliest thing I ever read. Goon posters? Refusing to tell the truth because other people lie? Obviously this is just a guy who wants to claim he's a successful market timer by only revealing his portfolio historically. These are a dime a dozen on investment blogs. I always love to read their excuses for not revealing their portfolios going forward, but that one was a new low. Anyone can spin a story about the past. It means nothing until they have verifiable results going forward.
Posted by: Jim | April 02, 2009 at 10:45 PM
What do you think about houses? My wife's been bugging me for two years about us getting into a house and I just kept telling her we couldn't afford it. Now prices are down and boy do I feel smart!!! Do you think it would be good timing to buy now?
Posted by: s_goode | April 02, 2009 at 11:16 PM
"Anyone can spin a story about the past. It means nothing until they have verifiable results going forward."
I have just the opposite take on this, Jim.
To have something work for the entire historical record is impressive. I certainly wouldn't say that that alone is 100 percent proof that the idea will work in the future. But it is a strong indicator.
In this case, we have a lot more. It is not possible for the rational human mind to imagine a scenario in which long-term timing would NOT work. For long-term timing to not work, valuations would have to have zero effect on long-term returns. How could that be? This is a case where the thing that always works in the historical record always MUST work according to the dictates of common sense. That's a second powerful proof.
There's a third. There's the fact that the opposite belief -- the belief that Passive Investing (not timing the market at ALL) has NEVER worked. Passive has been tried four times in U.S. history. It has resulted in bone-crushing losses for all who followed it on each of those four occasions. The average loss on the four occasions is 68 percent. We have also experienced an economic crisis on each of the four occasions in which large numbers of investors adopted a passive strategy (that is, they failed to engage in long-term market timing when required).
I find the combined effect of these three proofs compelling.
And the reality is that we DO have verifiable results going forward. Shiller published his first research showing that valuations affect long-term returns in 1981. So it has been possible to test Shiller's findings on an out-of-sample, going forward basis for nearly three decades now. Al of Shiller's findings have checked out. All down the line. You can't say that for any of the Passive Investing advocates.
Note the different reactions to the huge stock crash. The Passive Investing advocates have expressed surprise, even shock, over the price crash. You don't see any surprise among those who use the historical data to guide their allocation decisions. This group (and it is not a tiny group, though certainly a minority) saw a huge crash coming ever since the mid-1990s when the price levels reached told us that a huge price crash was inevitable (the PURPOSE of a market is to set prices properly, so sooner or later we had to return to reasonable price levels).
The idea that timing doesn't work is highly counter-intuitive. The only reason why anyone ever gave any credibility to the idea is that there is a lot of research showing that short-term timing never works. But that same data also shows that long-term timing ALWAYS works. If we can trust the data for the first claim, why can we not trust it for the second?
If there were no data, we would believe that long-term timing works because common sense tells us that it must be so. But fortunately we don't have to go solely with common sense. We have 138 years of historical data that CONFIRMS what common sense tells us must be so. Why is it again that most of the "experts" don't urge us all to practice long-term timing?
Rob
Posted by: Rob Bennett | April 03, 2009 at 03:06 AM
"What do you think about houses?"
I'm not an "expert" on stocks OR houses, S_Goode. So please don't take anything I say on the subject too seriously.
I think it's a wonderful time to buy a house. Buyers today are dealing from a bargaining position of great strength.
Is it possible that prices might go down a bit more? Absolutely. But the risk is today obviously only a fraction of what it was a few years ago.
You shouldn't buy more than you can afford. You MUST take into consideration the very live possibility that you will experience a price drop soon after buying that will remain in place for a few years. And you are probably going to have a hard time getting a loan in today's environment. But I bet that a little searching will turn up some fantastic deals. There's no question but that the odds are much more on your side today than they were a few years back.
These are the times when fortunes are made. In housing. In stocks. In the buying of businesses. The trick to achieving financial freedom is positioning yourself to take advantage of the opportunities presented to us all in times like these. The trouble for most is that if we don't position ourselves during the economic good times we are suffering too much to be thinking of taking advantage of opportunities.
My thought is that we all could cope better with the hard times if we focused more on the future good times implicit in them. What if the economy DOESN"T go over a cliff? That's the question that I think long-term investors should be asking themselves today (just as the question a few years back should have been -- What if it DOESN'T all turn our different this time than how it has turned out every other time in history, what then?).
Rob
Posted by: Rob Bennett | April 03, 2009 at 03:19 AM
Agreed. Timing matters greatly, because no matter how long we think our investment horizon might be, it's usually long enough to ride out the deep troughs in the market. In which case, a traditional approach to buy-and-hold with complete disregard for timing would ruin your portfolio.
I wrote on the same subject a few days ago at my blog. Good work, nice to see more people talking about the importance of "timing" in a constructive manner.
Posted by: Dana | April 03, 2009 at 06:19 AM
If you followed Shiller, you could have gotten out before the market tripled. Oops. And this was presented as a "good" example of timing. Just imagine how bad the bad examples are!
Posted by: Jim | April 03, 2009 at 09:45 AM
Bennett claims: "It is not possible for the rational human mind to imagine a scenario in which long-term timing would NOT work."
1. I am rational.
2. I can imagine that if an individual investor does not know how to value stocks, since valuation is relative, and can change based on CPI, inflation, productivity, relative returns on alternate investments, economic outlook, geopolitical situation, world financial system stability, etc -- pretty much ANYTHING that can influence risk or return will change what the 'right' valuation is. The idea that MArge Simpson of Evergreen Terrance, Anytown USA and people like her, can hope to guess right in purchase after purchase, year after year, and not chase lost returns after a down year, etc. is ridiculous. Active mutual fund managers can't even beat passive funds, yet Bennett espouses individual market timing of stocks for the average Joe, and says the mind cannot conceive otherwise? Ridiculous on it's face.
3. So, since I can imagine, and I am rational, Bennett is wrong. Argument over. Now please go sit down and please be quiet, and let the adults talk. We have heard quite enough of your self-important but silly and empty posturing.
Posted by: Buddy Elmore | April 03, 2009 at 10:43 AM
By the way:
"To have something work for the entire historical record is impressive."
Every proposed timing system does this, because the ones that don't get weeded out before anyone proposes them in public. It is in reality very easy to data mine and come up with a 70% - 90% correlation in the past. Statistically, the entire historical record is tiny. Having them continue to work in the future is the trick. Most fail the trick. To his credit, Shiller warned of this in his book and told people not to try to time the market but to be prepared for the possibility of reduced returns. Of course, many (most?) others were suggesting the same for a wide variety of reasons.
Posted by: Jim | April 03, 2009 at 10:44 AM
Rob,
I think it would be instructive if you could give some details on the criteria one would use to determine that the market's valuation is either undervalued, fair, or over-valued. You mentioned above that the 2000 time frame had the market at 3 times fair value. What criteria did you use to determine that. You say it is now at fair value and I believe you hinted that at 6500 it was somewhat undervalued. Can you describe the quantative analysis behind these conclusions. Do you use P/E? If so do you use trailing or projected earnings, how do you account for estimates being off and trailing earnings being unduly influence by the euphoria that lead to the over-valuation etc.
Recall that I was one of the first ones above to agree with your analysis. I have done this myself twice already in the last couple years (sold all my stocks in August 2006 and held off buying rental properties which I am not actively purchasing). However both of these cases were more of my subjective view that when looking at all the things going on that it couldn't all be real, was based on far too much debt and had way too high of a chance of starting to crumble. And I think those are valid ways to assess long term timing as well. In fact it might be hard to come up with a quantitative method that is reliable. But none the less you have alluded to some specific poings and valuation numbers so I presume you had a way of calculating those and I think it would be very instructive to share those methods.
Thanks.
Posted by: Apex | April 03, 2009 at 11:04 AM
For long term investing you must think about long term trends.
Trend 1: Population. Are we at peak population now? with nearly 7 billion souls on the planet does anyone think we can get away with another doubling of population? I'm calling that we are at or near the peak. More than 10 billion would be a huge drain on resources. If the population declines for sure there will be a global economic contraction and stock should go down.
Trend 2: Energy. Fossil fuel is also at a peak, the only thing keeping prices low is the collapse in demand. As soon as the global economy starts going positive again, oil prices will shoot up and trigger another economic crash.
Resources are a constraint.
On the positive side: productivity improvements and resource productivity improvements could help grow the economy and is probably the best way forward. If more people can be elevated out of poverty and used as productive workers that will help too.
Right now in the long term view the negative trends outweigh the positive.
I think investing the next 80 years won't be the same as the last 80 years where we had MASSIVE tailwinds of population expansion and fossil fuel growth. That alone to me explains the exponentional upswing of the fantastic growth of stocks. Don't take it for granted anymore unless we find another miracle energy source (not just renewables we have today as they only help slow the decline of peak oil) or colonize another world to create another population boom.
If you really think long term then you would consider the stock market to be a casino. Remember in a casino in the long term the house always wins. The trading house taking comission and the mutual fund taking fees are the house in this case and they are taking away from the remaining zero sum game.
Sorry so bleak but that is how I feel.
-Mike
Posted by: Mike Hunt | April 03, 2009 at 01:18 PM
I found a blog entry a few days ago on the Four Pillars blog. Rob told Evelyn that he would have set his stock allocation at 25% in 1995 and then left it there with no rebalancing in the following years. Evelyn pointed out that this would have given him a 25% allocation during the up years and a 50% allocation in 1999/2000 when the market tanked. Rob's response was not to get hung up on details. Check it out, it's a crazy read. It just shows you how a nice sounding idea doesn't always work out in practice.
http://www.four-pillars.ca/2009/03/20/the-curse-of-pretend-money/
Posted by: Jim | April 03, 2009 at 01:48 PM
"I wrote on the same subject a few days ago at my blog. Good work, nice to see more people talking about the importance of "timing" in a constructive manner."
It's good to hear those encouraging words, Dana. I think this is a big deal. I am trying to get a national debate started on the grave flaws in the Passive Investing model and on the model we should be building together to replace it (I call the new model "Rational Investing").
I am certainly going to check out your blog entry. I will be contacting you to see if you too would like to run a guest blog entry on some aspect of this question (if there are any other blog authors interested in hosting a guest blog entry, I hope you will let me know). Of course, if you have an interest in writing a guest blog entry for my blog, please feel warmly invited to do so. My readers are sick of hearing my voice go on and on re this matter. It would be a relief for them to hear it from someone else.
And we don't want to leave the Passive Investing advocates out of the fun either, to be sure. If there are Passive Investing advocates who would like to write a blog entry challenging any of these claims, I would love to hear from you and I can certainly open up some blog real estate for you to make your case before the small (but quickly growing!) community that congregates at my blog ("A RIch Life").
Rob
Posted by: Rob Bennett | April 04, 2009 at 04:35 PM
"If you followed Shiller, you could have gotten out before the market tripled. Oops."
Shiller issued his warning in 1996. The P/E10 value was in the mid-20s at that time. It rose to 44 in the late 1990. So it's certainly true that those who followed the Valuation-Informed Indexing strategy "missed out" on big gains for a time.
They are ahead today, however. And they will continue to move farther and farther ahead as time goes on. The edge possessed by those following a valuation-informed strategy grows over time through the magic of compounding returns.
There's a calculator at my site that lets the investor experience how this plays out in a multitude of real-life scenarios. It's called "The Investor's Scenario Surfer":
http://www.passionsaving.com/portfolio-allocation.html
There's no question but that Passive Indexing goes ahead of Valuation-Informed Indexing from time to time. This is not at all an uncommon scenario. It's a highly unusual scenario in which Passive remains ahead FOR THE LONG TERM, however. The problem is that the losses suffered by the Passives when the market price does ultimately correct (which it must if the market is not to collapse entirely) are so huge that it can take decades to recover. And the power of compounding, which works in favor of the valuation-iinformed investor, exerts a big influence over the long term.
Run some scenarios on the calculator and you will see the same basic patterns repeat over and over again. Investors go nuts from time to time, Passive looks promising for a brief time period, and then the fundamental realities of stock investing reassert themselves yet again. It happens over and over and over again!
The "experts" often argue that middle-class investors are too emotional to understand the realities, so it is better just not to let them know. This is not at all my experience. I have seen a great desire to hear about the realities of stock investing everywhere I have posted for seven years now. The big problem is the ideas that people have picked up by listening to the "experts." Many find it hard to believe that so many people have been for so long pushing ideas so far removed from what has worked best through the entire history of the U.S. market.
There IS a lot of emotion affecting our thinking today. That is indeed a big problem. The question is -- Was the emotion there before the "experts" started pushing all this Passive Investing junk down our throats? Or is it hearing the Passive Investing marketing slogans repeated thousands and thousands of times that intimidated us from even daring to listen to the message being told to us by our common sense?
I think the primary problem is the hundreds of millions of dollars that have been directed to the marketing of Passive Investing ideas. I think we are all capable of retiring many years sooner if we can find a place where we can engage in civil and reasoned discussion of the realities. I think that most of the big-name experts have sold the middle-class investor short.
Rob
Posted by: Rob Bennett | April 04, 2009 at 04:53 PM
"Active mutual fund managers can't even beat passive funds, yet Bennett espouses individual market timing of stocks for the average Joe"
I do indeed. Mutual fund managers are working at a huge disadvantage. They have to attract investors to their funds. And the key to marketing is the use of emotion to sell (look at just about any television commercial). So mutual fund managers MUST invest in a heavily emotional way if they are to remain in business.
This isn't so for the average Joe or Jane. The only investors we need to please are ourselves. So long as WE are not emotional, we can get away with investing rationally.
It's not primarily intellect or experience that makes one an effective long-term investor. It's gaining control of one's emotions. The individual investor has a huge edge over the fund manager in this department.
Any middle-class investor willing to devote a few hours to learning the realities of stock investing can learn what he or she needs to know to invest a good bit more effectively than most fund managers.
Rob
Posted by: Rob Bennett | April 04, 2009 at 05:19 PM
"since I can imagine, and I am rational, Bennett is wrong. Argument over."
But ARE you truly rational, Buddy? That's the $64,000 question.
I've been on discussion boards where I noted that investing is 70 percent an emotional endeavor and only 30 percent an intellectual one. And I've had people respond by saying "I am 100 percent rational! I have never had an emotion affect my investing decisions! It is impossible that I ever would. I am a Mastermind! If anyone says that I have emotions, I will spend the rest of my life tracking him down and then I will kill him and cut his body into thousands of tiny pieces! I have no emotions! No emotions, do you understand? NO EMOTIONS!:"
My usual reaction is to say: "Okay, I get it, friend. You have no emotions. I must have gotten mixed up somewhere along the line. Sorry about that. You have no emotions. I understand now."
C.K. Chesterton had a wonderful line (I am going to make it the epigraph for the book I am writing about investing) in which he said that the insane person is not the person who has lost the ability to engage in reason, the insane person is the person who has lost the ability to do anything BUT engage in reason.
Humans are emotional. The way it is. Try pretending that it is not so, and you get yourself in big trouble.
Passive Investing is the investing model that PRETENDS that humans are 100 percent rational (it does not SHOW this, it ASSUMES it -- despite 139 years of U.S. stock history showing that it has never been so). Passive Investing advocates aim to overcome the effects of emotion by pretending that emotion is not a factor. Ignoring emotion empowers it. The way to overcome the effect of negative emotions is to acknowledge their power and to try to cope. DENIAL of emotion is the most emotional strategy of all.
You SAY that you possess no emotions, Buddy. I don't believe you. I don't mean that as a personal dig. The claim just does not line up with my 52 years of experience walking Planet Earth. I have met thousands and thousands of humans in that time and each and every one of them possessed emotions. The Passive model assumes that emotions lose all influence when it comes time for the humans to invest. I don't buy it.
Rob
Posted by: Rob Bennett | April 04, 2009 at 05:32 PM
"Now please go sit down and please be quiet, and let the adults talk. We have heard quite enough of your self-important but silly and empty posturing."
I shared my thoughts re this sort thing in some comments posted above.
Rob
Posted by: Rob Bennett | April 04, 2009 at 05:33 PM
"Statistically, the entire historical record is tiny"
I don't agree with the word "tiny." But I agree that the historical record is not extensive enough for us to draw definitive conclusions solely from looking at it.
The trouble is -- We have to invest our money SOMEHOW, right? The idea of waiting for 500 more years of data is not a practical option.
The reality, of course, is that the Passives TOO like to point to the historical data in support of their claims. Passives are famous for accusing others of engaging in "data mining" but rarely point out that all of their claims are the product of data mining.
There are two big differences between how the Passives and the Rationals employ the historical data in support of their claims. One is that the Rational employ analytically valid methodologies for exploring the data while the standard Passive practice is to exclude the effect of valuations from all analyses (what a surprise that the Passives always "find" that valuations make no difference!). Two is that the Rationals use data to argue in support of claims that are in accord with common sense while the Passives use data to argue in support of claims that defy common sense.
The data DOES NOT answer all the questions. On this much we are in agreement, Jim.
Rob
Posted by: Rob Bennett | April 04, 2009 at 05:42 PM
"I think it would be instructive if you could give some details on the criteria one would use to determine that the market's valuation is either undervalued, fair, or over-valued."
I use P/E10 as my valuation assessment tool, Apex. This is the tool that Robert Shiller and John Walter Russell and many others who understand the importance of valuations use (it is NOT the only good tool, however). The P/E10 for a broad index (my work focuses on broad indexes, not individual stocks) is the price of the index over the average of the past 10 years of earnings (the flaw with the more popular P/E1 is that earnings need to be smoothed out to give an accurate read -- otherwise, you get funny numbers at times when the economy is doing especially well or especially poorly).
There's a calculator at my site ("The Stock-Return Predictor") that employs a regression analysis of the historical data to reveal the likely long-term return of a broad index starting from the various starting-point valuations levels:
http://www.passionsaving.com/stock-valuation.html
Playing with this tool helps people get a good sense of the extent to which valuations affect long-term returns. It essentially tells us the "price tag" that applies to stocks at any given time.
As a general rule, stocks offer a strong long-term value proposition at P/E10 levels below 20. From 20 to 25 is the warning zone. Prices above 25 are insane; it's hard to justify a stock allocation of much above 20 percent at those price levels. The average price drop on the four occasions in which we went above 25 is 68 percent. This time we went to 44.
I certainly do not say that we today know all that we need to know about how valuations affect long-term returns. We today know only a small fraction of what we need to know.
We need a national debate in which tens of thousands of normal investors and hundreds of "experts" are all sharing their thoughts with the aim of learning together how stock investing works in the real world. The valuations question is the most important investing question there is. My view is that 70 percent of all investing discussions should be aimed at answering the question -- How MUCH should I change my stock allocation in response to big price changes?
The problem is that this critical question was taken off the table during the Passive Investing Era. Passives argue that there is NO need to change one's stock allocation in response to price changes (that timing doesn't work). If there is no need to make any changes, it makes no sense to discuss how MUCH of a change to make.
The discussion that we all desperately need to have has been taken off the table for 30 years now. We cannot learn how to invest if we cannot even discuss how to invest. The first step to getting our economy back on track is persuading the Passive Investing dogmatists that they don't already know all that can possibly be known about investing. Once debate begins, we are going to see thousands of smart people get involved. We will be learning things about how to invest effectively that are unimaginable to us today.
That's when the real fireworks (the good kind!) begin!
Rob
Posted by: Rob Bennett | April 04, 2009 at 06:03 PM
"Sorry so bleak but that is how I feel."
All of the work that I do is rooted in analytically valid analyses of the historical stock-return data. I ASSUME that U.S. stocks will perform in the future something along the lines of how they have always performed in the past. It is of course possible that this presumption will not check out.
Those who believe that stocks will perform worse in the future than they have ever performed in the past need to subtract something from the numbers generated by the calculators. Those who believe that stocks will perform better in the future than they ever have performed in the past need to add something to the numbers generated by the calculators. I call one of the calculators the "Return Predictor," but the full reality is that all it does is REPORT how stocks will perform in the event they perform in the future something along the lines of how they have always performed in the past.
My personal view is that stocks will likely perform in the future something along the lines of how they always have in the past. But I of course possess no inside knowledge re these questions. I certainly do not pretend to possess any "expertise" re such questions.
Rob
Posted by: Rob Bennett | April 04, 2009 at 06:11 PM
"Check it out, it's a crazy read. It just shows you how a nice sounding idea doesn't always work out in practice."
I don't at all agree with Jim's conclusion. But I very much endorse his recommendation that those interested in exploring these questions further check out the Four Pillars thread. I agree that that thread is a "crazy read" in the best possible sense of the phrase. There's lots of exciting stuff explored in that thread.
Rob
Posted by: Rob Bennett | April 04, 2009 at 06:14 PM
"It just shows you how a nice sounding idea..."
Even my critics are now characterizing Valuation-Informed Indexing as "a nice sounding idea." Yowsa!
I've been at this for seven years now. I've seen lots of labels applied to my investing strategies. There has always been a significant minority that has described them in effusively positive terms. But there has also always been a group of Passive Investing dogmatists that has employed characterizations a whole big bunch less kind than "nice but flawed."
If we have reached a point at which we can all agree that we need to permit a hearing of some new ideas in the investing field, we have come a long way indeed. A lot of people are bummed out about our economic crisis. It has caused great human misery. Given my general distaste for giving in to Gloom and Doom, I like to point out now and again that if the stock crash causes us to open our minds to some new ideas, there may be a day when we will all look back at this crisis as having been a very good thing. It could prove to be the first step on a journey that permits millions of us to achieve financial freedom many years sooner than would have otherwise been possible.
I don't endorse Passive Investing. But I think it is important that we all aim to achieve as much balance as possible in our comments. So it might not hurt for me to say a few kind (and entirely honest!) words re those friends of mine who are big believers in the Passive Investing model.
The Passive Investing advocates were responsible for a great number of very powerful insights. All of the ideas that I explore at my site have their origins in an appreciation of the insights brought to light by the Passive Investing advocates. The national debate that I am calling for is not one that will exclude input by the Passive Investing advocates. To the contrary. One of the things that excites me about the prospect of having such a debate go forward is that I anticipate learning all sorts of exciting stuff from those who disagree with me on these questions. We all often learn more from those who disagree with us than we do from those who think every word we say is gold.
I hate Passive Investing. That's not too strong a way of putting it. But I hope that no one ever gets the ideas that I hate any of the millions of smart and good people who swear by this investing strategy. These people have earned our respect and affection by their efforts at uncovering the realities of stock investing and teaching them to us.
This entire thread encourages me in my hope that we will be moving to a more fruitful stage of our discussions in the not-too-distant future. I am grateful to all who participated.
Well, maybe not so much to that one fellow. Grrrr.
(I'm just joking around re that last comment.)
Rob
Posted by: Rob Bennett | April 04, 2009 at 06:31 PM
Wow! It's like a never-ending infomercial for Rob's self-importance! And he's been doing this for 7 years! Maybe he's trying to set a record for anti-productivity.
Posted by: FrankB | April 04, 2009 at 08:26 PM
"Maybe he's trying to set a record for anti-productivity."
Perhaps, Frank. You are certainly not the first smart person who has raised this possibility. I cannot even say that the thought has not crossed my own mind.
Could it be that humans are INCAPABLE of investing rationally and that promoting such a possibility is a huge waste of time? Someone who set out determined to find evidence for this proposition could certainly find a good deal of it in the historical record.
But how about the other side of the story? Are we ALL bad?
If we were all bad, there would not be any such thing as stocks. It was the humans who came up with that idea. And there wouldn't be an internet either. We came up with that one too. And it wouldn't really matter that people have lost their businesses and their homes and large portions of their retirement accounts in this mess we find ourselves in. If the humans are all bad, why should we give a darn about their stupid businesses and their stupid homes and their stupid retirement accounts?
We care about these things because we care about the humans and we care about the humans because the humans are not all bad. Honestly compels us to acknowledge that we are indeed at times bad, that we are indeed partly bad. But charity compels us to acknowledge that we are also capable of great good and deserve better than the hell we create for ourselves when we are bad.
"Valuations matter" is a good two-word summary of the Rob Bennett philosophy of stock investing. But to say that valuations matter is to say that emotions matter because both overvaluation and undervaluation are the product of emotions. And to say that emotions matter is to say that the fact that stocks are bought and sold by the humans matters because it is the human role in all of this that causes emotions to be a factor. So what we are really saying is -- "Humans matter."
If I'm wrong about that, then none of it matters, does it? If I'm wrong about that, it's not just the time that I have devoted to trying to help people learn how to invest more effectively that has been a waste. All of the time that I have spent reading books was also a waste, and also all the time that I spent having dinner with friends and all the time that I spent raising kids and all the time that I spent goofing around in the neighborhood and all the rest. So no biggie, right?
But if the humans do matter, what then? If the humans do matter, then investing matters. And if investing matters, we should be trying to help the humans do it in a way that stands at least a reasonable chance of working out in the long run.
My sincere take.
Rob
Posted by: Rob Bennett | April 05, 2009 at 06:22 AM
"But if the humans do matter, what then? "
Then maybe you should find a more productive use of your time for the next 7 years than typing highly repetitive very verbose messages without any actual information. Perhaps you should stop writing to your congressman, your local police, and the EFF because you are also wasting the time of those humans and the humans that pay those humans. Perhaps you should stop intentionally misconstruing other people's comments and stop taking quotes out of context.
Just a thought.
Posted by: FrankB | April 05, 2009 at 12:01 PM
"All of the work that I do is rooted in analytically valid analyses of the historical stock-return data."
This, from a fella who admits on his blog that he can't even balance his own checkbook. Reviewing his record, whatever it is that Bennett has in mind, it isn't moving the state of knowledge about investing forward. It appears that it is all about his ego: aggrandizement for him personally, and bitter hatred for those he has decided are his 'foes.'
I ain't none too smart on stocks and such, but I am smart enough to steer a mile wide from the path of this snake oil salesman.
Posted by: Buddy Elmore | April 06, 2009 at 11:03 AM
Geez. I normally lurk at this site and simply read. The discussion is usually quite interesting and I learn some things.
But this thread causes me to go running away!!!! Thousands upon thousands of words by Rob Bennett, a notorious crank who claims he has a secret investing plan that's guaranteed to work - except that he never actually gives a description sufficiently precise so that it can be tested going forward, who has been banned from many, many boards, who claims it's all due to some vast conspiracy of "goons" and who calls the police and his legislators to do something about it.
Ahhhhhhhhhhhhhhhhhh.......
Posted by: Boo | April 06, 2009 at 11:33 AM