I'm Still Buying

A couple weeks ago in my post titled The Poor Economy is Having Very Little Impact on Me, one reader made the following comment:

What got many people INTO this mess were bubble heads always insisting that it was always a great time to buy a house and it was always a great time to buy stocks. Remember when FMF would post "I'm buying stocks because they're at a great discount" back in 2007 when the dow dropped from 13k to 11k? Well the DOW is now at 8k and it should be a great time to buy stocks but I don't think I've read a single post this year where FMF says "it's a great time to buy stocks."

Well, what got people into the current economic mess wasn't buying homes or investing -- at least buying homes they could afford and investing in index funds (what I do) -- but I'll leave that alone. Today, I'd like to address the comment that implied I've stopped buying stocks (index funds in my case) because the market has been bad.

We'll start out with how I answered that implication in the comments of the original post. I pointed to two pieces where I mentioned that I was still buying. Here's what I said in 2008 Net Worth Review: Ouch! this past January:

"I'm still investing at a good rate (401k and part of my paycheck) automatically each month as well as saving in other avenues throughout the year. I know the market will come back eventually and since I have a 20-year time horizon, the money I invest now should do well over that time. That said, I'm expecting the next year or two to be really rough. But who knows what will really happen? I certainly don't."

And in May I said the following in More Reasons to Invest in Index Funds:

"I've continued to invest in index funds (mostly stocks, but some bonds) throughout the stock market's fall and I'm counting on the fact that they'll do quite well when the rebound occurs."

Now, let me state for the record, that I have been buying and kept on buying all the way through, into, and now (hopefully) out of the recent economic decline. Here's what I've done over the past year, for example:

• Contributed monthly to my 401k. I put in the maximum each year, split into 12 equal, monthly installments. This money goes into a stock index fund.

• Automatically have some of my paycheck diverted to Vanguard and invested in a stock index fund and a bond index fund every single month. It works like clockwork -- I set it up once and it happens automatically now.

• Made contributions to our kids' 529 accounts. I not only contributed the maximum amount that we can deduct on our taxes for 2009, but since I felt I wanted to save more and that stocks were at a low price, I doubled that amount a couple months ago. These funds are invested in age-appropriate mutual funds.

• Made contributions to our kids' education savings accounts -- the max for the year already. These are in cash now as they're being transferred from Etrade to Vanguard as I write this.

• Contributed the maximum allowed into my SEP IRA. All of this money was invested in a stock index fund.

So for any of you wondering, yes, I have kept investing all through the downturn and I plan on continuing to do so. I have a long-term (15 to 20 years) investment time frame and I believe the US economy will recover and grow well within that time, making my investments worth a significant amount more than they are now.

Comments

[David]

I agree.

I've actually increased the amount I invest, and how aggressively I invest it.

So far this year, I'm up around 15-20%, even though the market just recently broke even for the year.

I bought a house in mid 2007, right before things started going bad. But by buying something I can afford, I don't regret it at all.

[Rob Bennett]

I agree with the fellow who wrote that "What got many people INTO this mess were bubble heads always insisting that it was always a great time to buy a house and it was always a great time to buy stocks."

I know that you cannot help believing what you believe, FMF. We all believe what we believe. But there is a disconnect between what that fellow is saying and what you are saying and I think that disconnect is causing all of us on all sides of all the questions lots of communication problems.

Just as an attempt a clarification, I want to try to sum up your position and the other fellow's position. You are saying that there is no price at which stocks do not represent a good buy. The other fellow is saying that there must be SOME price at which stocks no longer represent a good buy.

I agree with the other fellow. I believe that there can be reasonable differences of opinion as to what the price is at which stocks are no longer a good buy. But I am not able to make any sense whatsoever out of the idea that stocks are a good buy at ANY price.

It's a fundamental question. It is a question of such importance that many big names are afraid even to discuss it today. I hope that that is going to change in the not too terribly distant future. I believe that the first step to economic recovery is overcoming the taboo on discussing the real points of disagreement.

Rob

[Eugene Krabs]

It should also be said that the comment was made by looking backwards. That is, we know what happened in the past, but how about future? Do we, right now, know what will happen to the market in 2011? Would we have known what would will happen in 2009, back in 2007?

Because, believe me, if I had known what will happen, my own investment would have been dramatically different. And for that matter, if I can somehow know what will happen in 2011, I'm sure some dramatic change in my investment will occur also.

But we don't, and that's the point. Let me say that again: WE DO NOT KNOW THE FUTURE.

Does the commentator in question know the future?

But because of that, and because investing is forward-looking, not backwards, we have to keep contributing and keep investing.

[David]

I think it always can be a good time to buy stocks and always can be a good time to buy houses.

In my opinion, good decisions don't depend on timing the market. Thus you should use the same set of criteria when the market is up, and the same set when the market is down.

What you can afford in either situation doesn't change (unless you've lost your job of course).

Your investing timeline likely hasn't changed in the past few years either. If you have a long term time frame and have been using dollar cost average, downturns in the market can be a good thing.

If you have a short time frame - you should not have had the money in stocks without realizing the risks.

So I don't think that always saying yes to buying was the problem. It was that people made decisions that depended on unpredictable future events - like the value of their house would increase and allow them to sell or refinance before it became overwhelming. Or they would just be able to keep their money in the market for a few years til they needed it.

[FMF]

Rob --

That's not what I'm saying -- exactly. Here's what I am saying:

*If you're buying for the long-term, yes, stocks are always a good buy IMO.

*In the short term, no one can accurately predict when stocks are at a "good" price and when they aren't.

Read this piece in context with my other posts, such as this one:

http://www.freemoneyfinance.com/2009/06/why-even-the-best-investors-cant-pick-winning-actively-managed-funds-consistently.html

Then you'll have a better sense of what I'm really saying.

[Miranda]

I'm all about the index funds as well. They're the best! Especially if you have a long time frame (mine's 20 -25 years). I've also been investing all through. And we're opening another retirement account for my husband, and upping our investments in the current account. It's all about buying while things are on sale...

[Trask]

This is Trask and I wrote that comment and Rob did a good job of simplifying my point but let me expand.

FMF just wrote:
*If you're buying for the long-term, yes, stocks are always a good buy IMO.

AND

"I know the market will come back eventually and since I have a 20-year time horizon, the money I invest now should do well over that time."

Okay so if we were to transport ourselves 20 years into the past to 1989 and you kept buying stocks, where would you be today in 2009?

The Dow was at 3000 in 1989 and it's at 8700 today. Impressive right? But when you do the math, you're looking at a ~5.5% return over that period.

If you expect a 10% return in index funds now the Dow needs to grow from the current 8700 to 63000 in the next 20 years. And while none us know what will happen in the future, I find it highly suspicious that the Dow will climb to this level any time soon particularly with the trillions of dollars in deficits, possible collapse of the US currency, 80 million boomers draining entitlements, environmental challenges, energy challenges and possible philosophical changes in people's outlook.

Here you are day after day telling people to "spend less than you earn" yet the US economy is 80% consumption. Do you really believe that if people take your advice that the Dow will return 10% year over year for the next 20 years?

There is a certain mathematical logic that you need to apply to anything you suggest to your readers and often, while few call you out on it, the advice contradicts itself.

You tell readers they should save more but they should tithe - contradiction.
You tell readers spend less than you earn but expect 10% market returns - contradiction.
You tell readers not to time the market but a 20-year horizon is perfect timing - contradiction.
You tell readers stocks are always a good buy but never a good sell - contradiction.

[Joel]

Where do people get the silly idea of things like "stock firesales" and "stocks on sale" at the current levels. There was a bubble in the pricing. Just like housing. It was unsustainable and well beyond historic results. It wasn't where the prices "should be". Stocks aren't "on sale" now they're priced about right given the historical curves over long time periods.

If you think the stock market have taken a huge hit then you're thinking about it wrong. Think of it more as they have 'reverted to the mean'. That is, to the place they should be if you are thinking "long term". Over very long windows, the inflation adjusted and with dividends included return from the market is about 6.5%. Over shorter windows, you might get 4% or you might get 7%. However, factor in that companies are tending to lower dividends as time goes by and the outlook is not so rosy going forward (over the next 20 to 25 years). By the way, To keep the higher end of the returns you really need to long stable periods of low inflation. High-inflation does terrible things to the results and pushes them negative over multi-year periods.

Look at the long-term inflation adjusted house price indexes - relating median house prices to median salaries. The last bubble was unsustainable. Our population just doesn't grow rapidly enough, and earn money rapidly enough, to sustain a historically unprecedented ratio of price to salary.

Combine that with the fact that we are an aging population. In 1990, 40% of the US population was younger than 35 years old; by 2010, only a third will be younger than 35. In 2010, the majority of the US population will be 45 years and older. By 2020, one in five workers will be 55 years and older

Older people tend to own more assets, of all sorts, than younger ones. The problem is that they need to liquidate assets to retire in the style they wish to. They need to get out of the stock market. They tend to have bought "bigger and better" houses and then want to downsize to "free up equity". As the general population ages, and you can look for data from other countries like Japan, it means that there are more sellers than buyers which puts downward pressure on prices of all sorts.

Now, certain lucky people do well and manage to cash out at the top of a bubble. If you sold your house and move from a stock heavy to bond heavy portfolio at the right time then you are golden. And some people do it out of dumb luck. Given enough people retiring each year then of course you get those years when people were really really lucky. Think Forrest Gump investing in some company called "Apple". But "for example" is not proof. And people make dangerous assumptions based off lucky people.

Housing prices will creep up over time. Does that mean you should be $20k clunkers in Detroit or wherever? No. Stocks will creep up over time - does that means its a firesale right now? No...

[Erik Folgate]

You will always have critics, especially with the large traffic levels that you have. It's part of the territory when you throw yourself into the public arena.

Personally, I regard you as one of the most honest PF bloggers on the internet.

I will guess that many people who write critical comments about personal finance bloggers either just like to argue and/or they are failing in their own finances so they find themselvs on the defensive when they read other people's opinions about money.

[FMF]

Trask --

See what Eugene said. It's EASY to make claims looking at the past -- a kid can do it. What do you know about the future?

As far as the supposed contradictions:

"You tell readers they should save more but they should tithe."

Many top personal finance advisors say that you'll earn more because you give -- what goes around comes around. This has been my experience as well.

"You tell readers spend less than you earn but expect 10% market returns."

How is this a contradiction? How is it even logical/connected. You're not making any sense.

"You tell readers not to time the market but a 20-year horizon is perfect timing."

Timing is moving in when you expect the market to go up and moving out when you expect it to go down and doing so with regular frequency.

"You tell readers stocks are always a good buy but never a good sell."

I never said that. Eventually, all stocks are a good sell as part of rebalancing/asset allocation.

Here's the real contradiction:

*You reading this blog.

You consistently take things out of context and cite portions of what I've written to make a point. As we all know, that's very easy to do (again, a kid could do it.) Show me some real meat and maybe I'll care.

BTW, you never admitted you were incorrect saying I hadn't said I was buying stocks in the quote above. I'm sure you'll cop out by saying the statement was "I don't think I've read a single post this year" which technically gets you off the hook. But then again, that defense would imply that you don't read all my posts, so how do you know everything I'm saying in totality? And yet you claim to. Man, that's the biggest contradiction so far...

[FMF]

Thanks, Eric, I appreciate those thoughts.

[The Math Guy]

"I have a long-term (15 to 20 years) investment time frame and I believe the US economy will recover and grow well within that time..."

I don't mean to attack (or pick on) FMF here, but let me just bring up a larger discussion based on the above quote, specifically two key words in the above sentence (which is towards the end of the original post): "I believe."

I'm not saying that it's wrong to believe that the US economy will recover and grow over the next 15 to 20 years, however, I would merely like to point out that gambling your future life (not only retirement but also any subsequent rough times brought about because of the recovery NOT happening either at all or sufficient enough to meet your needs (think Japan's lost decade)) on a belief is not the best way to go about things. True, the market over any 30 year period has typically return around 10% (including dividends), but here's the kicker: just because it did this in the past, does it mean it will continue to do it in the future? (ever heard of past performance is no guarantee of future results?) And more to the point, what's the RISK in assuming that it will?

Now, everyone has their own reasons for thinking that the market either will or won't perform well over the next 10 years, but why don't we all just start basing our investment decisions on fact that don't depend on having "faith" in the markets? (I have faith that my bus is going to come on time because if it doesn't well then I'll just wait for the next one. But having faith that my stock invested retirement account will be all nice and recovered 20 years from now seems like something much too important to leave to faith alone...I require some measure of certainty and definitely very good measures of risk)

For example, simply buying the S&P 500 when it's above the 10 month moving average and selling it and moving to cash when it's below produces greater returns with less risk than the market over ANY time frame longer than 3 years (and, by the way, would've gotten you out of the market at the end of November 200...7! google "Mebane Faber quantitative asset allocation" or see my blog).

So, I think it's important for those with influence to begin to consider departing from the "wisdom" of the past (buy and hold, dollar cost averaging, etc) and to start discussing what we all really need to accomplish our financial goals: investment methodologies which don't depend on emotion, shaky data, "experience" or any other type of non-quantifiable "faith" in the markets.

[FMF]

Math Guy --

And your suggestion/solution is...?????????

[FMF]

Math Guy --

I'm especially excited about the "earn 24%/year with less risk than stocks" claim on your e-book.

[The Math Guy]

My suggestion is that we take a quantitative look at investment decisions. The moving average system is one such possibility. Look at Mebane Faber's 3,6,12 month average across asset classes for another (which, by the way, applying this to 2X leveraged Stocks, Gold, Real Estate, and unleveraged long-term Bonds yields the 24% per year).

Guys, this isn't rocket science. The logic is simple: would you rather have faith in the markets or be in control of your money? Would you rather invest based on the hope that the market will perform well or follow a sensible approach based on how the market is CURRENTLY performing?

You don't have to agree that using a monthly moving average on the market works well, or that rotating asset classes which have negative correlations gets you better returns with less risk, but you should AT LEAST recognize the need for such a discussion, ESPECIALLY when the market lost nearly 40% last year.

[Old Limey]

Planning for one's retirement has to be predicated on the future of the US economy.
The government, the Federal Reserve, the Secretary of the Treasury, and many commentators these days are putting a very favorable spin on every news item that appears. This is probably what they should be doing in order to keep people's hopes and spirits up.

I have found one of the very best and most informative programs on TV to be Fareed Zakaria's GPS program on CNN, aired in two time slots on Sundays. Even though we retired 16 years ago my wife and I watch or record it regularly. On 5/31/09 he had two guest speakers discussing the US economy, they were Niall Ferguson and Joshua Cooper Ramo. A video of this interview is available at CNN.COM .If you search for Fareed Zakaria you will find the "Economy Panel" interview near the top of the page.

If you want to know what's really going on, not just the spin, I encourage you to listen to these well known experts and take their views into consideration. It could help you decide how to plan for your future.

[Rob Bennett]

That's not what I'm saying -- exactly. Here's what I am saying:

Thanks for your response, FMF.

My sincere belief is that there is a communication problem here. I think Math Guy is absolutely right that the Passives have gotten in the habit of stating their personal beliefs as if they were objective truth. That's what needs to change. The Passives should certainly say what they believe. But they need to be more modest in their claims and more open to other points of view.

I certainly don't question your intelligence and I certainly don't question your good will. I do question the investing advice.

We can predict effectively how stocks are going to perform in the long term (ten years out). I have studied that question in great depth and there is now a mountain of evidence showing that this is so. Given that that is so, it just does not make sense to go with a high stock allocation at times when stock prices are where they were from 1995 through 2008. The historical data shows that at the top of the bubble the most likely 10-year return on a broad stock index was a negative number.

You're right in a sense that in the long term things will work out. But only in the very distant long term. It could take 25 or 30 years for the Passives to be back at a place where they will have earned a decent return on their money. Those who protected their portfolios by lowering their stock allocations when prices were insane are in much better circumstances today and will be earning compounding returns on the money they didn't lose by giving in to the pressure to invest passively for many, many years.

We all should be working for the same goal -- to learn how to invest more effectively. Rationals should be listening to Passives and Passives should be listening to Rationals. We all know different things. There is no One True Way.

Rob

[The Math Guy]

Well put. Glad to know there are other "Rationals" out there.

[FMF]

Math Guy --

Since it's not rocket science and since you can earn 24% per year, I assume you're independently wealthy from your investments, correct?

[The Math Guy]

Well, since it takes about 3 years for something earning 24% a year to double, if I were independently wealthy AFTER using this strategy then I must have been independently wealthy BEFORE starting this strategy. Sadly, I wasn't, and thus using this strategy hasn't changed that by much. Moreover, Faber only came out with his white paper toward the middle of 2007 (in case you're interested, the monthly moving average strategy was UP 5.2% for 2008, and the "24%/year strategy" was UP 14.8% for 2008), so using any of these strategies have at most made anyone 11 to 24% wealthier.

This is in fact the crucial point though. I too in 2006 when I started looking around for investing advice came across the usual "wisdom," but because of my training I shopped around for other strategies which had more rigor to them. It took me a while to search around (and experiment) with various investment strategies. Long story short, I discovered several which made more sense (both from a logical perspective AND from a risk control perspective) than simply "dollar cost average into the market and you'll be fine after 30 years."

Rather than continue defending myself, I have one simple question for FMF:

Why do you seem to be so against the type of discussion Rob, I, and some of your other readers are advocating?

If you are really interested in helping your readership would it not be prudent to at least hear out other people's opinions, even though they might completely "conflict" with your own (I put it in quotes because I agree with Rob, we BOTH have much to learn from each other)? Moreover, would it not be also in YOUR best interest to compare others' research on the markets?

[Rick]

I always love these arguments. So many passionately wrong arguments on every side :-)

Anyway, I think this goes back to a comment I made yesterday. You can beat the market, if you want to spend the time and effort to learn the market. If you don't want to spend this time, index funds are indeed the best way to go. And anyway you look at it, index funds do beat most actively managed mutual funds.

Further, if you want to invest the time, you can time the market, at least to some extent. You get the idea when stocks are overvalued, and when they are undervalued. You might not perfectly time the market, but as long as you're close enough, that's enough to beat the market as a whole. HOWEVER, if you don't want to spend time researching this, periodic investments and dollar cost averaging is the way to go. You CAN get rich this way -- just maybe not as rich as if you timed the market. But this doesn't matter. Look at FMF. He got to where he is following his own advice. So it works. There are multiple paths to becoming rich, and his advice evidently is one of them.

I agree somewhat with Trasks' statements, but then he went off and said a whole bunch of things are contradictions. No they are not. Just to address one of these statements, he said, "You tell readers spend less than you earn but expect 10% market returns - contradiction." This is not a contradiction. Spend less than you earn. Invest the difference. Expect 10% market returns on the amount invested. Easy as pie. Not contractictory at all. And sure, our economy is based on consumption. Maybe we should move our economy back to manufacturing and innovation -- things that actually CREATE wealth, rather than just redistributing it. Yes we have work. But no, this is not contradictory.

All that said, I do think the economy is in for some bad news. I do not believe we are out of the rough. I personally believe we are in for about 10 more years of negative to flat real returns. Any nominal returns we do see will be due to ultra-high inflation caused by the Fed's reckless policies. Already we see evidence that the treasury is having difficulty selling all the debt that the government is going into. If China decides to stop buying treasuries, the only entity that will purchase them is the Fed, and this will cause such high inflation your head will spin.

[FMF]

Math Guy --

I thought so. But you can write back in a few years and say you told me so. That will be sweet.

I'm not against the conversation (the comments are still up, right?). But here's my take on the situation:

*The sort of out-of-context/misleading/heated comments by Trask are totally out of line. There's no use in having a conversation with this sort of person.

*This blog is about what I've done/what I'm doing and that's what I write about. So far, comparing what I've done and what you suggest, my method has worked for me extraordinarily well (based on my net worth), so I'm not really looking to change.

*I don't believe claims of "earning 24%." Maybe you are the next Warren Buffett, but "24% returns" and "it's not rocket science" are two phrases that, when together, send huge warning signs my way.

That said, if you'd like to write a guest post here on "How to Make 24% on Your Money", I'll look it over. I'm sure a lively discussion would follow.

[FMF]

Rick --

I know! You would have thought I said people should not get a pet or move to another city to save on overall costs or something! ;-)

I agree with what you said in general, but there are a couple things I disagree with: I don't think most people can pick the right stocks or time the market even if they have the best skills/knowledge available, lots of time, and sizeable finances to do so. For thoughts on this, see how some of the biggest financial companies and the managers they pay to try and do these things, can't do them:

http://www.freemoneyfinance.com/2009/06/why-even-the-best-investors-cant-pick-winning-actively-managed-funds-consistently.html

[Eugene Krabs]

I haven't read mebane faber's white papers yet, but I have to say that an investment strategy based on simple moving average seems... dangerous to me. Because moving averages are based on past performances, and past performances are no indication of future performances.

I don't recall Warren Buffett ever saying, "I think this is a great investment because it's been perform so well in the past six month."

But again, I haven't read his paper, so please feel free to take my comment with a grain of salt. But after that, please be careful not to be "dazzled" by the numbers. I suspect that if it was that easy, we'd all be doing it by now.

And seriously, moving averages?

[rwh]

I made a killing buying auto industry stock at .02 and selling when it spiked to .07. I moved to San Francisco and bought a pony.

[Trask]

*The sort of out-of-context/misleading/heated comments by Trask are totally out of line. There's no use in having a conversation with this sort of person.

And yet you used one of my comments for a post and have had an extended conversation about the whole thing. Lol!

Alright FMF, you win! I shall refrain from every commenting on your blog from hence every more......

[FMF]

Trask --

What I said wasn't out-of-context, misleading, or heated.

RWH --

Ohhhhh! A pony!!!!!!!

[Mark C]

FMF:

Why don't you just post a graph of the S&P or Dow from 1994 to the present day, plot the mean along the peaks and valleys? You'll see a gradual, non-"hockey stick" growth of well over 7% per year, which is much better than bonds, money market, or private 401k fixed income funds. Let the wave of 1999-2000 cancel out the trough of 2008-2009, and the index will follow the gradual ascending mean return over your 10- or 20-year periods.

Dollar-cost averaging, and rebalancing according to age and risk, is the only way to invest and beat fixed income investments.

Pigs get fat, hogs get slaughtered...

[Rob Bennett]

You CAN get rich this way -- just maybe not as rich as if you timed the market. But this doesn't matter. Look at FMF. He got to where he is following his own advice. So it works. There are multiple paths to becoming rich, and his advice evidently is one of them.

I like the balance evidenced in your post, Rick.

I don't say that there is no one who ever got rich following a Passive strategy. I say that it is a high-risk approach, not suitable for the typical middle-class investor.

We don't know yet where FMF is going to end up. If valuations go to where they have gone on all earlier occasions at which we went to the sorts of valuation levels that we saw in recent years, we have another 50 percent price drop coming sometime within the next five years or so. When we see that, the media tune is going to be extremely negative on stocks. Is FMF going to continue buying then? I think that remains to be seen. He is still buying today, but we are only at fair value today. The real test of a Passive strategy comes when we are at half of fair value and we stay there for some time. I don't think that FMF has really been tested yet.

The other thing is that some Passives are lucky enough to get in at times when following a buy-and-hold strategy is a lot easier than it is for most middle-class investors who try the idea. If you started buying in 1975, you were so far ahead by 2000 that even nine years (and counting) of bad returns has not been enough to hurt you all that seriously (it certainly is so that stocks offer an amazing long-term value proposition). How about the people who only began saving enough money to invest in stocks from 1995 forward? Those people are far less likely to see this strategy work out.

Just about any strategy can work for a small number of investors. Even buying lottery tickets works for a small number. For Passive to be viewed as a good strategy for the typical investor, it would have to work for a high percentage of those who employ it. The historical data does not support arguments that Passive is going to work out for too many (in my interpretation of it!). Passive has always in the past caused hugh stock crashes (bigger than what we have seen thus far) and huge crashes has always caused most investors ignoring valuations to get out of stocks.

During the 1990s, we used to hear stories of very old people who just refused to buy any stocks. There were lots of people who laughed at them. I think we should learn from them, not laugh at them. Those are the investors from an earlier era who came to believe that it is a reasonable approach to put large amounts of money into stocks without first learning the extent to which price levels affect long-term returns.

I think it is sad that we need to keep relearning these lessons over and over and over again. If it sounds too good to be true (and the idea that you don't need to take price into consideration when buying something sure sounds too good to be true to my ears), it's probably not true.

Rob

[Rob Bennett]

Alright FMF, you win! I shall refrain from every commenting on your blog from hence every more......

You obviously have to do what you think is best for you, Trask. But I feel a need to say that I hope you will reconsider.

There's a section in the book "The Wisdom of Crowds" in which the author explains that communities are often "smarter" than any individual member of the community. But that happens ONLY if ALL community members share their views frankly and plainly. If minority viewpoints are suppressed, the entire community misses out on the balance and back-and-forth it requires to make sense of the topics being considered.

It is your patriotic duty to come back here from time to time and help us all out, Trask!

(I'm joing around. Kinda, sorta.)

Rob

[Mark C]

Rob:

You're definition of long-term investing for growth as "passive" is over-simplification. The "buy and hold" approach has nothing to do with buying stocks at any price and holding until you sell in retirement. Investing using a passive, long-term strategy can also mean dollar-cost-averaging, diversification, quarterly re-balancing, and positioning for risk according to one's age and need for cash flow in retirement. Retirement also should not be seen as a time when everyone is going to withdraw all their 401k savings and blow it all on a trip around the world. Most well-prepared retirees will withdraw between 5-10% per year on into their 70's or 80's depending on health and lifestyle.

History continues to prove out these points.

[Apex]

I will say that I find some truth to the valuation argument. I think intuitively most of us agree that valuation matters. The debate is really around how one can accurately determine valuation, and obviously that is very much harder to do. I do make some of my own personal valuation assessments and change my investment actions based on them, but I am not going to enter the debate about how one determines such things as I don't have any good metrics. I do it intuitively and certainly wouldn't suggest thats a good model for others to follow.

What I do want to comment on is the idea that the advice being dispensed concerning valuation applies to the masses. By definition it cannot. For instance, if the masses agreed on a means of determining valuation and also agreed and acted such that the second anything became over-valued the masses got out of that investment and the second it got undervalued the masses moved into that asset, then assets would always be perfectly priced and would never represent any over or under valuation. This would be optimal for everyone involved as it would represent a huge smoothing of volatility but its also just theoretical stuff that could never occur in practice.

However what it shows is that if something like using moving averages or some other method were to work, it would not be obviously clear and would not be widely used or it would stop working. This is actually a widely known idea in financial investing. Any rule which is too closely followed quits working. There is some evidence this began to happen with the Dogs of the DOW theory, assuming it was valid to begin with, which is also probably debateable.

The main point is that the market long term cannot return more than the gain in value provided by the companies in the market. If everyone tried to follow moving averages using the same kind of strategy it would not be possible to beat the market because the very actions of the masses would be self correcting. Either their actions would prevent valuation imbalances from happening or if they did happen, then once the masses went to move on them the imbalance would immediatley disappear and only the few fortune ones who moved first would have been saved from the correction to proper valuation. You can't have the masses all selling an over-valued market. Someone has to buy it and if they all went to sell it, it would immediately correct to or below proper valuation.

So again, definitionally, beating the market can only be done by a minority of people.

If we could get the market to always be properly valued that would be best for the masses. But thats not going to happen.

Barring that I think both FMF and Rob's proposals are rational and helpful. I would love to see more research into how you can determine proper valuation long term. Perhaps it is as simple as long term smoothed PEs (which I think approximates what Rob proposes with his PE-10 model). If more people subscribed to the valuation model I believe the effect would be a smoothing of volatility and a more equalizing of investment returns for all.

I do believe there is an inherent conflict of interest in the financial services industry as suggesting that stocks are ever too high to buy is not good for business. So I think thats partly why it's partly an accepted fact that stocks are always good for the long term. If long term is very long, and stocks are an up trending asset (which has been true for hundreds of years) then yes eventually stocks must return more than a cream can. The question is still worth asking though if changing allocation between stocks and bonds and other assets at different times based on valuation models makes sense. I personally think it has validity. I make valuation determinations on everything else in my life. I make it on investments as well. It's admitedly much harder with investments because determining both proper valuation and likely time frame to valuation correction are very difficult. But I still take it into account in my allocations.

I guess what I am saying is I do not subscribe to passive absolutism with respect to investment valuations being irrelevant. However, that being said, for many this may just be beyond their grasp/time/ability/interest/etc. And for them (which is most) I think FMF gives some pretty darn good advice as opposed to what they might get from other sources such as paying for high priced money managers and commission based financial planners.

So I think both Rob and FMF are right! Group hug? :)

[FMF]

Apex --

You consistently crack me up!

[Rob Bennett]

Investing using a passive, long-term strategy can also mean dollar-cost-averaging, diversification, quarterly re-balancing, and positioning for risk according to one's age and need for cash flow in retirement.

That's all so and that's all positive. Mark.

Please don't be led to believe by my strong criticism of the Passive model that I do not feel great respect and affection for those who have developed and advocated this approach. John Bogle is my fourth favorite investing advisor of all time (behind only Robert Shiller, John Walter Russell and Warren Buffett). It is by reading Bogle's book that I first got on the path I am on today. I think the guy is a genius and I often refer to him as the godfather of the Rational Investing model (I acknowledge that Bogle advocates Passive Investing but I believe that he has put forward at least as many statements supporting Rational Investing (rational investors change their allocations in response to big price swings) as he has statements supporting Passive.

Bogle says that you should take four factors in consideration when setting your stock allocation: (1) the long-term track record of stocks; (2) your life goals; (3) your financial circumstances; and (4) your risk tolerance. I add a fifth factor -- the stock valuation level that applies at the time.

I think it would be fair to say that that's pretty much the only difference between us. There are lots of implications that follow from including that fifth factor. So I think the difference is a big enough deal to justifying describing the Rational approach as an entirely different model. But that one difference is pretty much the entire story.

I am NOT saying that Passives are dumb. No way, no how. I am NOT saying that Passives are bad people. No way, no how. I am saying that Passives made a mistake.

I sincerely believe that with my entire heart, mind and soul. And the implications if I am right are huge. If the Passives made the mistake that I believe they made, then there are going to be millions of people suffering busted retirements in days to come as a result of that mistake. This can be demonstrated with numbers.

What would you have me do in such circumstances, Mark?

If some of the Passives would chill out a bit, I think we could turn this into something wonderful. My personal view is that the things we have learned (it's not just me who has been working this for seven years now, there are hundreds of us who have been working it in the Retire Early and Indexing discussion-board communities) represent a win/win/win for every single investor in the world.

Why has it been so hard to get this issue on the table, to get some serious people to permit discussions of it while not letting emotions get too out of control?

If you have any thoughts re that one, I would very much like to hear them. I obviously do not have any bad motive here. I am trying to help people out. I am a human and humans make mistakes. So that's a possibility. But why not have discussions of the question until we get to the bottom of it? Why not get as many smart people involved as we can to see where it goes?

Is anyone able to imagine any possible downside?

Rob

[Rob Bennett]

So I think both Rob and FMF are right! Group hug? :)

You made so many good comments that I hardly know where to start, Apex. But I'll start with the group hug idea because I think that is the most important thing. Yes to group hugs! We need lots of group hugs! I do not want to hurt anyone's feelings. I do not! I have said this about 10,000 times (not here, at other places) and some seem to have a hard time believing me. But I will swear again and again that this is so (and there is a record that can be checked if anyone cares to do this). I am not trying to be a negative. I am trying to be a positive.

So again, definitionally, beating the market can only be done by a minority of people.

This is certainly so. It is not a problem. We all agree that the stock market provides an average long-term return of about 6.5 percent real. So we are covered. We do not need to beat the market. The average long-term market return is plenty good enough for all reasonable people. We don't need to worry about this one at all.

I guess what I am saying is I do not subscribe to passive absolutism with respect to investment valuations being irrelevant. However, that being said, for many this may just be beyond their grasp/time/ability/interest/etc.

Have you ever tested this, Apex? I have seen great interest in these questions at many places. I don't get the sense that this is at al beyond the grasp of the vast majority of middle-class investors. Many have a hang-up about it today. The hang-up is that this is not what the "experts" have been telling them for 30 years. What if the experts changed their tune? That would change everything, wouldn't it? If we convince the experts to change the message they push, everything is groovy, so far as I can see.

And we have contacts with some of the most influential experts. Our discussions were held at the Vanguard Diehards board for several years. Bogle and Bernstein and Swedroe and Ferri all participate there. If we get those four to sign on, I think it would be fair to say that we are well on our way to being written up in the Wall Street Journal and Money magazine and so on. At that point, it's everywhere and the long national nightmare is over.

The debate is really around how one can accurately determine valuation, and obviously that is very much harder to do.

There's great truth in this comment. But I don't see that as a reason for not discussing this stuff. I see it as an argument for discussing it. If valuations matter and if we today do not know enough about valuations to make effective use of the insight that valuations matter, it seems to me that the first priority is to learn more about how valuations work. That means talking about this stuff and encouraging as many other smart people to talk about this stuff as we possibly can.

This would be optimal for everyone involved as it would represent a huge smoothing of volatility

This is why I am here. This is my vision.

but its also just theoretical stuff that could never occur in practice.

So was the idea of putting a man on the moon. Until we did it.

I do believe there is an inherent conflict of interest in the financial services industry as suggesting that stocks are ever too high to buy is not good for business.

Precisely so. However, I have also seen a good number of signs that there are people in the industry who would like to get out of the corner they have painted themselves into. I propose that responsible people do all that they can to make that happen for the greater good of every single person involved.

I think FMF gives some pretty darn good advice as opposed to what they might get from other sources such as paying for high priced money managers and commission based financial planners.

It's a wonderful blog. I am certainly not saying different.

Wouldn't it be all the more wonderful if this blog led the way to us figuring out how to put a man on the moon?

Rob

[LotharBot]

FMF said "If you're buying for the long-term, yes, stocks are always a good buy IMO."

Something being a "good" or "bad" buy isn't a matter of how long you plan to hold it... it's a matter of how much you have to give up to get it, how much it's worth to you, and how it fits in with the rest of your purchases etc. It's a price(including opportunity cost)/benefit calculation, same as anything else. Even with a 20-year horizon, buying stocks at the peak of the bubble last year would not have been a good buy; it would have been at best an average buy. Buying this year in February would've been a great buy, IMO.

Now, making a series of buys which range from "average" to "great" puts you in pretty good shape overall, which is the point of dollar-cost averaging. But you can do better. You can do like I did in the past few years and say "gee, stocks and real estate seem to be inflated. I'll stay away from them." Then when they drop, you can buy twice as much of them for the same value -- which puts you in much better shape for your 20-year horizon.

You can't "time" markets in the sense of finding the exact peaks and valleys, or in terms of consistently out-guessing them day in and day out. But you can recognize that certain assets are valued higher or lower than they should be for various reasons, and spend money on things you can get at a good price rather than things you can get at a poor price. I think we'd all agree that, during the beanie baby craze, a smart investor would've noticed the things were overpriced; why do we pretend you can't do the same with more general asset classes?

[Mark C]

Rob:

After reading your posts, it's clear you are worrying too much about things you and we all have no control over. Chill out and be positive on the long term growth of the global economy, and the market indexes will respond in time to that growth. Stop trying to find a new market timing strategy, without admitting to yourself that you are timing the market. It sounds like you tried the "passive" approach with the advice of some stock pickers and it didn't work out for you recently. You're much better off with index funds and a healthy dose of reality when it comes to expected returns.

I think you're committing a fallacy of false dilemna when you use the most extreme example of "passive" investing to advocate for "rational" investing. From what I can understand, you believe passive investors have never hear of stop loss. As I explained earlier, I have a much more rational view of passive investing.

It's not worth raising your blood pressure to try and maintain a 10-20% annual return, when 7% will do just fine. Any good financial calculator will prove to you that saving a higher percentage of your income every year, say 25%, will lead to a much bigger pile of money in retirement than saving only 10% and getting a 15% return. Just simplify your life, live frugally througout your working years, and you'll be able to retire early and comfortably. When you pay yourself first and try hard not live beyond your means, it's easier to do without unnecessary things later in life.

[Apex]

Rob,

Thanks for the response and analysis of my comments.

I would like to respond to one thing you said about my comment with respect to volatility smoothing being theoretical.

If I read you right you are saying you think if we could get a large percentage of people to understand the valuation model and react appropriately to it that we could drastically smooth volatility. In theory that seems all perfectly true to me. The reason I doubt it working on a grand scale is because people are emotional, independent minded, greedy, fearful, bastards (pardon my french - but the last one refers to all the ways people cheat and lie to subvert the system). In light of the human condition and what it makes people do I am just not sure how you can get most people to act like benevolent robots always working towards the slow steady accurately valued asset base for the masses. If you don't get most people doing that then I think you still get the massive valuation swings you get now.

I think your efforts to get a place at the investment wisdom table is admirable and worth pursuing. However I don't see much chance of you converting all the other oracles at the table to your religion. I think it's much more likely that improper market valuation will continue to occur as long as their are markets and money chasing them and the best service you could provide would be to get the market valuation model accepted as a respected possible investment strategy rather than the grand unified investment strategy that will bring about massive market volatility smoothing and global investment peace. (said a little tongue in cheek).

[Rob Bennett]

"In light of the human condition and what it makes people do I am just not sure how you can get most people to act like benevolent robots always working towards the slow steady accurately valued asset base for the masses."

How did we get people to drive to recycling bins?

How did we get people to not smoke in restaurants?

How did we get people to contribute to blood drives?

Yes, people have a low, nasty, mean side. People also have an intelligent, generous, loving side. Both of these things are so.

When it comes to investing, we actually have something working for us that wasn't working for us re those other initiatives -- personal self-interest. Valuation-Informed Indexing lets you retire five years sooner than would otherwise be possible. For those who don't want to pay attention to valuations just because it's good for the economy, there's the financial freedom angle. How many people do you know who wouldn't like to achieve financial freedom five years sooner?

Even the Stock-Selling Industry would be helped by making the change. How is the industry doing now, when half the population is scared to death to put their money into stocks? Would it really hurt the industry so much if we avoided these crazy up and down swings? More people would feel comfortable buying stocks and stocks would perform better. It would be a win/win/win/win/win.

What we have here is a Tragedy of the Commons problem. Every single person on Planet Earth benefits from us all learning the realities of stock investing. But most of us see it as being in our self-interest to set up obstacles to seeing that happen. It's comparable to the environmental situation. Everyone benefits from having clean air and clean water. But if there are no public service efforts to remind people of their responsibilities to take care of the environment, people are going to engage in thoughtless behavior that pollutes it. It's the same with the stock market. We all benefit from having a functioning and rational market. But we are all weak and we all need to be reminded from time to time of the realities and of our responsibilities in this regard.

I see no reason to believe that most people will not be willing to go along once they are permitted to hear about the realities. Yes, there will be some who will be tempted to follow Get Rich Quick strategies. Guess what will happen to them if the investing experts and the politicians and the economists are all advising us to lower our stock allocations because prices have gone too high? Prices will be driven back down and the greedheads will lose out. After that happens two or three times, everyone will get the message. The conventional wisdom about stock investing will become something far different and far more healthy than what it is today.

The reality is that the statement "timing always works" is every bit as accurate as the statement "timing never works." It's just a question of what form of timing you are talking about. The reason why most today know about the reality that "timing never works" but not about the reality that "timing always works" is that The Stock-Selling Industry has spent hundreds of millions of dollars promoting the one idea and zero promoting the other. What if we change that? What if we pass a law saying that they must spend as much money promoting Rational Investing over the next 10 years as they have spent promoting Passive Investing over the past 30? What happens then?

What happens then is that stock investing becomes a far more sane thing than it has ever been before. I don't see it as just a "good idea" for us to act as a society to bring that about. I see it as mandatory. The purpose served by stock investing has changed. We have in recent decades decided as a society to encourage middle-class investors to use stocks to finance their retirement plans. There are responsibilities that go with that. One of those responsibilities is that we lay off the worst of the marketing nonsense and begin shooting straight with middle-class people as to how stock investing works in the real world. We cannot continue to encourage people to invest in this asset class and not permit them to hear the realities of how stock work. I just do not think it will fly long-term to do this.

There is not one person who ends up losers if we all work together to bring on the change. Not one. We're all winners. Call me a cockeyed optimist if you want, but it seems to me that there has to be some means of bringing about a change that leaves every single person a winner and creates not one loser anywhere. I believe that this is an idea whose time has come. And I think that all of those who are critics today are going to become very excited indeed once we begin taking serious steps to bringing the rest of the world around. There are very few who are so cynical that somewhere deep in their hearts they don't like the idea of making the world a better place.

Rob

[Rob Bennett]

the best service you could provide would be to get the market valuation model accepted as a respected possible investment strategy rather than the grand unified investment strategy that will bring about massive market volatility smoothing and global investment peace. (said a little tongue in cheek).

I respect the intelligence of what you are saying, Apex. And my sense is that there are many who think as you do. However, my take is that only a strategy precisely the opposite of what you are proposing here can work.

Please don't think that I started out trying to change the world. The history of this is that I put up a post at the Motley Fool site reporting on what I had learned about the errors in the Old School retirement studies. There was great interest. And then a fellow who had posted an Old School study at his web site got it in his head to destroy the entire board rather than permit people to learn the realities. And many tolerated this! Including the site owner! (The Retire Early board had been the most successful board at the site until it was destroyed.)

I found these realities amazing. I had always assumed that most people were trying their best to learn how to invest effectively. What I had seen happen with my own eyes told me that this is not so. Most people are trying not to learn how to invest effectively but to avoid ever having to acknowledge that something they once believed had turned out not to be so. I recently asked the fellow who destroyed the board how much he lost in the stock crash. He said "well in excess of $1 million." But he still devotes all his life energy to blocking people from learning the realities at discussion boards and blogs. I have never heard him put forward a peep of protest re the people who told him about the strategies that caused him to lose well in excess of $1 million.

Stock investing is 70 percent emotional and 30 percent rational. There are thousands of people today who devote enormous amounts of mental energy to coming to an understanding of 30 percent of the picture. There are few who even look at the 70 percent. And the strategies that work re the 70 percent are often the opposite of the strategies that work re the 30 percent (because what appeals emotionally is often the opposite of what appeals intellectually). So we actually have a situation today where 70 percent of our efforts to understand investing are being directed not to unearthing the realities but to rationalizing things that make us feel good emotionally but destroy our investment portfolios. We are working harder and harder and spending more and more to destroy ourselves ever faster and ever more effectively.

We cannot turn this around with a niche strategy. People are very much affected by what their friends and neighbors and co-workers say. So long as we are spending millions and millions of dollars to persuade ourselves of the merit of strategies that can never possibly work, we are going to suffer worse and worse and worse financial losses. What we need is to reverse the polarity. What we need to do is to come to understand that the realities of stock investing are not something to fear but something to embrace.

Look at the safe withdrawal rate (SWR) issue. That's what got this started. When you calculate the SWR accurately, you find that the withdrawal rate that is described in the Old School studied as "100 percent safe" has only a one in three chance of working out for those who retired at the top of the bubble. That means that there are going to be millions of busted retirements resulting from just this one error of the Passive Investing model (and there are hundreds). This idea of burying our heads deep in the sand cannot continue indefinitely. We are someday going to have to take a serious look at what we have done and get about the business of fixing the mistakes.

The move to Passive was a big move. Passive is a model that claims to be "scientific" -- there are studies looking at historical data and all this sort of thing. But the model was designed with marketing considerations uppermost in mind. Mixing science with marketing creates big problems. Science is objective. Marketing is about appealing to the emotions. Mix these two in the way they were mixed in development of the Passive model and you are going to create huge explosions.

What I love about the Passive model is the grounding in science and objectivity. What I am trying to do is to preserve what is good in the Passive model by kicking out what is bad in it. To advance in our understanding of what works, we need to use scientific-like analyses. That was a very big move and a very good move. But we cannot continue to let the science play second fiddle to the marketing considerations. When you promote yourself as reporting science, you take on a responsibility to put the marketing stuff in second place.

The marketing power behind Passive Investing is huge. We are not going to be able to overcome it. The only way over the mountain that I see is to use the marketing power for good. If marketing could be used to persuade millions to believe in Passive, then marketing can be used to persuade millions to believe in Rational. That's good marketing. That's marketing working in the service of the science rather than in opposition to it.

People want to learn how to invest effectively. That's the bottom line. So long as that is so, there's grounds for optimism. I acknowledge that we have a black mountain that we need to get past in getting the Passives to say the three magic words ("I" and "Was" and "Wrong"). But I believe that once we get to that point it's all downhill sledding from that point forward. Once everyone is working on the same side (as we all should have been going back to the very first day of the discussions -- we are all pursuing the same goal after all), progress is going to be attained very, very quickly (I hope!).

Rob

[Rob Bennett]

"Stop trying to find a new market timing strategy, without admitting to yourself that you are timing the market."

I'm not the least bit coy about saying that I time the market, Mark.

I say that timing is mandatory for the long-term investor who wants to have any realistic hope of success. I don't even see how it is possible to imagine having any realistic hope of success if you are not willing to time the market.

Think about what it means to time the market. When you purchase any asset, it is key to get a good price, right? Well, how do you get a good price when buying stocks? By timing. There is no other way to do it.

I believe that timing has gotten a bad name because The Stock-Selling Industry had devoted hundreds of millions of dollars promoting the marketing slogan that "Timing Doesn't Work." There is a technical/legalistic way in which that is so. There is a good bit of academic research showing that short-term timing (changing your allocation with the expectation of seeing a benefit within a year or so) doesn't work. I would never give two seconds consideration to the idea of engaging in short-term timing. But the same historical data that shows that short-term timing never works also shows that long-term timing (changing your allocation with the expectation that it may take five years or even longer to see a benefit) always works. It is every bit as accurate to say that "Timing Always Works" as it is to say that "Timing Never Works" (it all depends on what form of timing you are talking about).

I view it as a breakthrough that we learned that short-term timing never works. But it was every bit as big a breakthrough when we learned that long-term timing always works. I think that we should be teaching investors both of these critically important realities. We have spent hundreds of millions promoting the message that short-term timing never works. Now we need to spend hundreds of millions promoting the message that long-term timing always works and is required for long-term investing success.

If we had all timed the market back when prices first went to la-la land, we wouldn't be in this economic crisis we are in today, Mark. Timing isn't the problem. Timing is the solution.

Rob

[The Math Guy]

I totally agree Rob. And for those that are following the Industry's "wisdom," please take 5 MINUTES of your time to save yourself the disappointment of lost future gains by realizing that Dollar Cost Averaging (DCA) is a TERRIBLE way to invest. Don't believe me? Then believe the people with Ph.D's in Finance (although you should believe me since I have a Ph.D. in Math, but anyway):

Go read: http://moneycentral.msn.com/content/P104966.asp
and read the two academic articles cited toward the end of that article.

Here's the kicker:

"Numerous studies of real market performance, models, and theoretical analysis of the strategy have shown that in addition to having the admitted lower overall returns, DCA does not even meaningfully reduce risk when compared to other strategies, even including a completely random investment strategy."

You should read that last part again..."even including a completely random investment strategy." Think about this for half a second: this means that anyone following the "wisdom" of their financial advisers, or other so-called "experts" in finance who advocate "easing into the market" through DCA are getting SOLD. Follow the actual RESEARCH and not SALESMANSHIP and you'll discover that investing with DCA is pretty much equivalent to investing RANDOMLY. In other words, DCA investing is akin to waking up every morning and flipping a coin and if it's heads you invest that day, if it's not you don't.

Now, will this "strategy" make you money in the long-term? Yes. Is it the best strategy you could use? Absolutely NOT. If you even glance at those two articles, you'll notice the word "Sub-Optimal" in the title. DCA (aka random investing) does produce returns...suboptimal ones. Wouldn't you rather have made an extra $200,000 to $500,000 by the time you retire?

We all need to wake up and read the research, not rely on the people who are trying to SELL us investment products. I mean, come on, how many times have you asked the mechanic who just performed the free 20 point checkup on your car if your car is in good shape? Don't you think there's an inherent conflict of interest for the mechanic? (lie to you (or at least spin the truth) to get some business, or tell you the actual truth and risk the loss of your business).

The only way to investment success is through sweat and hard work, not through "tried and true" methods which you should just take on faith (ESPECIALLY when there is AMPLE evidence telling you that these methods aren't the best strategies).

[Apex]

"How did we get people to drive to recycling bins?"

Very few do or did. When I grew up we recycled aluminum cans only because they paid us for it, in fact my cousin and I used to go to the local landfills and scour them for aluminum cans and collect them to recycle and the landfills were loaded with them. When I moved to places that didn't have an easy place to get paid for it, I didn't bother. Then we had garbage service that actually mandates that there be separate recycling containers. They made it so easy that it was hardly worth not doing. But very few people were collecting their own recylcing, driving to a recycling center, and turning in the recycled materials for free.

"How did we get people to not smoke in restaurants?"

We passed laws, we did here in Minnesota just a few years ago. Prior to that we had smoking and non-smoking sections and most smokers still smoked in restaurants and the non-smoking sections were mostly just the less smokey section. I am not sure what state you live in but in the upper midwest if you don't force people not to smoke, they will sit right next to you without any thought that you do not care for all the smoke they are filling your air with.

"How did we get people to contribute to blood drives?"

Very few do. Less than 1 in 10 donate and less than 1 in 4 of those that are elligible to donate do so.
http://www.americasblood.org/go.cfm?do=page.view&pid=12
And they have made it very easy, they come to your work, your church, tons of places, yet still less than 1 in 4 of those who could do it, do it.

I think all those examples prove my point. No matter how much you make people aware, no matter how much you make it a social good or a social stigma, if you give them choice you can't even get 50% of the people to do "the right thing" unless you mandate it by law, pay them to do it, or make it painlessly easy.

I appreciate your attempt for radically altering the investment landscape, but I think we will have to agree to disagree on the scale with which this can be successful if you give humans free choice.

[Apex]

"Don't believe me? Then believe the people with Ph.D's in Finance (although you should believe me since I have a Ph.D. in Math, but anyway):"

Are these Ph.D.s better than the ones held by the financial analysts in the banking industry and the Fed Board Governors who determined through quantitative analysis that we had now found out how to properly assess future risk of less credit worthy borrowers to the point that through mortgage backed securities and credit default swaps we could take on these riskier customers, spread the risk and effectively fully hedge for it so that we could now loan to people who "conventional wisdom" had said were not credit worthy?

I am not saying that proper analysis can't be done, but the record of Ph.D.s in finance is not very good. It proves very little other than that people can be educated beyond their common sense.

[The Math Guy]

There's a subtle point that you've overlooked by simply taking that quote out of context. The whole backbone of my comment is the inherent conflict of interest these financial advisers/professionals have. The finance Ph.D's you're talking about DO have these inherent conflicts of interest (hmmm, if I'm Goldman Sachs and I see everyone securitizing mortgages around me, when the supply of prime mortgages starts to dry up and I start thinking of securitizing sub-prime ones you better believe I'm gonna want my quants (aka Ph.D's) to give me a way to do it (i.e. CDS)).

So it's important, again, to ask yourself "who am I listening to, and what are THEIR true interests." The research on the pitfalls of DCA is solid, and it comes from people who care about the illogical advice most of us are sold on. True researchers only have one motive: to advance the understanding of whatever is being researched. The simple fact that the Ph.D's you're talking about work for an industry where conflict of interest is rampant effectively turns their expertise into hired "peace of mind" for the CEO's to take on further risk.

So, again, who are we listening to, and what are their true interests. My answer is simple: listen only to what you can prove and understand, and if anyone else disagrees, let them prove you wrong. I guarantee that both parties will emerge better educated and with a deeper understanding than otherwise.

[Apex]

I agree with your conflict of interest statement but your take would imply these people were just lying. They were using quants to fools us and didn't actually believe their math meant anything.

If that was true then surely GS, Lehman, Bear, BAC, Citi, etc. would not have held any of this risk themselves. They would have just sold it all off to the rest of us suckers, made the profit, and been flying high when it all went south.

Only if they actually believed their quants would they have held this stuff themselves and been decimated by it.

So how did that play out again?

[The Math Guy]

Well, I don't actually know what they (the CEO's) were thinking, but when you factor in the fact that the derivatives market today totals about 500 TRILLION, it becomes pretty clear that EVERYONE was in on the game. So in a way, we don't need to know what they're thinking, we just have to look at what they actually did, and a 500 trillion dollar derivatives market clearly shows that they were all investing in these things hand over fist. So, in fact, they are holding on to these things. Where to you think that first bailout of bear stearns went? It went to Goldman to settle CDS contracts it had on it. Karl Denninger has been ranting about this type of stuff for years now. And, to add perhaps the PERFECT example of the inherent conflict of interest and the misuse of Ph.D's, let me end with one word:

Enron.

[Apex]

I guess I am missing your point because I don't see how the "everyone was doing it" argument changes my point which was essentially that having a Ph.D. doesn't stop you from doing really bad math and having others even those with conflicts of interest follow/believe it. And thus Ph.D. math doesn't prove much about the correctness of the analysis with respect to financial investing. In fact the Ph.D. might make someone think they are more clever than they are and justify complex math models that are not correct. Thats how I see it anyway.

Again I am not saying analysis is not possible. I just don't necessarily gain confidence from the Ph.D. Personally, I would sooner trust someone whose primary education is experience rather than someone who's primary experience is education.

[Rob Bennett]

I appreciate your attempt for radically altering the investment landscape, but I think we will have to agree to disagree on the scale with which this can be successful if you give humans free choice.

I think you did a good job of making your case, Apex.

It could be that I am being willfully optimistic re this one.

Rob

[Rob Bennett]

I agree with your conflict of interest statement but your take would imply these people were just lying. They were using quants to fools us and didn't actually believe their math meant anything.

This comment was not directed to me but it is so important that I feel a need to offer my take anyway.

I believe strongly that the vast majority are not lying.

There is a phenomenon in the psychological literature called "Cognitive Dissonance." When some sort of conflict develops in our thinking that is painful to deal with, we ignore it.

There was a time when the literature supported the claims being made today. Then new research came along showing something very different. People had already built careers teaching the old stuff. And people had spent huge sums of money marketing the old stuff. And people had come to personally believe in the old stuff.

So it has been very, very hard for people to acknowledge the earlier errors and reverse themselves.

People know enough to be defensive. They know that they are on shaky ground. But they very, very much do not want to know the realities. So when they hear about new studies or articles or books, they look the other way. They don't want to know. So they don't know.

Marketing considerations do indeed have an influence. The sorts of people we are talking about often make salaries of $1 million or more. All that goes up in smoke if they take in the lessons of the new research and stop endorsing the conventional wisdom. That's heavy pressure not to ask too many questions, not to work this stuff too hard.

We're dealing with humans, not data processing machines. We need always to keep that in mind.

We're all flawed humans. I don't believe that there is any such thing as an "expert" in this field today. I think that we all need to make an effort to adopt more humble stances.

Rob