Stock Investing Risks That Are Often Overlooked

Observation #1 on Stock Investing Risks — The risk of investing in stocks is far greater at times of extremely high valuations (like today — this article was written in September 2006) than it is at times of low or moderate valuations.

Stock Investing Risks
The P/E10 value today is 26. Prior to the late 1990s, the U.S. stock market had visited this price level on only two occasions — the late 1920s and the mid-1960s. On those two occasions, we experienced wipeouts of middle-class portfolio values in the years to follow.

The moral? Stock investing risks are not distributed equally across all time-periods in which it is possible to own stocks. There are price drops at times of low and moderate valuations. But those are the sorts of price drops that most middle-class investors are able to withstand without experiencing too great a strain. The monster risks are the ones taken on by investors going with high stock allocations during times when the sorts of valuation levels that apply today are in effect.

It’s not a small increase in risk that applies when valuations go to nosebleed levels. I think it would be fair to describe the risk that applies today as a risk of a different nature from the risk that applies at moderate or low valuations.

William Bernstein made the point in his book The Four Pillars of Investing by telling us how low the DOW would need to drop if we were to see the sorts of price drops that we experienced on those two other daring journeys to the tippy top of the valuation mountain. The number (at the time he was writing the book, which was published in early 2002) was DOW 1400.

Observation #2 on Stock Investing Risks — The potential gains from owning stocks are less today too.

There are many cases in which taking on added risk of loss brings with it the compensation of an added potential for gain. It doesn’t work that way when stocks as a whole become wildly overvalued, though. At today’s prices, the downside risk of stock ownership is great, but the upside potential is small.

The lowest P/E10 value on record is 5. The highest is 44 (we hit 44 in January 2000, the top of the recent bull market). Prior to the recent bubble, the highest P/E10 value we had seen was 33. If we presume that stock valuations will remain within their historical valuation boundaries, there are a whole lot of possibilities on the downside but few on the upside. It’s theoretically possible that we could work our way all the way back to P/E44. But where could we be reasonably expected to go from there except down hard?

Risks of Stock Investing

If the possibility of not earning a good return on your stock investment can be counted as a form of risk separate from the more frequently considered risk of losing a bundle, today’s stocks are a high-risk asset class in two important ways.

Observation #3 on Stock Investing Risks — The bear knows that crushing your portfolio balance requires first crushing your spirit.

The worst of the secular bears (those that follow strong secular bulls) are so unusual that few of today’s investors know what it is like to live through one. Many of today’s investors think of a bear market as something that lasts a year or two or three or four or five or six or seven or eight.

If only it were so!

The large bears seem to see it as their life purpose to take back most of the money that investors earned during the bulls that preceded them. It is only when they sell their stocks that investors give back their earnings, and many investors refuse to sell in a year or two or three or four or five or six or seven or eight. So the bear waits them out, giving them a taste of rising prices for just long enough to cause them to feel encouraged before crushing their hopes again. Only when most of the winners of the bull market days have sold at least some of their stocks does the market permanently change direction and begin its long climb back to the higher valuation levels.

Investing Is Scary

There’s a good chance that the trip down and then back up again will not be a quick one. The purpose of a bear is to crush investor hopes and the largest of the bears understand that the best way to crush the human spirit is not with sudden shocks that soon pass away but with a slow-grinding financial pain that wears down the soul and the investment account both.

John Walter Russell examines some scenarios that reveal the nature of stock investing risks in a bear market in an article entitled “P/E10 Predictions Revisited.”

Observation #4 on Stock Investing Risks — You might swear off stocks altogether.

I’m a stock guy. I think that stocks offer the best path to financial freedom for most middle-class investors.

That’s why I feel strongly that investing advisors should tell the straight story about the risks facing the investors of today going with high stock allocations. If the bear ends up being not as bad as what you planned for, you will brush yourself off and walk away, and all will be well with the world. What you don’t want to have happen is for the bear to be far worse than you imagined.

That’s the sort of experience that causes people to swear off this wonderful asset class forever. It could happen to you. Going with a smaller stock allocation today might permit you to go with a far larger stock allocation at the beginning of the next secular bull. You want to be in on the fun all of your fellow stock enthusiasts are going to have then, don’t you?

Observation #5 on Stock Investing Risks — You stand to suffer personal embarrassment.

People like to talk about money topics as if all that is at issue is dollar bills. Dollar bills are easy to count, for one thing. It’s not as scary to talk about dollar bills as it is to talk about human emotions, for another.

It’s human emotions that determine what happens to the dollar bills. It’s scary talking about them, but we must talk about them if we are to make sense of the dollar-bill stuff.

People don’t invest in the way that they believe will earn them the most money. That’s never the sole motivation. People invest in ways that they think will make them feel good about themselves and about life.

Bull markets make people feel smart and proud. Bear markets make people feel like dopes and losers.

If you can’t afford to help your daughter with her college expenses because you weren’t smart enough to lower your stock allocation in time, you’re going to feel like a jerk. Think it over.

Observation #6 on Stock Investing Risks — One of the most painful risks of stock investing is missing out on attractive investing alternatives.

Fear of Stocks
Many of the saddest stories heard while traveling through this Valley of Tears begin with the words “If only….”

Treasury Inflation-Protected Securities (TIPS) were paying a 30-year guaranteed real return of 4 percent in early 2000. You bought some, didn’t you?

Don’t feel bad. Almost no one else did either. Stock prices were soaring in those days. The government had to jack up the return on TIPS to absurdly high levels for a risk-free investment just to get a few people to place orders.

I purchased TIPS when they were paying 3.5 percent real. When I tell people that today, they say: “Wow, that sure was a smart move, whatever made you know to buy those?” The sad truth is that I should have bought some of the 4 percent TIPS. I knew it was an amazing deal. Like everyone else, I was looking for reassurance from my fellow humans before making the move, and the reassurance that 4 percent TIPS were a good deal came too late. By the time the rate had dropped to 3.5 percent, I worked up the nerve to grab hold of the gift the U.S. government had been trying to hand me for several years and mumble a soft “thank you, Uncle Sam.”

TIPS are today paying between 2.0 percent and 2.5 percent. That’s not as good as 4.0 percent or 3.5 percent. So some refrain from buying on the thought that they have already “missed out.” You missed out on 4.0 TIPS. But you haven’t missed out on TIPS paying between 2.0 percent and 2.5 percent. Buy some! See how it feels to be invested in something other than stocks!

Don’t be surprised if TIPS rates drop lower when stock prices are down and everyone comes to appreciate the value proposition that TIPS offer. Then there will be people bemoaning the fact that they “missed out” on TIPS paying 2.5 percent.

Stocks are a jealous mistress. You don’t need a jealous mistress, you need a nice, strong, dependable income stream from your investments. Look into TIPS to avoid the risk of feeling regrets over opportunities squandered.

Observation #7 on Stock Investing Risks — Compounding works in reverse too.

You’ve heard the one about compounding returns, right? The way I recall it is, if you save 39 cents today, it will be worth 17 million and change in 20 years if you only permit the miracle of compounding returns to work its magic. Something like that.


Stocks Are Scary

Now, what happens if you lose one-half of your portfolio value because stock prices return to reasonable levels sometime over the next few years?

Please type in your stock portfolio value in the space provided — ___________.

Now, please divide by two. Type in the result of that calculation here — ___________.

Finally, multiply that number by 600 billion (to show how much you will lose by not having the miracle of compounding returns work its magic on the number of dollars indicated in the space completed above. Enter the product of that multiplication effort here — ___________.

You don’t want to lose (please enter the amount entered for the divide-by-two calculation here as well — _____________). Not just because it’s an awful lot of money for someone like you to lose. You also don’t want to lose it because it will be a loss that will keep on doing harm to your financial freedom dreams for many years to come. The same magic of compounding returns that can do you so much good if you invest responsibly can do you a lot of harm if you do not invest responsibly.

Observation #8 on Stock Investing Risks — The risk that counts the most is the risk of the loss of the time it took you to earn the money you now have invested in high-priced stocks.

Joe Dominguez, author of the book Your Money or Your Life, taught me the most valuable money lesson I have ever learned. Dominguez said that money is time. We trade the hours of our day for money. So what we really lose when we lose money is the time that we will have to trade away to get that money back.

If you earn $60,000 per year and save 10 percent, it takes you five years to accumulate $30,000. Lose $30,000 in a stock-market downturn, and you just gave up the fruits of five years of work effort. Not good.

Most Americans are too heavily invested in stocks today. I want to scare you into lowering your stock allocation (or at least into thinking about it enough to come to an informed decision that it is not the right thing for you to do). It’s not your money that is at stake, according to Dominguez. It’s your life.

Safe Investing — What Most “Experts” Won’t Tell You

The good news is that we know more about safe investing today than we have known at any earlier time.

The bad news is — It’s difficult indeed for us to share what we know with each other!

Safe Investing The incredible reality is that, at a time when most middle-class investors are desperately seeking to learn about safe investing strategies (this article was posted in March 2010), a Social Taboo has developed blocking reasoned discussion of the wonderful things we have learned from the academic research of recent decades. This article describes both the research findings and the Social Taboo that has thus far blocked you from learning about them.

Safe Investing Taboo Secret #1 — You Must Consider the Price Being Charged for Stocks Before Buying Them

Many people believe that they must give up on obtaining a good return to invest safely. No! Or they believe that there are complicated rules that must be mastered by those seeking to learn how to invest safely. No again! Safe investing is simple investing and rewarding investing. It all can be reduced to five words — valuations affect long-term returns.

That really is it. That really is all that you need to know. We have data on U.S. stock performance going back to 1870. Do you want to guess how many times investors who purchased stocks at low or moderate prices obtained poor long-term investing results? The answer is — it has never yet happened. Now do you want to guess how many times those who purchased stocks at prices of two times fair value obtained good long-term results? That too has never yet happened. If there is one Iron Law of safe stock investing, it is — Never, ever, ever, ever consider buying stocks without first looking at the valuation level that applies for them at the time.

This is so obvious that in ordinary circumstances I would be worried that I would be insulting your intelligence by pointing it out. These are not ordinary circumstances. Stocks were selling at insanely high prices for the entire time-period from 1996 through 2008, and prices remain on the high side today. So what have the experts been telling you during that entire time-period? That stocks are always a good buy, that things will work out in the long run so long as you don’t try to “time” the market (taking price into consideration is of course a form of timing since those who understand the importance of valuations are of course going to go with higher stock allocations at times when the long-term value proposition for stocks is good than they are when the long-term value proposition for stocks is poor), that Buy-and-Hold is what works and that practicing Buy-and-Hold means staying at the same stock allocation regardless of price changes.

Safe stock investing is easily available to all of us. The academic research has been telling us for 30 years now that paying attention to valuations is what works. And yet the people who we think of as “experts” in this field have been telling us precisely the opposite story; they have been telling us that we do not need to look at price, that it might even be a bad thing to take price into consideration, that taking price into consideration is a form of timing, and that we must not go there.

Safe Stock Investing Is the promotion of Buy and Hold Investing part of a great conspiracy to bankrupt the middle class? Are the experts dumb? Or too lazy to read the literature as it comes out? Or are they just flat-out corrupt?

The answers are “no,” “no,” “no,” and “no.” But I do think it is fair to say that we live in strange investing times when 90 percent of the big names in the field advocate the opposite of what really works. That’s why this article does not end with my description of the first taboo secret. To have confidence in that secret, you are going to need to come to an understanding of why today’s investing advice is so mixed up and confused and misleading and dangerous.

Safe Investing Taboo Secret #2 — Our Understanding of How Stock Investing Works Is Primitive

Presuming that you are persuaded that buying stocks only when they are available at reasonable prices is the key to safe investing (I am highly confident that this is so, but I implore you not to make any investment decisions according to what I say — please scrutinize my claims as part of the process of forming your own take on these questions), you are faced with a puzzle. Why doesn’t John Bogle say what Rob Bennett says? Why doesn’t Money magazine say what Rob Bennett says? Why don’t Motley Fool and Morningstar and the Early Retirement Forum say what Rob Bennett says? They don’t, you know. In fact, I am banned at those places because I reported to the middle-class investors who visited there Taboo Secret #1, that they must take price into consideration when setting their stock allocations. The “experts” who posted at those sites didn’t take too kindly to the idea of Old Farmer Hocus spilling the beans.

How come?

It’s because they are not as “expert” as they like to pretend to be. None of us are. Taboo Secret #2 is that we just don’t know all that much about how stock investing works.

In a purely rational world, that would cause us all to speak with a great deal of humility. It would cause us to be careful to avoid dogmatism, to remain open to new ideas and alternate points of view. Unfortunately, that’s not always the way the humans operate. Perhaps you’ve noticed.

We want to get this investing thing right. Not knowing everything scares us. So do you know what we do? We fake it. We act more confident than we feel. We put on a show by using big words and citing stacks of studies (often irrelevannt ones) to cover up the fear we feel in telling people how to invest when we don’t really know for sure.

I can tell you what I believe is a safer way to invest. But I too cannot be entirely sure. To gain confidence in the findings of the new research, we need to have a national debate on what really works in investing. For the experts who have advocated Buy-and-Hold, that would mean — ssshhh! — acknowledging that they just might have gotten some things wrong. It’s not done! Not in this field!

A Better and Safer Way to Invest in Stocks It’s only the confident who can admit mistakes. The Catch-22 is that we cannot learn what we need to learn without first admitting that we have gotten some things wrong and we cannot bring ourselves to admit that we have gotten some things wrong for so long as we are paralyzed by the fear of what it means that we don’t know it all yet. So we just keep on doing the Buy-and-Hold thing, which is the opposite of what the academic research of the past 30 years says works. Oh, my!

Safe Investing Taboo Secret #3 — While Primitive, Our Understanding of How Stock Investing Works Has Improved Greatly in Recent Decades

The good news is that we know today a lot more about safe investing than we did before the development of the Buy-and-Hold Model. The Buy-and-Hold Model was at one time rooted in science. The most popular investing strategies of today are not the product of guesswork. They are the product of academic research in which the historical stock-return data is studied by academics seeking to learn in a systematic way what really works.

We have learned wonderful things as a result of this new approach. We have tapped into six important insights: (1) that short-term timing (changing your stock allocation with the hope of seeing a benefit within a year or so) does not work; (2) that it is best to ignore the short-term noise of stock price changes and market commentary; (3) that stocks on average provide the best long-term returns; (4) that it is important to limit transaction costs; (5) that stock picking is hard for investors who do not have the time or inclination to put a great deal of effort into the project; and (6) that successful investors stick to a plan for the long term.

The middle-class dream of truly safe investing is within our grasp today.

Safe Investing Taboo Secret #4 — The Dream of Making Safe Investing Strategies Widely Available to Middle-Class Investors Has Been Delayed By an Unwillingness Among “Experts” in the Stock-Selling Industry to Acknowledge Mistakes Made Many Years Ago

Our move to science-based investing advice came with a risk for the investing “experts” employed by The Stock-Selling Industry. Scientific learning is an ongoing process. It is common for academics to get things wrong on the first try and to admit mistakes and return to the drawing board. Most of the “experts” that you hear quoted on television and on web sites and in magazines are loathe to admit mistakes. They feel that it is “unprofessional” to get things wrong. So they are more inclined to fake it than it return to the drawing board and come up with better ideas when the old ones are found to be wanting.

Safe Investing Strategies This has become a huge problem in regard to promotion of the Buy and Hold strategy. Buy-and-Hold (staying at the same stock allocation at all times) makes sense only if there is no such thing as overvaluation. If stocks can become overvalued, investors obviously need to lower their stock allocations when they do because an overvalued stock market is a stock market headed for a price crash. The risk of investing in stocks is obviously far greater when a crash is imminent than it is when a crash is unlikely. In the event that overvaluation is possible, investors seeking safe investing strategies need to rule out the possibility of following a Buy-and-Hold approach and instead need to be sure to always lower their stock allocations once prices rise to insanely dangerous levels.

The academic research revealed to us in 1981 that overvaluation is a real phenomenon (the Buy-and–Hold model was developed at a time when the academics believed otherwise). So the “experts” should have been warning middle-class investors about the dangers of Buy-and-Hold for the past 30 years. Unfortunately, the shame that the “experts” feel over failing to do this grows greater as the economic crisis caused by the failure to warn investors of the dangers of Buy-and-Hold causes more and more human misery. What a mess!

Safe Investing Taboo Secret #5 — Buy-and-Hold Appears to be Nearing a Collapse

Safe Stock Strategies Since the crash, those who are familiar with the academic research showing that there is precisely zero chance of Buy and Hold ever working for the long-term investor have become more vocal about the new (to us — but known to the “experts” for 30 years now!) academic findings. As the economic crisis worsens, it seems likely that it will become possible for enough middle-class investors to learn about the new research for the process of rebuilding our destroyed economy to begin.

I’ll point you here to just one example (you’ll find many more if you explore other sections of the site) of how things are changing. Andrew Smithers recently wrote an article on the research findings that will be permitting us all to learn about safe investing strategies in days to come. He said: “When tested, however, the Efficient Market Hypothesis failed, as real equity returns do not follow a ‘random walk with drift’ but exhibit negative serial correlation. This meant that sustained periods of real returns, which were above the very long-term average, were followed by below average returns and vice versa.
This evidence obviously meant that the EMH, as applied to the stock market in aggregate, must be discarded or modified. Attempts at modification have failed. No one has yet produced a version of the EMH which can be tested and fits the evidence. Thus, the EMH must logically be discarded, as a valid hypothesis must be testable…. It is therefore possible, contrary to the EMH, to know whether markets are overvalued.”

There’s light at the end of this very dark tunnel!

Safe Investing Taboo Secret #6 — The New Research Points to Some Extremely Encouraging Insights

Once we open the internet up to honest posting on the realities of stock investing, I believe that we will see responsible political and economic leaders step forward to launch a national debate on the realities of stock investing. We have been discussing these issues in the Retire Early and Indexing discussion-board communities for eight years now, and we have developed some tentative insights that suggest many exciting safe investing strategies of the future.

What are Safe Investing Strategies? Stock investing is always risky, right? Is that not what most people believe? Once you give up on the Buy-and-Hold Model, it becomes clear that this is not necessarily so. Rob Arnott has said that today’s conventional investing wisdom is rooted in “myth and urban legend” and the idea that stocks must be riskier than other asset classes appears to be one of the many ideas developed during the Buy-and-Hold Era that will not stand the test of time.

Why is it that we think of stocks as being risky? It’s because, in the days before index funds, investing in stocks meant investing in the fortunes of one particular company. Any one business enterprise can fail and that possibility meant that the entire investment amount of the middle-class investor would be put at risk. With the introduction of index funds, it is no longer necessary to take such chances. When you buy an index fund, you are investing in the future of the entire U.S. economy, not in the prospects of any one particular company. The odds of a wipeout are considerably less.

Index-fund investing is exceedingly risky today because most index-fund investors are following Buy-and-Hold strategies. However, once it becomes possible to let people know about the research of the past 30 years, the risks associated with failing to take valuations into account go “Poof!” The research indicates that valuation-related risk is about 80 percent of the total risk of stock investing. So, as we move to the promotion of Valuation-Informed Indexing strategies, the risks associated with stock investing are likely to be greatly minimized. All you have to do to tap into the benefits is to survive whatever number of stock crashes it takes for the investing “experts” to acknowledge the mistake they made in thinking that there was no need to take valuations into consideration!

Safe Investing Taboo Secret #7 — The Tools You Need to Make the Move to More Effective Investing Strategies Are Available to You Today

Safe and Sensible and Simple Investing Strategies

Simple and safe investing strategies are here today for those willing to make the small effort needed to become familiar with them. I recommend that you take four steps:

1) Learn how to work The Stock Return Predictor,
an investing calculator that reveals the most likely 10-year return on stocks purchased at any of the possible starting-point valuation levels. The Predictor tells you the price tag attached to the stocks you are buying. You wouldn’t buy a car or a comic book or a sweater or a banana without first looking at the price tag, would you? I don’t think you should be willing to buy stocks without first looking at the price tag either;

2) Review the materials a the Index Investing section
of the site. If Buy-and-Hold is the past of stock investing, Valuation-Informed Indexing is its future. Read enough articles to learn the basics (be sure to read the article on “The Case Against Valuation–Informed Indexing”!) and check out other sources to determine whether for you these ideas stand up to scrutiny or not;

3) Listen to a few of the podcasts made available at the “RobCasts” section of the site. Those with a particular interest in safe investing might want to begin with Podcast #72, “When Stock Losses Are True Losses and When They Are Not.” That one explains that not all losses are created equal. Losses that are temporary in nature do not make investing more risky in any significant sense. Losses that are long-term in nature should be avoided by those with a desire to follow safe investing strategies (shouldn’t that be all of us?); and

Avoiding Risk in Stock Investing 4) Please tell your friends and neighbors and co-workers about the investing ideas explored at this site and do what you can to get the Ban on Honest Posting lifted at the various boards and blogs. The sooner we launch the national debate on the new investing realities, the better off we all will be. There is no such thing as safe investing at a time when the reckless promotion of Buy-and-Hold strategies is pushing us ever closer to a Second Great Depression. We all should be united in trying to get the information out to people that they need to hear to regain confidence in our markets and in our economic and political leaders.

Safe investing is a reality today for those who truly want it. Please ask questions and share experiences with your fellow community members as you begin the exciting process of exploring these new investing ideas!

Middle-Class Investors Are At a Disadvantage

Middle-class investors are at a disadvantage because experts give different advice to paying clients than they do to those who rely on free sources of investing guidance.

Middle-Class Investors Are At a Disadvantage If I had to pick the one thing that I learned during The Great Safe Withdrawal (SWR) Rate Debate that most stunned and amazed me, it would be the nine words that Dallas Morning News Columnist Scott Burns wrote in his column from July 2005 reporting on the New School of SWR Analysis. In reference to the New School findings (that the Old School numbers that were used in millions of retirements are off by 1.5 to 2.0 percentage points from the numbers obtained from use of an analytically valid methodology), Burns noted that we don’t often hear these findings discussed in the media today because: “It is information most people don’t want to hear.”

Holy smokes! Ponder the implications of that one for a moment. The experts know that millions of retirements are at grave risk of going bust in decades to come but they don’t tell us this because they fear what our reaction will be to the news. Not good.

We’ve seen evidence that the experts are more inclined to tell the straight story to the wealthier clients who are able to pay them for their counsel. For example, there was a Wall Street Journal article published in December 2005 stating that many financial advisors have in recent years adopted the practice of telling their clients that the infamous “4 Percent Rule” (the Old School studies falsely claim that a 4 percent withdrawal is safe at all price levels) needs to be pared back considerably for retirements beginning at today’s valuation levels.

My guess is that financial advisors feel more comfortable talking straight when they can talk to a client face to face and respond to questions about the investing realities that are generally viewed as too hot to handle in widely published media reports.

Many middle-class investors cannot afford to pay financial advisors to help them with their stock allocation decisions. They assume that they are getting the straight story in reports they read in newspapers and magazines. To the extent that that’s not so, middle-class investors have been put at a disadvantage.

Middle-class investors are at a disadvantage because buy-and-hold strategies are far harder to execute for those with limited assets.

Middle-class investors are as a general rule naturally reluctant to invest too heavily in stocks. It’s a powerful phrase expressing a powerful idea that has coaxed them into letting down their guard during the recent bull market. The phrase is “buy-and-hold.” Follow a buy-and-hold strategy and you cannot go wrong with stocks in the long run, we have been assured.

Is it so? It’s partly so. Buy-and-hold really is a winning strategy for those able to stick to it through the wild bear market that always follows a wild bull market. Many of today’s middle-class investors are not so positioned. That group has been placed at a big disadvantage.

Take Charge of Your Finances

One investor has $3 million in assets and experiences a price drop of 50 percent. Another has $600,000 in assets and experiences a price drop of 50 percent. The first investor is left with assets of $1.5 million. The second is left with assets of $300,000. Which investor feels more pressure to break his buy-and-hold commitment and to sell? It’s the middle-class investor who is feeling far more pain in these circumstances.

Buy-and-hold has never been tested in a bear market. It may work for some wealthy investors who can laugh off the temporary losses experienced. It is unlikely to work for the majority of middle–class investors, investors who cannot afford to sustain large losses without suffering serious concerns about their financial futures.

Middle-class investors should be following buy-and-hold strategies. But they should not be using the same risk-assessment rules to determine how much money to put at risk in stocks purchased at times of high valuations. Panic sets in quicker for those with smaller portfolios. So middle-class investors need to take a more cautious approach to buy-and-hold for it to work for them.

Middle-class investors are at a disadvantage because they are more dependent on their investment portfolios to finance their retirements.

Wealthy investors often enjoy multiple income streams. Perhaps they own real estate as well as stocks. Perhaps they have a partial interest in a small business not traded on the stock market. Perhaps they have contacts that they can use to generate additional income to make up partially for losses suffered in a stock price crash.

Middle-class investors going with high stock allocations have all of their financial hopes riding on the spin of a single wheel. This would be risky even if stock prices were at reasonable levels. It is extremely risky with stock prices at the levels they are at today (this article was posted in September 2007).

Middle-class investors are at a disadvantage because their knowledge of financial affairs is limited.

Few of us have time to learn everything that we would like to learn. We specialize in the topics that are most important. For those with large amounts of money, learning about money is a top priority. Even wealthy investors with little natural interest in investing often know the basics just because these sorts of matters have been discussed at the kitchen table and by friends and relatives throughout their lives. That’s not the case for many middle-class investors.

More Bad News for Investors

Investing is an activity like few others in that for many of us it is forced. Say that you do not enjoy the process of learning about investing and would prefer not to engage in it. You have to do so whether you like the idea of not. All those who hope to retire need to earn money from investments. Sooner or later, we all need to break down and invest, regardless of how poorly prepared we are to do so.

There’s no rule that says that people must become informed before they put money on the table with a stock investment. What do you think that most ill-prepared middle-class investors do to make themselves feel more comfortable with their investment choices? They fool themselves into thinking that they are better informed than they truly know themselves to be. They take comfort in the good results they obtain in bull markets, allowing themselves to form expectations that those results can continue after the bull market comes to an end. They rationalize. They hope for the best. They become defensive when asked whether they are comfortable with their investment decisions.

In many fields of endeavor, poor preparation reveals itself quickly, before it can do too much damage. It’s not like that in the investing field. The least informed investor couldn’t help but make lots of money in stocks in the 1990s. Once the 1990s came to an end, though, things began to change. In the years ahead, being better informed will count for more. As a general rule, that puts middle-class investors at a disadvantage.

Middle-class investors are at a disadvantage because they don’t have as much personal experience of the great bear markets of the past.

High-school kids die in car crashes all the time. I remember the one from my junior-year class who did. When something happens to someone you know personally, it makes much more of an impression.

Middle-class investors know about bear markets. They’ve read something about them or heard something about them. The stories they heard did not hit with full force because they were stories of things that happened to people they did not know personally.

Middle-class investing is a relatively new phenomenon. Wealthy investors have had grandmothers and uncles affected by earlier stock-market blowouts. Many middle-class investors are the first generation of investors to put substantial amounts of assets at risk in the stock market. They know only on an intellectual level some things that wealthy investors know on a deeper emotional level.

Middle-class investors are at a disadvantage because they are more trusting.

Middle-class investors want to believe that investing analysts are on their side. I have witnessed this reality over and over again. I remember a poster on the Vanguard Diehards board who said that she thought of Vanguard Founder John Bogle “like a father.” Bogle is often referred to as “Saint Jack” among the middle-class investors who adopted indexing as their favored investing strategy in the 1980s and 1990s and made a bundle as a consequence.

Depression Fellow Jack Bogle ain’t no saint. He’s smart enough. He seems to be a generally kind man. There’s a lot right about his investing strategy. But there’s a lot wrong about his investing strategy too. Like all mortals, he has his off moments as well as his on ones. He gets stuff wrong. I have caught him at this on more than one occasion.

Middle-class investors who follow Bogle don’t want to hear that he gets things wrong. Middle-class investors who follow other investing gurus don’t want to hear that their gurus get things wrong. That’s unfortunate.

Bogle isn’t going to make you whole when conditions change and all the things that made his strategy seem so right for one time come to make it so wrong for another time. Neither are any of the other gurus. We all need to learn from someone and it’s fitting that we feel respect and affection for those who help us learn. We need to draw lines, though. We need to respect what is worthy of respect and to be critical of what is worthy of criticism. We owe it to ourselves and our families to look out first for ourselves and our families.

I believe that many middle-class investors are aware on some level of their vulnerability in the investing area. I believe that some develop excessive levels of trust as a means of pushing feelings of vulnerability down to some place where they do not cause discomfort. I see this as a mistake. You feel vulnerable because you should feel vulnerable. You need to trust less and engage in hard questioning of gurus more.

Middle-class investors are at a disadvantage because bull markets are all about them and they don’t know it.

What’s a bull market? It’s a time when stock prices rise to absurd levels, levels that could never be justified by the economic realities that govern long-term returns. What causes stock prices to go to such absurd levels for a time? It’s the fooling of the middle-class investor.

My favorite investing question is one that often comes up in the wake of a big price drop. Some brave soul will work up the courage to ask a question that he fears will make him look stupid but which in reality is the key to understanding on a deep level what stock investing is all about. The question is: When stock prices fall, where does all the money go?

It disappears. It goes “poof!”

Clouds on the Investor Horizon

How can this be? It can be because there is no economic reality to bull market prices in the first place. Prices rise when the demand for stocks rises. Demand cannot remain at unusually high levels forever. It eventually falls back to normal levels. So prices fall to normal levels too. When people complain that stock prices are low, they often are complaining about prices returning to an objectively normal level that only appears low to those who for a time grew accustomed to prices that were absurdly high as the result of a temporary increase in the demand for stock ownership. Prices could fall for a long, long ways from where they are today and not be at a level that could reasonably be described as “low.”

Wealthy investors always own stocks. Middle-class investors often become interested in stocks after there have been lots of media reports about how well stocks have been doing in recent years. It is rising levels of middle-class participation in the stock market that cause bull markets.

And it is falling levels of middle-class participation in stock markets that cause bear markets. There comes a time when middle-class investors must cut back on their stock ownership levels because the experts (in whom we place too much trust) always overestimate the extent to which middle-class investors can afford to put their accumulated wealth at risk in this tricky asset class.

When we pull back, we hurt ourselves. But we must pull back. Because our participation in the stock market during bull markets is always overdone. It could be said that we middle-class investors have the power to set the prices of stocks. Unfortunately, it’s a power that rarely works to our good. We possess the power but we do not understand it. So we are always the last to understand why it is that we bought too much and why it is that we must in time pay a price for having bought too much.

Middle-class investors are at a disadvantage because big stock losses will leave them with limited assets to invest in stocks when prices return to reasonable levels

The upside potential for stocks is greatly limited today. The downside potential is huge.

How can it be then that U.S. stocks have a long record of providing a return after 30 years or so of something close to 6.5 percent? That would seem impossible if the value proposition of stocks long remained what it is today.

The answer to the puzzle is that it is not likely that the value proposition is going to long remain what it is today. Prices will be coming down as part of a natural cycle that has been repeating itself since the first stock market on Planet Earth opened for business. Then they will be heading back up again.

Middle-Class Worries Over Money

It’s when prices are reasonable that you can hardly miss by investing in a good percentage of your money in stocks. Will you be prepared to take advantage of the mouthwatering long-term value proposition available to us middle-class investors the next time prices are reasonable? Take a quick look a The Stock-Return Predictor. When the P/E10 level returns to 14, the most likely 10-year annualized real return rises from 0.84 (where it stand today) all the way up to 6.34. It’s the investors who enjoy those sorts of returns who experience the exciting side of this wonderful asset class to its fullest.

You’ll be ready to reap some big rewards if you can tune out much of the conventional advice directed to middle-class investors at times of high valuations and prepare for the better stock investing times to come for those who keep their heads about them when too many of their friends, neighbors and co-workers are losing theirs.

Happy investing, my fellow middle-class investor! Please stop by the blog from time to time and let us know how things are working out for you. We learn together.

Investor Confidence — What’s Faith Got to Do, Got to Do With It?

If only you believed in miracles, baby…
So would I.

— The Jefferson Starship, “Miracles”

Comparison #1 Between Building Faith and Building Investor Confidence — Experience Is Your Teacher

Investor Confidence

There are some who put off building faith until their later years on the thinking that that there will be more time for it when the demands of daily life are less pressing. This is a bad idea. Overnight conversions are the exception.

The usual path to advancement is that you develop faith in one area, and that gives you the power to strengthen your faith in other areas. I don’t think it’s entirely so that “you’ve either got faith or you’ve got unbelief and there ain’t no neutral ground” (Dylan made this argument in his song “Precious Angel” — my sense is that he was in a particularly grumpy mood at the time this song was written, early in his “religious” period). Faith is developed gradually, piece by piece, over time. Many of us have some faith and are hoping someday to have more but need to work at it continuously to get from where we are to where we want to be.

Investor confidence is built gradually too. Saying the words “I’m a buy-and-hold investor” means little. I find those words coming from the mouth of an investor who ignores valuations as convincing as the words “I believe in God” coming from the mouth of an unrepentant sinner. The fact that someone says the words is a sign that her heart is in the right place or at least that she possesses some desire to have it moved to the right place. But actions speak louder. Good actions result from experience making good choices when faced with temptation (to sin or to abandon your buy-and-hold strategy).

There’s a problem with relying on personal experience to develop investor confidence. A bull market can last 20 years (the last one began in 1982 and ended in 2000). So there are many investors who do not personally experience the downside of unrealistic investing strategies until well into the later years of their investing lifetimes. This is why I recommend studying the historical stock-return data. Seeing how stocks have performed in the past gives us a way of gaining indirect “experience” in how stocks work without having to suffer the financial losses associated with learning our lessons the hard way.

Comparison #2 Between Building Faith and Building Investor Confidence — Pride Can Ruin You

Someone who is certain he is saved probably isn’t. There’s nothing that more delights the devil than to steal a soul who came close to escaping his reach by injecting it with a heavy dose of pride in his own sanctity.

Pride leads to overconfidence among investors too. Say that you made lots of money in stocks in the 1980s and 1990s, so much that you felt safe beginning an early retirement in 2000. The historical data points to that time-period as the worst time-period in history to begin a retirement. But many of those who were making money during the 1980s and 1990s were not inclined to check into the realities before proceeding with plans that sounded reasonable given how stocks had been performing for the prior 18 years.

The Confident Investor

Were these investors “winners”? Many would say “yes” given the extraordinary returns they experienced for many years. But those who experience busted retirements are not winners; they are losers. Pride causes excessive investor confidence. Those who see the stock gains of the 1980s and 1990s as evidence that valuations don’t matter do not possess a true investor confidence any more than those who boast of their holiness possess a true faith. True investor confidence expresses itself in quiet, not boastful, ways.

Comparison #3 Between Building Faith and Building Investor Confidence — It Gets Easier

Building your faith is hard work. It gets easier with time, however. The first step — accepting that there might be a God and that you might want to keep His law in mind when deciding what work to do and what friends to hang out with and what movies to watch and how to converse with your fellow humans — is a shocker. Those who stick with the project long enough to enjoy some of the rewards that follow from it learn that, while it never gets easy, it does get easier.

There are a lot of people who are afraid to adopt Valuation-Informed Indexing as their investing approach when they first hear about it. It’s not the norm, at least not at times when prices are where they are today. It seems odd, it seems strange. If you become a Valuation-Informed Indexer, you will be following strategies not followed by many of your friends. That’s tough stuff.

I’ve been following this approach for 11 years now and at this point I cannot imagine ever wanting to go back to the dark side. Considering prices comes to make all the sense in the world once you get used to the idea. It no longer seems odd to me to do so. What seems odd to me today is the idea of not considering prices.

If you stick with a realistic investing approach long enough, you will enjoy better returns as the result of doing so. Once that happens, taking a long-term perspective is no longer the hard road. It is the comparatively easy one. What is hard starting out becomes easier with time.

Comparison #4 Between Building Faith and Building Investor Confidence — It’s All About Believing in the Unseen

There are many intellectual arguments that can be advanced in support of a faith in God. Reading those arguments can help you develop your faith. But they cannot get you all the way there. Doubts can undermine the strongest intellectual arguments. Sooner or later you need to make the leap to believing in the unseen. A purely intellectual faith is not a strong and long-lasting faith.

There are many intellectual arguments that can be advanced in support of buy-and-hold investing. Reading those arguments can help you develop investor confidence. But they cannot get you all the way there. Unexpected short-term price changes can tempt you to buy at bad times to buy or to sell at bad times to sell. Sooner or later you need to make the leap to believing that stocks will perform in reasonable ways in the long term and to using that belief as the cornerstone of your investing strategy.

The long term is “the unseen” in investing. It’s real, as real as God’s country. But the human mind is drawn to consideration of short-term results. I cannot tell you how many times I have had conversations with investors who claim to be following long-term strategies and who point to short-term results as their evidence that it is okay to ignore valuations in setting their stock allocations. The long term is what’s real. The short-term is what seems to be real. Success comes from coming to believe in the long term, the unseen of investing time frames.

Comparison #5 Between Building Faith and Building Investor Confidence — You Need to Tune Out the Noise

Investor Emotions

I read somewhere that to be “holy” means to be “set apart.” I don’t particularly want to be set apart, you know? I want to be in the middle of things. I respect the Amish for giving up electricity to keep the temptations of the modern world at bay. I don’t want to follow their lead, however. I like my Dylan albums and I like my DVD player and I like my computer and I like my electric toothbrush.

My run to God is a run made in a potato-sack race, all stumbles and jumbles. My hero is Saint Augustine, who prayed to be made chaste “but not just yet.” To make significant progress on my quest for heaven, I’ll need to tune out the worst of the secular world.

There’s a lot of noise that serves to distract you from your realistic investing goals too. You want to be a buy-and-hold investor but other investors have gotten caught up in the enthusiasms of a wild bull market and are saying that it is okay to ignore valuations. That’s the devil talking. That’s temptation. That’s the big red apple. That’s noise. Tune it out.

Investor confidence comes from being able to distinguish what’s real from what is not. U.S. stocks have been delivering a long-term annualized real return of about 6.5 percent for a long time now. When returns go well above that, know that they are not lasting stuff, not real. The noise won’t hurt you so long as you do not let it influence your investing decisions. Successful investors need to keep themselves “set apart” from the nonsense gibberish being given voice in the newspapers and on the radio and on the television.

Comparison #6 Between Building Faith and Building Investor Confidence — You Can’t Fake It

Faith will help you know what is the right thing to do. But you can’t fake it. Only a real faith yields inner peace. A false faith leaves you in a grumpy mood, like Dylan was for a few years back in the early 1980s. Faith will offer you comfort during hard times. But a false faith will crumble in hard times. Faith will fill your heart with gratitude. But only a true faith does that. A false faith can leave you angry and isolated and trapped in negativity.

Pretending (even to yourself) to believe in something you don’t really believe in is a strain. The path of faith is a different path from the path of unbelief. As you walk farther down the new path, you are forced to give up more of what you believed while on the old path or to live in contradiction. Faith begins with one simple decision (that there is a God), but it comes to influence every aspect of your life.

Buy-and-hold affects every aspect of your investing plan. It affects your allocation choices. It affects what sort of investing news you listen to and what you make of that news. It affects what sorts of returns you come to expect to receive from your investments. Most investors who today claim to be believers in buy-and-hold have not thought through what is involved in taking that path. It is a good path. But it is a demanding path. The buy-and-hold path is a path that works only for those with a serious commitment to walking it all the way to the end.

For those who lack a serious commitment, buy-and-hold is a dangerous path. There is nothing worse than a buy-and-hold strategy that fails; it is the buy-and-holders who sell last, when prices are at their lowest. You can’t fake buy-and-hold. True buy-and-holders inform themselves of the realities before proceeding down this high-potential but high-risk path.

Successful Investors Buy-and-hold is not a halfway strategy. It requires commitment. Commitment requires true belief. A true buy-and-hold can open to you the juiciest of financial rewards. A faked buy-and-hold can sour you on stocks for life.

Comparison #7 Between Building Faith and Building Investor Confidence — You Can’t Do It Alone

You won’t grow your faith by sitting in a room concentrating on the task. You’ve got to read books. You’ve got to talk it over with friends. You’ve got to test your faith in real-world situations. You’ve got to mix it up a bit. You’ve got to sing out your faith and twist and shout about your faith and laugh along with your faith. A living faith is not a theory.

Investor confidence too must be lived to be real. It’s not possible to have strong confidence in strategies that are not tested by reading about and exploring and trying to understand competing strategies. It’s not possible to have strong confidence in strategies that have not been discussed with others, lots of others, all sorts of others. It’s not possible to have strong confidence in strategies that have not been tested in real-world dramas.

I don’t believe in short-term timing. I haven’t believed for a long time. Every now and again, I will hear an argument for what is going to happen in the short term that sounds plausible. Sometimes, I make a mental note to check back in a few months to see whether the short-term predictions paid off or not. One of the reasons why I don’t believe in short-term timing is that it so often fails these tests.

I believe in long-term timing. I believe because I have read so many of the best-informed experts say things that tell me that it must work. And because I have looked at the historical data from multiple angles and each new look adds to my confidence. And because I have sought input from so many who do not believe who have been unable to offer reasonable arguments for why they believe that long-term timing does not work. I can proclaim my belief in long-term timing on any stage and know that I will not be shot down because my belief is rooted in public encounters in which long-term timing survived challenges put forward by people who are strongly motivated to smash confidence in it.

My beliefs about investing are not my beliefs alone any more than are my beliefs about God. Lots of people more knowledgeable than I am have contributed to my beliefs, both in God and in Valuation-Informed Indexing. If there is no God, it’s not just me who got that one wrong; lots and lots and lots of smart people got it wrong. If Valuation-Informed Indexing doesn’t work, it’s not just me who got that one wrong; lots and lots and lots of smart people got it wrong.

Comparison #8 Between Building Faith and Building Investor Confidence — A Testing Can Be a Strengthener

It’s not until your faith has been tested that you know how strong it really is. People often have a hard time understanding why God does bad things to good people. Perhaps sometimes it is to test their faith and thereby to strengthen it (and thereby to increase the odds of a mother and child reunion).

The conventional approach to buy-and-hold (an approach that ignores valuations) has never been tested. It became popular during the wildest and most out-of-control bull market in U.S. history and, while the bull market appears to have come to an end in 2000, we have not yet seen a price drop to anywhere even remotely in the neighborhood of fair prices. What will happen to the conventional approach to buy-and-hold when it faces its first real-world test? My guess is that it will be proven (even in the eyes of those who today are not open to hearing of its flaws) a gravely flawed strategy.

Out of the failure of the old buy-and-hold will come the birth of a new buy-and-hold, a realistic buy-and-hold, one that can stand up to what happens both in bull markets and in bear markets. We appear to be in the early days of a testing of the now-dominant investing model. I believe that this testing will undermine confidence in the phony version of buy-and-hold but will strengthen confidence in a genuine buy-and-hold, the realistic and informed approach to buy-and-hold. The mother and child reunion is only a motion away.

Investing for the Long Term

We don’t like to be tested. But we need to be tested if we are to develop truly effective long-term strategies.

Comparison #9 Between Building Faith and Building Investor Confidence — Ultimately, It Comes from Inside

You need to hear the words of others and learn from the experiences of others to build your faith. You die alone, however. That’s the ultimate test. Do you believe or do you not believe at the last moment, when there is everything to be gained by believing but when doubts have their greatest power because there is no time left to resolve them? At the hour of your death, you can’t kid yourself or anyone else. Either you’re a believer who believes with the fervor of a Mickey Dolenz or you’re a cynical pretender.

You’ll face a moment of truth in your effort to build your faith in buy-and-hold too. The average portfolio loss on the three earlier times when we have been to today’s la-la land prices is 68 percent (that number does not include the effect of earnings on dividends paid during the time the price drop was taking place). Say that some years from today (this article was posted in May 2007) your stock portfolio is worth one-third of what it sells for today. Will you hold? If your investor confidence is a deep one, one that comes from inside, you will (if your investor confidence is deep enough, you will have already moved to a stock allocation that permits you to hold with relative ease).

If it’s not, then you won’t. “There won’t be no God to comfort you, you taught me not to believe that lie.” That’s Randy Newman talking over the disturbing realities of old age with a man of little faith. When you face death, whether the investing kind or the other kind, you do so alone. Your investor friends will all be selling. The media that now tells you to buy will then be telling you to sell. The market, which is the closest thing we have in InvestoWorld to a Devil (Mr. Market always tries to persuade you to do the thing that hurts you in the end), will surely be telling you not to resist the natural inclination. Will you? Will you? Will you?

Whatever you will do, you will do because of whatever structure of investor confidence you have built inside you in the years leading up to that critical investing moment. I’ll say a little prayer for you, internet friend.

Comparison #10 Between Building Faith and Building Investor Confidence — No Matter How Many Times You Fail, It’s Worth Trying Again

People make fun of Catholics because they go to confession, have their sins forgiven, say their Hails Marys, take a walk around the block, and then get down to the business of committing the same sins all over again. I hate to tell tales on my own kind, but the truth is that it has been known to happen. Don’t ask me how I know. Let’s just say that I have a close friend who calls himself a Catholic and who has occasionally been found to be guilty of this sort of thing, okay?

Experienced Investors

God knows that you’re going to commit that sin again. He wants you to confess it anyway. The idea is that, by confessing it, you gain some grace that gives you a fighting chance of not committing it as frequently. We humans are good at playing the mess around. Still, we can be redeemed. No?

My guess is that there will come a day when most of the humans reading these words will be humans who committed the sin of putting too high a percentage of their portfolio in stocks when stocks were selling at very high prices and who learned that they should have heeded the words of The Wise But Ignored Old Testament Prophet Shiller. If you are one of those, please hear these words — the Church will take you back.

Sin is sin. I cannot tell you that it doesn’t matter. It would have worked out better had you stayed to the straight and narrow. Like Johnny Cash did, you should have walked the line. Still, stocks really do offer a long-term return of 6.5 percent real to those who follow reasonable asset-allocation strategies. You cannot get back the money you have lost. You can begin today investing in more realistic ways and thereby gain confidence that you will do a lot better in days to come than you have done in days passed. Think of investor confidence as grace. Grace overcomes the darkest of sins.

Say 10 Our Fathers and 10 Hail Marys.

Sinner, thou art forgiven.

Go in peace.

Why You Want to Buy Investing Newsletters

Reason #1 for Buying Investing Newsletters — You Have More Confidence In Decisions That Require You to Spend Money

Thoughtful Investor

Most newspapers make more money from advertising than from subscription fees. Why don’t they give the newspapers away for free and thereby increase the number of readers they can deliver to advertisers? Because people don’t respect information they get for free. Advertisers will pay more to be in a publication for which a charge is imposed because people have more confidence in information for which a charge is imposed.

You want to have confidence in your investing decisions. To do so, you need to have confidence in the sources of information you rely on to make your decisions. It’s possible today to get a good education in investing without paying a dime. There are many fine books available at the library. There are many fine web sites available on the internet. The problem is — How do you separate the good information from the bad?

One way to persuade yourself that the information you are relying on is good is to pay for it. Buying investing newsletters is a relatively low-cost way to do that.

You don’t have to buy investing newsletters to obtain good information on how to invest. It’s not a requirement. I don’t see it as such a terrible thing to do, however. Knowing that you paid money for a newsletter might make you feel obligated to read it each month. Reading it each month might really make you better informed as to the the theory underlying your investing strategy. Given how much money is at risk in your effort to make good investing decisions, the subscription price might be a small amount to pay for the benefits obtained.

Reason #2 for Buying Investing Newsletters — They Permit You to Take Credit for Your Investing Successes

There’s a good bit of luck involved in investing. Those who invested in U.S. stocks in the 1980s and 1990s found it difficult to lose money. Those who were fully invested in 2000 have found it hard to stay even with those invested in far safer asset classes in the time since. Timing is everything (but yet they tell you that you can’t time the market!)

If you lose, you lose; that’s the fault of the market. If you win, you’d like it to be your “fault.” If you bought investing newsletters, you’ve got a credible claim to persuade yourself that you did something to generate those nice returns you obtained. Buying investing newsletters transforms investing success from something that just happened to something that you made happen.

There is an element of kidding yourself that goes into this, of course. But is that so terrible? If you start thinking that your good decisions make you the world’s greatest investor, it’s terrible. If you just permit yourself a little pat on the back for doing reasonably well, there’s little harm in feeling a little better about yourself than you would otherwise feel. There are more expensive ways to bring on good feelings about yourself than paying for investing newsletters.

Reason #3 for Buying Investing Newsletters — They Provide You with Access to a Friendly Voice

Investing Insiders

Good salespeople can make almost unlimited amounts of money. The key to good salesmanship is making people feel comfortable with decisions to spend money.

I’m not knocking it. Our economy is a consumer economy. We need to get people to buy things to keep the wheels spinning. Salespeople make things happen. My personal and highly biased view is that journalists should get paid a whole big bunch more than salespeople. Still, I kinda sorta see why salespeople usually get paid a lot more. A journalist can write the most important book ever written and it does no one any good unless a salesperson gets someone to buy it. Salespeople make things happen.

The usual way in which people are persuaded to purchase stocks is through stockbrokers. Investing newsletters can provide the same general service at a lot less cost. Again, there’s no requirement to buy investing newsletters to prompt you to buy stocks. But will you really make the purchases without first hearing the friendly voice? Or do you need the friendly voice offering reassurance to get the transaction completed? Investing newsletters provide a friendly voice at a relatively low cost.

Reason #4 for Buying Investing Newsletters — They Foster Learning Through Repetition

Say that you happen to come across an article on the internet that provides outstanding answers to many of your investing questions. How much good does that article do you?

There’s a good chance that the article doesn’t do you that much good.

If you return to that web site (hint — bookmark me now while you’re thinking about it!), it can do you a lot of good. If you only read the amazing article one time, the message is not going to sink down deep to where it exerts a big influence on your investing decisions. Humans learn through repetition. You need to hear good information not one time, but two times, three times, four times, five times, six times, seven times. The more times the better.

Most investing newsletters provide the same general information over and over again. That’s a rip-off, in one sense. In another sense, it’s a good thing. If the information is good, you are better off being exposed to it twelve times than you are being exposed to it one time. Newsletters that repeat a good message thereby make it more likely that that good message will result in good long-term investing returns for you.

Reason #5 for Buying Investing Newsletters — Doing So Makes You Part of a Community

Information is everywhere. What investing newsletters are really selling is access to a community. When you buy the Value Investor Newsletter, you become part of the value investor community. When you buy the Momentum Investor Newsletter, you become part of the momentum investor community.

Why is community so important? Because you sense what you are up against in trying to learn how to invest effectively. Millions of others are doing the same thing and we cannot all obtain better-than-average returns. If you need to process all the information needed on your lonesome, you’ve got a big job. If you have a community behind you helping you out, you just might make it afterall.

Investing Tips

It makes sense to want to tap into the collective wisdom of a smart investing community and it’s worth paying for investing newsletters to do so. The tricky part is avoiding the bad communities and identifying the good ones. There really is power in the community concept and, if you come to identify with bad ones, that power goes to work against you.

Reason #6 for Buying Investing Newsletters — They Give You Ammunition to Use to Discredit “Enemy” Strategies

Communities not only bring good stuff in. They keep bad stuff out. People buy investing newsletters because they provide them with “answers” to points raised by those advocating alternate investing strategies.

The danger of groupthink enters the picture here. You can often learn a lot by giving “enemy” strategies their due. When your favored strategy holds up in the face of criticism, seeing it do so gives you that much more confidence in it. When it fails to do so, seeing it fail to do so provides you with the warning that you need to make changes in your strategy.

I’ll pay more for investing newsletters that are fair in their consideration of alternative strategies than I will for those that encourage cult-like acceptance of one school of thought. Investing newsletters that encourage thought are more likely to produce good fruit in the long-term.

Reason #7 for Buying Investing Newsletters — They Provide You With Bite-Sized Learning Bits

The biggest cost of a book is the time it takes to read it. Investing newsletters are short. That’s their primary appeal.

Reason #8 for Buying Investing Newsletters — They Provide an Edge

You’ve probably heard the joke about the one hunter who asks the other hunter why he is tying on his sneakers. The one tying on his sneakers says that he’s seen a bear heading in their direction. The other fellow says: “Are you crazy? You’re not going to be able to outrun a bear!” While taking off, the other fellow shouts back: “Oh, I figure that I don’t really need to be able to outrun the bear. I figure that if I can outrun you, the bear will be otherwise occupied for awhile.”

That’s the way it works. Investing is a zero-sum game. There is only so much in the way of returns being generated and lots of investors trying to earn their share of them. You need an edge. Even a small edge can be worth a lot of money if it is enough to put you ahead of the mass of investors.

Investing Newsletters

Most of the promised edges don’t pan out, of course. We keep looking for them, however. That’s one of the reasons why we buy investing newsletters. It’s like drilling for oil. If one of ten investing newsletters you buy provides you with a significant edge, it can bring in enough money to more than pay for all the others.

Reason #9 for Buying Investing Newsletters — It’s a Low-Cost/Low-Risk Decision

Investing decisions are hard. There are so many of them that need to be made. Most of them cost money. Most of them involve risk.

The decision to buy an investing newsletter doesn’t cost much money and doesn’t involve taking on much risk. It’s a relief to be able to make a decision like that every now and again.

Reason #10 for Buying Investing Newsletters — They Provide a Filter on the Investing Information You Need to Review

If you trust the author of your investing newsletter, buying the newsletter can help you avoid having to read lots of other material. Investing newsletters are a filter that many find it worth some money to pay for.

Reason #11 for Buying Investing Newsletters — They Provide Educational and Entertainment Value

Investing Gurus Lots of people buy investing newsletters at least in part for non-investing reasons. They educate themselves on strategic thinking that can be applied in other areas of life. Or they entertain themselves with amusing asides or well-written explanations of investing developments. It doesn’t make sense to pay the price of an investing newsletter just for the non-investing education provided or the entertainment value provided. But these can be nice extra rationales for buying investing newsletters that deliver the more obvious dollars-and-cents benefits too.

The 24 Most Common and Most Costly Investing Mistakes

#1 of the Investing Mistakes — Putting Too Much Faith in Experts.

Investing Mistakes

Most experts are compromised in some way. They might hope to sell you something. They might not be willing to jeopardize their popularity by shooting straight with you. They might be wedded to a school of thought they learned about in school and be reluctant to give it up even though it has been discredited.

#2 of the Investing Mistakes — Trying to Know Too Much.

No one knows everything there is to know about investing. Insist on getting everything pinned down before acting and you’ll never act.

#3 of the Investing Mistakes — Being Satisfied with Knowing Too Little.

The biggest problem with trying to know too much is that it eats up time that could have been spent developing a firm grasp of the fundamentals. You must possess a clear understanding of the fundamentals before putting money on the table.

#4 of the Investing Mistakes — Failing to Consider Prices.

It kills me to see people who watch what they spend on cars and houses and vacations not even pay attention to the prices that apply for the stocks they buy. Many of us spend more in the course of a lifetime on stocks than we do on cars or houses or vacations. Don’t agree to a bad deal just because you are anxious to complete a deal. The income you will be paid for your investing patience may well end up being the largest per-hour income you will ever be paid.

#5 of the Investing Mistakes — Giving Too Little Attention to the Emotional Side of the Story.

All investing decisions are made as a result of a mix of reason and emotion. The reasoning side of the story is relatively easy to figure out. So there is lots of material in the literature addressing it. The emotional side of the story is harder to figure out. So it is harder to find good information that addresses this side of the story. The biggest risk that investors take today is the risk associated with not being informed about the emotional side of the investing decision-making process.

#6 of the Investing Mistakes — Focusing on the Short-Term.

Few of today’s investors will acknowledge a short-term focus. But many point to results they have obtained over the past 10 years when their strategies are questioned. Investors as a group are about halfway to where they need to be to develop the skills needed to become true long-term buy-and-hold investors.

#7 of the Investing Mistakes — Not Paying Heed to Common-Sense Doubts.

Much of the conventional investing wisdom does not add up. You don’t need to study investing for years to see that. Your common sense tells you. Listen to those warning voices. Don’t assume that because a good number of others are going along with a strategy that does not seem to make complete sense that it’s because you are dumb that you have doubts. Get all of your questions answered before putting money at risk.

#8 of the Investing Mistakes — Putting Too Much Confidence in Numbers-Based Analyses.

Pride Comes Before a Stock Crash

Mark Twain cautioned us about lies, damn lies and statistics. Numbers can be used to “prove” the merit of just about any investing strategy imaginable. Numbers alone are never enough.

#9 of the Investing Mistakes — Putting Too Little Confidence in Numbers-Based Analyses.

Words alone are often not enough either. After you have learned not to trust numbers, you need to learn to trust them again in circumstances in which they add value. Numbers that support strategies rooted in common sense are a huge help because knowing what the numbers say can help you tune out a lot of dangerous nonsense.

#10 of the Investing Mistakes — Granting Too Much Influence to the Views of Friends, Neighbors, and Co-Workers.

Listen to what your friends, neighbors, and co-workers say about what plumber to use. Be skeptical about what your friends, neighbors and co-workers say about what investment is right for you. What ‘s the difference? Your friends, neighbors and co-workers have no reason to steer you wrong about plumbers. When stock prices are high, there’s a good chance that your friends, neighbors and co-workers own stocks and have become emotionally invested in this asset class. It might be that they are deceiving themselves as much as they are deceiving you. Knowing that will offer little comfort when the investment fails to live up to expectations.

#11 of the Investing Mistakes — Failing to Discuss Things Regularly with a Group of Like-Minded Friends, Neighbors and Co-Workers.

You can’t go by what your friends say just because they say it. However, it can be a big help to find a friend with similar investing views. Humans are social animals. We need reassurance to stick to our strategies. We learn more by talking things over with those of like mind than we do by reading books.

#12 of the Investing Mistakes — Treating Investing as a Life Endeavor Unlike Most Others.

Dating can teach you about investing. Raising a child can teach you about investing. Advancing in your career can teach you about investing. Bodysurfing can teach you about investing. Why do so many put “Investing” in a box by itself? Humans invest. You don’t take off your human hat and put on an investor hat when it comes time to make decisions about stocks or bonds or real estate or whatever.

#13 of the Investing Mistakes — Making Financial Plans Based on Newspaper Numbers

You need to know what you are worth to make realistic financial plans. At times of overvaluation and undervaluation, your stock portfolio is not worth what the newspaper numbers say it is worth; it’s true worth is a good bit less or greater than what those numbers indicate. If you fail to make adjustments, you will find yourself over time becoming more and more reluctant to accept the realities. Down that road lies real trouble.

#14 of the Investing Mistakes — Letting the Dark Side of Human Nature Gain the Upper Hand.

Think for Yourself When people talk about investing emotions, it’s too often fear and greed that are the focus of the discussion. How about hope? How about love? Some emotions cause us to do bad things, some emotions cause us to do good things. Don’t tune out your emotions; that never works. Tune in to the good emotions and use them to counter the negative influence of the bad ones.

#15 of the Investing Mistakes — Not Taking Enough Chances.

There is no such thing as a truly risk-free investment anymore than there is such a thing as a truly risk-free life. The entire point is to take some chances. So get in there and take some chances. Ask a girl to dance. Get rejected. You’ll figure it out. It’s by taking chances that we learn, and it’s by learning that we get rich.

#16 of the Investing Mistakes — Taking Too Many Chances.

It’s one thing to ask a girl to dance. It’s something else to drive drunk at 80 miles per hour on a motorcycle in an attempt to impress her. Don’t take all your chances at one time. Spread them out. Wait for the right girl to come along and put it all on the line then. Take calculated risks.

#17 of the Investing Mistakes — Failing to Learn from the Past.

You don’t need to crash your motorcycle to figure out that it’s not a fun thing to do. If you see that there’s something that has caused lots of others to crash their motorcycles before you came along, don’t do that thing.

#18 of the Investing Mistakes — Failing to Anticipate How the Future Will be Unlike the Past.

Maybe in the old days there was no need to invest globally. Maybe that’s changing. Read the motorcycle magazines to keep up with changing times.

#19 of the Investing Mistakes — Adopting a Bull vs. Bear Mentality.

Bulls know things that bears do not know. Bears know things that bulls do not know. The object of the game is to make money. That means that you are not above learning from bears or bulls. If you find yourself adopting an “us vs. them” mentality, you’re doing something wrong.

#20 of the Investing Mistakes — Putting Too Much Faith in Academic Theories.

Overcoming Obstacles on Your Way to Investing Success

Academic theories can help so long as you keep the insights they seem to offer in perspective. The more complex a theory is, the more skeptical you need to be regarding it. Ask yourself — Why is this theory popular? Is it because it explains riddles? Or is it because it benefits people trying to sell something or props up a story that has become too good to be true?

#21 of the Investing Mistakes — Taking Too Much Personal Credit for Successes.

Everyone who owned stocks made money in the bull market of the 1980s and 1990s. Those who started thinking that it was their own genius that was responsible have faced more inner resistance to the idea of lowering their allocations when prices got out of control.

#22 of the Investing Mistakes — Taking Too Much Personal Blame for Failures.

Lots of investors are likely going to suffer pains when stock prices return to more reasonable levels. Is it their fault? To some extent. Not entirely. This is a story that repeats over and over. So it is fair to say that the pull to overinvest in overvalued asset classes is a strong one. You should try to learn from your mistakes. To do that, you first need to stop hitting yourself.

#23 of the Investing Mistakes — Not Laughing Enough

A sense of humor is the distinguishing trait of the world’s most successful long-term investors. Why is a sense of humor so important? It helps you distance yourself from your decisions. It allows you to pull back emotionally and allow your reason to tell you what it wants to tell you.

#24 of the Investing Mistakes — Failing to Learn from Mistakes.

If you make your big mistakes young, consider yourself blessed. If you make a big mistake when you are up there in years, that really hurts. Perhaps you have more time ahead of you than you realize, though. Perhaps it won’t take as much time to make up for reversals as you are now thinking it will take. God created mistakes to teach us. The learning experience has monetary value — not immediately, but over time. Don’t let any whopping big mistakes go to waste.

Why Investing Books Are Boring

Investing Books Are Boring Because They Talk Down to the Reader.

Investing Books Are Boring
There is a line in a book by William Bernstein (The Four Pillars of Investing) that served as a breakthrough for me in my effort to understand why today’s investing advice is so poor. Bernstein noted that he discusses lots of mathematical concepts in his writings and commented that he has been told that each numerical calculation included in a book decreases sales dramatically. The clear suggestion being put forward was that this is a bad thing.

Is it?

I suppose that some think it would be nice if we were a society of Albert Einsteins and we all counted down the hours while we were at work until the coming of that wonderful moment when we could return to the one thing in our lives that made it all worthwhile — being able to stay up all night studying the mathematical calculations set forth in the latest investing guide. Bruce Springstein wrote a song about this special moment of the day:

When I’m out on the street, I never feel sad and blue
When I’m out on the street doing investing calculations with you!

It goes something like that anyway. I’m not convinced that this would be such a great thing. That sort of world would be a world of monsters, in my estimation. We need Numbers Guys and Gals, to be sure. But I don’t want to live in a world in which everyone is a Numbers Guy or Gal. I see it as a healthy thing that the people who are not Numbers Guys and Gals and who work hard all day are looking for something a bit more on the light side for the bedtime reading table.

Bernstein blames the reader for not liking mathematical calculations. He should be blaming himself for liking them so much that he feels a need to include in his books more of them than most people can tolerate. I like Bernstein. I like his book. But come on.

Mathematics is part of investing. That’s a fact. It doesn’t follow that investing guides aimed at the general public need to include extended discussions of mathematical concepts. The idea is for the author to learn from that stuff and then present the insights developed by doing so in a nice easy-to-swallow format for the benefit of his readers.

I detect a bit of a patronizing tone in Bernstein’s comments. I don’t think it is intentional. I don’t think he sees it himself. I think he believes that he knows more about investing because he is comfortable with mathematical calculations. I think he is wrong. I think that Bernstein could learn a lot from some of those people who are not willing to work their way through too many mathematical equations in an investing guide.

The job of an investing guide is to help people learn. If mathematical equations don’t do the trick, the job is to find another way, not to complain that the way in which you would prefer to proceed doesn’t do the trick.

Investing Books Are Boring Because They Are Written by People With Poor Communication Skills.

We’ve had a good number of conversations at the Retire Early boards about the differences between different personality types. The “planner” type (these are INTJs, in Myer-Briggs personality testing lingo) dominate in the investing advice field. This type is good with numbers. This type is terrible at communication with other humans. This type should not be writing investing guides.

Please do not think that I am down on INTJs. I have picked up hundreds of investing insights from INTJs. Still, I believe that this type generally should not be writing investing guides. INTJs are not good communicators.

Do you remember how people used to say that Ronald Reagan had no business in politics because he was just an actor in B-Grade movies? It turned out that Reagan went pretty darn far in the politics field despite his lack of “credentials.” What he possessed was communication skills. Communication skills matter.

Too many investing guides are written by people with the wrong sorts of skills for writing an investing guide. They are written by people who manage lots of money or by people who love numerical calculations or by people who elbowed their way to the top of a mutual fund and want the ego gratification that comes with having your name on a popular investing guide. The millions of middle-class investors who need to learn how to invest are looking for something very different from what these sorts of people can provide. So they are naturally bored by many of the investing guides available to them in bookstores today.

Investing Books Are Boring Because They Don’t Tell the Full Story.

Why We Don't Listen to Investing Advice The types of people who are widely referred to as investing “experts” tend to stick together. They read the same articles, attend the same speeches, think the same thoughts, offer the same advice. The dominant model of how investing works in recent years is the Stocks-for-the-Long-Run Model, which is rooted in a belief in a disastrous academic theory known as the Efficient Market Theory. If these people got out and talked with people not associated with the stock-selling industry more often, they would come to see the holes in this theory and in this investing model. But they have permitted themselves to get all caught up in what Elvis Costello once referred to as “a brilliant mistake.”

I wish that I could push a button
And talk in the past and not the present tense,
And watch the Efficient Market Theory
Disappear like it was common sense.
It was a fine idea at the time.
Now it’s a brilliant mistake.

Again, it’s been a few years since I listened to the album that contains that song. It’s possible that I’m just a little mixed up about a word or two of that one. I’ve got the feeling right anyway. That’s what counts in the investing advice biz, right?

Analyses rooted in the Stocks-for-the-Long-Run Paradigm ignore the human element of stock investing, the manner in which emotional humans first push stock prices up to absurdly high levels (this article was posted in September 2007) and then down to absurdly low levels. Ignore this element and you ignore half of what you need to know about how to develop realistic long-term investing strategies.

Can you imagine any book that ignores half of what those interested in the topic addressed need to know about it being exciting? The writers of investing books need to get their heads out of the In-the-Koo-Koo-Clouds World dreamed up by the Ivory-Tower Eggheads and get real. Real is not boring.

Investing Books Are Boring Because They Don’t Make Sense.

Please don’t think that I have it in for William Bernstein. His book is the one that often comes first to mind when I am formulating these arguments because it is so frustrating a read. Chapter Two of The Four Pillars of Investing is my favorite chapter of any investing book that I have read. The rest of book is gravely flawed and at times extremely dangerous. The mix of the good and the bad contained in this book sums up for me all the flaws that make so many investing books so boring. A community member named “Raddr” (he’s the owner of the site) once went so far as to assert that Chapter Two is “out of context” with the rest of Bernstein’s writings! That one kills me. How can an entire chapter be out of context? But Raddr has a point. Chapter Two puts forward critically important points about valuations that Bernstein ignores in most of his other writings.

Bernstein says on Page 3 that: “Assets with higher returns invariably carry with them stomach-churning risk, while safe assets almost always have lower returns.” He says on page 234 that: “it’s likely that future real stock returns will be in the 3.5 percent range.” He says on Page 235 that: “Treasury Inflation-Protected Securities (TIPS) currently yield a 3.5 percent inflation adjusted return” but that “for firm believers in the value of a diversified portfolio, this options is profoundly unappealing.”


The point of diversification is to reduce risk. It’s not possible to have less risk than is present in an all-TIPS portfolio. Bernstein is saying that TIPS are likely to provide the same long-term return as stocks at far less risk. So what’s the downside of this “profoundly unappealing” asset class? Bernstein is holding all the pieces of the puzzle, but he is not able to figure out how to fit them together. He puts forward a good number of intelligent-sounding sentences. But then he offers advice that is at odds with the course of action arrived at by a logical consideration of the points made in those sentences. Bernstein himself doesn’t find his arguments sufficiently compelling to cause him to take them into consideration when formulating his investing advice; how can he expect them to hold the attention of his readers?

Bernstein’s clear preference for stocks even at times when stocks are absurdly overpriced does not make sense. An argument that does not make sense is like a song without a melody. Playing it so loud that it demands attention works for only a short while. That sort of thing gets boring fast.

If I discovered such a logic error in a book that I wrote, I would be mortified and would want to call the book back. But if all the investing books that contained such elementary errors in reasoning were recalled, the bookstores would need to hire more employees to handle the massive increase in foot traffic. By no means is it only William Bernstein who is guilty of this sort of thing. Truth be told, Bernstein is one of the best, not one of the worst. My sense is that the authors and editors of most investing books just flat-out do not care whether the arguments in them make sense. The aim seems to be to attain enough surface plausibility to attain a sale in a field in which standards are low but not to worry whether the ideas put forward hang together or stand up to serious scrutiny.

What's Next in Investing?
Have you ever watched a suspense movie in which the plot does not make sense (I know you have because I’ve watched dozens of them!)? Such movies can pull you in and keep you excited for a time. As the plot line grows more and more absurd, however, you lose interest. Investing books that do not make sense are boring.

Investing Books Are Boring Because They Place Too Much Focus on Numbers.

The most valuable poster in the Retire Early community is John Walter Russell (owner of the site). This fellow is not just a Numbers Guy, he is Numbers Machine. The numbers are important. You must study the numbers to know how investing really works.

It doesn’t follow that investing books need to be filled with numbers. I am making a separate point here from the one I made above. The point above is that most middle-class investors do not find much appeal in a book filled with numbers. The point here is that, even if they did find appeal in such a book, a book that is focused on the numbers is telling the boring part of the investing story.

What do the numbers mean? What do the numbers tell us? That’s the exciting part of the story. The numbers must be discussed in any effective investing guide. But let’s not get carried away, eh?

My sense is that the authors of many boring investing books focus on the numbers because it is safe territory to talk about them. Many of the people frequently referred to as “experts” possess only a surface understanding of the subject and do not feel comfortable exploring too deeply what the numbers mean.

The authors of many investing books are faking it. Faking it produces a boring read.

Investing Books Are Boring Because They Get the Numbers Wrong.

It’s not just that most readers don’t like struggling with numbers and that investing books focus too much on the numbers. Another reason why many are so boring is that they get the numbers wrong. If there is anything more boring than having to work your way through a lot of dumb numbers, it’s having to work your way through a lot of dumb numbers that don’t add up.

Stocks for the Long Run is the granddaddy of numbers-based investing books. I wouldn’t call that book boring; it’s been too influential to be called boring. I would say, though, that Stocks for the Long Run will not stand the test of time. When stock prices come down, the holes in the arguments put forward in the book will be revealed (please see the article at the “The Book I Read” tab for a discussion of the flaws of this investing guide), and most people in search of an investing guide will be much less interested in learning what it has to say than they are today.

If you are going to report the numbers, be sure to get the numbers right. That’s the ticket to producing a non-boring numbers-oriented investing guide.

Investing Books Are Boring Because They Take Copycat Positions.

Mathematics of Investing

They all say pretty much the same thing, don’t they?

Buy-and-hold. Stocks are best. Timing doesn’t work. Blah, blah, blah. Blee, blee, blee. He said it and he made lots of money doing so, so I’ll say it too, maybe I’ll add a chart or a cartoon to bring a bit of something that might look for a moment like life to the dead horse. I hope that many fall for it a second time and I catch a big wad of that easy money I have seen so many others grab onto in recent years, blee, blee, blee.

When those trite phrases from the huge bull fade from popularity, there will be a new series of trite phrases inspired by the huge bear that inevitably follows a huge bull that will be just as boring to those seeking an understanding of how stocks really work in the long run.

The truth about stock investing cannot be summed up in a trite phrase or two or three. An exciting investing guide needs to report the truth in the phrases noted above while also pointing out the flaws in them. Science is more exciting than science fiction.

Investing Books Are Boring Because They Fail to Explore the Connection Between InvestoWorld and that Place That We Fancifully Refer to As “The Real World”

Few people buy cars because they like cars. People buy cars because they want to be able to get from one place to another place.

Few people buy telephones because they like telephones. People buy telephones because they want to have conversations with their friends.

Few people buy investing books because they like investing books. People buy investing books because they want to do things with their lives that they will only be able to do if they obtain a strong long-term return on their accumulated savings.

Too many investing books talk about investing as if it were a separate topic from the topic of how to live a successful life. It is not a separate topic. An exciting investing guide must always keep the connection between the little picture and the big picture in mind. Telling people how earning better investing returns can change their lives, that’s exciting. That’s the point of the project. Too many of today’s investing guides get too caught up in their convoluted arguments on behalf of the trite catch phrases that they fail to address the point of the project in an effective way.

Investing Books Are Boring Because They Are Quickly Dated.

Getting Started in Investing

I noted above how the trite observations that serve as the driving force of most of today’s investing guides will become outdated once stock prices return to reasonable levels. People should not have to buy new investing guides each time we enter into a new stage of the investing cycle. An exciting investing guide is one that can be read for profit both in bull markets and in bear markets. Investing books written to appeal to the investor prejudices of one particular type of market come to be seen as boring in a relatively short amount of time.

Investing Books Are Boring Because They Overlook the Drama of the Topic.

The investing story is an exciting story. It is a story of fear and greed and hope and love. It is a story of shame and guilt and friendship and generosity and determination and humor. It’s all there. It is a story of how pride causes the downfall of those who have come to see themselves as bigger than they are. It is the story of how the little guy can gain an edge on the powerful by tapping into a few powerful insights of the type that helped David overcome Goliath.

The investing story is an exciting human drama. You wouldn’t know it from reading most of today’s investing guides. But it’s so.

Ask Bruce Springstein.

It Takes More Than Intelligence to Be an Intelligent Investor

It takes more than just the thing we usually refer to as “intelligence” to become a truly intelligent investor. The successful investor combines the kind of intelligence measured in I.Q. points with common sense, emotional balance, and street smarts.

Intelligent Investor Scenario #1 — You Learn of an Exciting Development

Intelligent Investor

You see an article describing a miracle drug that has recently been approved by the government. You are able to envision many ways in which the company producing the drug can make profits from it. Can you increase your investment returns by investing in the company producing the drug?

You probably cannot increase your investment returns by investing in the company producing the drug. There are lots of people who know about the value of this drug. The price of the stock of the company producing the drug probably already reflects the intelligence that you are trying to make use of here.

Intelligent Investor Scenario #2 — You Discover Something That Most People Don’t Know About

You hear from several friends that they like a new chain restaurant that now operates from a single location but that plans to open at hundreds of locations within a few years.

Your odds of a good outcome are slightly better in this scenario. But they still are not terribly good. The odds are better because the intelligence you would be putting to use would be a more specialized form of intelligence.

Not many investors have friends who have tried out this restaurant concept, so you have an edge. However, there may be a good number of investing professionals following developments, and they may either have heard the same sort of feedback that you have heard or have heard better-balanced reports (giving them a greater edge). This intelligence is not public, but it is questionable whether it is intelligence that can be reliably put to use increasing investment returns.

Intelligent Investor Scenario #3 — You See An Investor Overreaction

Litigation is brought against a company with a long record of good earnings, causing its price to drop to seemingly absurd low levels. You had considered buying shares in the company at a far higher price, and are now tempted to buy despite the litigation because the price has dropped so low.

In these circumstances, I think that your odds of a successful long-term outcome are good. In this case, you are not trying to take advantage of factual information that can be exploited more effectively by others. You are seeking to take advantage of your understanding that investing is primarily an emotional endeavor, and that investors often overreact to news developments of this sort.

So long as the company’s long-term prospects really are solid and so long as you have what it takes to wait for the bargain purchase to pay off, your odds of a successful outcome are good. There are always exceptions, of course. But if you seek to take advantage of a number of scenarios of this sort over the course of a lifetime and do the research work needed to make the edge you obtain by doing so a genuine one, I think you stand a reasonable chance of being rewarded for the effort.

Intelligent Investor Scenario #4 — You Accept Your Own Limitations

Investing Plan

You lose big on a stock you thought was a sure winner and conclude that you are better off investing in a broad index.

There are two types of intelligence at work in this scenario. The I.Q.-type intelligence tells you that indexing provides diversification benefits you could not obtain by investing in a basket of individual stocks. Even more importantly, choosing index funds evidences an emotional maturity that is likely to pay off big in the long run.

Choosing to invest in an index because you doubt whether you have what it takes to successfully pick individual stocks is a sign of emotional intelligence. This is why Warren Buffett, the greatest stock-picker of all time, says that most middle-class investors would be better off in index funds.

Intelligent Investor Scenario #5 — Your Humility Is Rewarded and Turns Into Pride

After several years of indexing in which you obtain outstanding returns, you stop paying any attention to investing at all, and put everything on autopilot.

This is how indexers get into trouble. It is not emotionally healthy to come to believe that indexing is the final solution to the investing problem.

Indexers that get arrogant forsake the humility that makes indexing so appealing a concept. If your returns have been so good as to persuade you that you need not even concern yourself with educating yourself about your investing choices anymore, stocks are probably overvalued and headed for a trip down a waterfall.

Intelligent Investor Scenario #6 — You Push Feelings of Panic Aside

Stock prices drop dramatically and you give thought to lowering your stock allocation. After talking the idea over with some friends, however, you are persuaded that you must hold for the long term to be successful. So you force yourself to ignore your feelings of panic.

Buy-and-hold is indeed the way to go. But an approach to buy-and-hold that requires that you ignore feelings of panic is unlikely to stand the test of time. Buy-and-hold can be practiced successfully only by investors who have informed themselves well of how stocks have always performed in the past and who thus possess confidence that their stock allocations are the right ones for them.

If you are feeling panic, there is a reason, and you had better give serious consideration to the idea of lowering your stock allocation before prices drop even lower and the prospect of doing so becomes even less appealing. This is a case where the investor with street smarts would recognize the holes in the conventional arguments for a blind buy-and-hold strategy, and who would profit from possessing this form of intelligence.

Intelligent Investor Scenario #7 — You Feel Reluctant to Move Outside Your Comfort Zone

What Smart Investors Do Different

You elect to invest only in a broad U.S. index because you do not feel that you understand overseas markets well enough to have confidence in investments you make in them.

Diversification is a good thing. All things being equal, it would be better not to own stocks only in a single market. The other side of the story, though, is that having enough confidence in your investment choices to stick with them for the long term is critical.

I see the choice made in this scenario as a reasonably good use of emotional intelligence. It would be best to combine it with a resolution to learn more about foreign markets over a specified length of time.

Intelligent Investor Scenario #8 — You Feel Drawn to Push Beyond the Barriers of the Comfort Zone Accepted by Many Others

You read an article about the losses suffered in the Japanese market and conclude that it is not safe to be invested in a single market, even the U.S. market.

In this case, the same sort of emotional insight being put to use in Scenario 7 is being put to use supporting a contrary conclusion. This decision is also emotionally smart.

Investors who do not feel comfortable investing overseas probably should not invest overseas (although it would be good for them to make some efforts to overcome the discomfort). Investors who do not feel comfortable investing solely in the U.S. market probably should not invest solely in the U.S. market.

Intelligent Investor Scenario #9 — You Permit Greed a Ride in the Driver’s Seat

A terrorist attack causes a plunge in stock prices. You consider increasing your stock allocation before prices return to their former levels with the thought that you might be able to make a killing within six months or so.

Color me skeptical. Nothing like this has happened before. How can you be sure that prices will return to their former levels within six months? How will you react if prices are even lower in six months?

Intelligent Investor Scenario #10 — You Find the Middle Ground Between Fear and Greed

Your response to a terrorist attack is to increase your stock allocation with the thought that you will see good results somewhere in the long-term future.

This is a case where emotional intelligence can pay off handsomely. There is no guarantee that prices will ever recover if we end up in a third world war. The risks associated with this move are real. The other side of the story is that you would be gaining a share in the profit-generating capacity of U.S. businesses at a far better price than was paid by those who were going with high stock allocations prior to the terrorist attack.

The Seven Traits of Highly Effective Investors

We’ve seen our way through dark times before, and those willing to put money forward the next time we are put to the test in a vote of confidence that we will again stand to win big down the line in the event that history repeats.

Intelligent Investor Scenario #11– You Pay Heed to Appropriate Fears

Prices rise dramatically and you lower your stock allocation on the thinking that the value proposition represented by a stock purchase is no longer as strong as it was when you set your allocation.

This is a street-smart move. The ivory-tower eggheads who say that the market is efficient won’t cover your losses in the event that a change in the price paid for stocks really does affect the long-term return provided, just as common sense and the historical stock-return data and a good number of experts tell us it must. I have nothing against ivory-tower eggheads as a general policy. In this case, though, their claims just do not add up, and I feel that I must invest my money in a way that makes sense to me.

Intelligent Investor Scenario #12 — You Ignore Appropriate Fears

You figure that the ivory-tower eggheads are so much smarter than you that they must be right. So you ignore valuations even when prices rise to frighteningly high levels.

I don’t view it as a street-smart move to put all your trust in experts. They have a lot to teach us. As a general rule, we certainly should learn from them what they are willing to teach us. If you don’t understand the intellectual justification for the advice being offered, though, you’re not going to have the confidence in it to stick with it when it is subjected to a real-world challenge.

It’s one thing to adopt tips offered by others that make good sense to you. It’s something very different to try to gain a free ride on the strength of someone else’s reasoning power.

But what do I know?

The Dark Side of Compounding Returns

The Power of Compounding Returns Is as Great as Everybody Says It Is.

I’m famous for taking a contrary view. Rob Bennett is the fellow who says that saving need not require sacrifice. Rob Bennett is the fellow who says that retirement can be accomplished in stages. Rob Bennett is the fellow who says that the stock market is not efficient. Don’t look to me to offer a contrary take on the key compounding returns question, however. Compounding is a powerful force. It’s every bit as powerful as just about all money advisors tell you it is.

Compounding Returns

It is the compounding returns phenomenon that explains the biggest mystery that newcomers to the Retire Early Movement want to have explained. Most middle-class workers are worried that they will not be able to retire at age 65. In the Financial Freedom Community, we have people pulling it off in their mid-40s. It’s not possible, is it? This falls into the Too-Good-to-be-True category, does it not?

The stuff we talk about at our boards is real. It seems unreal to many because the power of compounding returns is so counter-intuitively great. The reality is that few of us could afford retirement if we had to use money we earned with the sweat of our brow to finance it. Most of our retirements will be financed by money earned by our money. It takes about 25 years to finance a comfortable middle-class retirement. Most don’t become serious savers until age 40, so they are lucky if they can get the job done by age 65. Those who start at age 20 are able to complete the task by age 45 if they get a few breaks along the way.

Take a moment to consider what I am saying here. Those who retire at age 65 do not necessarily enjoy richer retirements than those who retire at age 45. Those who retire at 45 do not necessarily earn more or deny themselves more. They structure their Life Plans differently, that’s the thing. They frontload their saving effort. Those who retire at age 45 might not save a dime after they quit the workforce. it doesn’t matter. Retirement is attained by replacing the money you earn with money your money earns. Do that 20 years earlier and you free up 20 years of living to make use of as you please. Cool deal

That’s the power of compounding returns. Compounding returns is the real turtle soup and not the mock.

The Compounding Returns Phenomenon Applies to Spending Too.

Now we get to the part where I offer contrary views.

Most money advisors remind you regularly how important the compounding returns phenomenon is to your saving effort. Fine. I agree. They leave out a very important point. The compounding returns phenomenon applies to all money allocation decisions, not just to decisions to save. When you spend effectively, there is a compounding returns effect too.

how to multiply moneyYou face a choice to spend money on a gym membership and to get in shape or to put the money in your Section 401(k) account. Most money guides suggest that the better choice is to save. This is not necessarily so. The reason why it is not necessarily so is that spending generates compounding returns too, often benefits greater than the benefits that can be obtained from saving.

Buying that gym membership might improve your health. That could end up making you hundreds of thousands of dollars richer over time. It might enhance your self-confidence, helping you to get a promotion. Again, that could put hundreds of thousands in your bank account down the road a stretch. It might help you meet the girl or boy of your dreams. That can make a big long-term financial difference; happy and settled people are generally more productive.

I urge you to begin thinking about the compounding returns phenomenon in a new light. You should not only be comparing the benefits of spending with the benefits of saving. You should also be comparing the benefits of different spending options. Some spending options generate big compounding benefits. Some do not. Move some of your money from the poor-performing categories of spending options to the strong-performing categories of spending options, and you will attain financial freedom a good number of years sooner.

Compounding Returns Apply to All Smart Money Decisions Made by the Young.

The compounding returns phenomenon isn’t a spending vs. saving thing; it is a young vs. old thing. Money decisions made when you are young have greater long-term impact than money decisions made when you are old. It’s a painfully obvious thing to say, but it needs to be said because this reality is rarely explored in the conventional literature. All money decisions have effects that extend far beyond the time-period in which they are made. Money decisions have a ripple effect. A money decision made at age 20 influences how happy you are at age 25 and 35 and 45 and 55. The younger you are when you make a money decision, the more the ripple effect applies.

I worry that these words will depress my readers of a certain age (I’m 51). “We blew it, all is lost!” we are tempted to conclude. To some extent, that is indeed true. If you are 50 and have not yet gotten serious about money, you have indeed blown a lot of exciting opportunities. Accept it. Have a good cry. Get to a point where you can laugh about it. Move on.

I’m telling you that your bad decisions have had a more powerful effect than you realized. That’s the bad side of this story. There’s a good side. The good side is that future good decisions will also have more power than you have understood they could have until you took a closer look at the power of the compounding returns phenomenon.

How Returns CompoundIf you live to 90, a money decision made at 50 will have a 40-year ripple effect. You have let a lot of power to make your life the best it can be slip through your fingers by waiting until you are 50 to get your act together. But the power you have remaining to you today is greater than what most people realize they have available to them in the course of an entire lifetime. There’s lots of good stuff you can do starting at age 50. The power of compounding returns is truly immense; harness it and you can turn things to your advantage even at this late date.

You Can’t Capture the Full Power of Compounding Returns Without a Budget.

People hate budgets. With a passion. Lots of money advisors have given up trying to persuade people to keep budgets. Even a good percentage of the best savers in the world do not keep budgets. A lot of experts have concluded that people will not keep budgets no matter how many times they are told they should do so, and so it’s not worth putting forward the effort to try to persuade them.

I cannot accept this. Budgets are so powerful that I just cannot give up on my effort to persuade you to begin keeping one. It is because of this compounding returns thing that budgets are so powerful. Every money decision has ripple effects. When you make a bad choice, it hurts you far more than you intuitively expect it will. When you make a good choice, it helps you far more than you intuitively expect it will. Your budget (better referred to as a “Life Plan”) is the tool that helps you distinguish the good choices from the bad. You need a budget, friend!

Say that it takes you one hour per week to keep your budget updated. Say that keeping a budget lets you overcome paycheck dependence 10 years sooner. Is it worth it?

It’s an insane question. Everyone should have a Life Plan. You cannot achieve your potential without a Life Plan. There is no business anywhere of any size that does not keep a budget. You, Inc., needs one too.

Compounding Returns Can Kick Into Reverse.

You’re out of work for six months and you have to take $15,000 out of savings to keep up with the bills. Oh, well — it could have been worse, right?

Wait a minute — it is worse! If you take $15,000 out of savings, your loss is not just the $15,000. It’s the $15,000 plus all of the compounded returns that would have been earned by that money in years to come.

I don’t offer this thought to depress you. I put it forward because it is important that you see that compounding returns work in two directions. When you add to savings, you add more than the nominal amount of the dollars saved. Once those dollars are invested, they begin creating an income stream of their own. When you lose control over them, you lose both the dollars themselves and the income stream that they would have generated (which in the long term is likely to be a bigger loss).

Investing Losses Cause a Reverse of the Compounding Returns Phenomenon Too.

Multiplying Money

Please note the application to investing. People are far too glib about the long-term effect of stock-market losses, in my view. It’s of course true that you need to be willing to take risks to earn a good return on your money; stocks are a risky asset class but also a great asset class. But don’t underestimate the long-term effect of losses. Losing $15,000 in your stock portfolio is as bad as being out of work for six months and having to go into savings to the tune of $15,000 to cover the bills. A $15,000 loss in nominal terms looks a lot worse when you take into account the loss of compounding returns that you suffer as a consequence of that loss.

Rules of Thumb Depending on Compounding Returns Can Create a False Sense of Security.

The common rule of thumb saying that you need to save 10 percent of your income to be able to retire at age 65 presumes that you will begin saving early in life and that you will enjoy many years of compounding returns on the money put into savings in your 20s and 30s. Hearing that saving so small a percentage of income can get you to where you want to go can engender a false sense of security. If you do not begin saving when young, you fall behind each year not by the amount that you failed to put aside but by the far larger sum that is the amount that you failed to put aside plus years of compounding on that amount.

Compounding Returns Create Leverage.

The bottom-line is that compounding returns create leverage. Use this power well and financial freedom opens up to you years sooner than would otherwise be possible. Fail to take this power into account in your financial/life planning and you limit your life options in a serious way.

The idea is not to mindlessly save anymore than it is to mindlessly spend. Save in circumstances in which the compounding returns benefit is great for spending and you hurt yourself as much as you do if you spend in circumstances in which the compounding returns benefit is great for saving. Take on too little risk with your investments and you lose the compounding benefits available to those who take on more risk; take on too much risk with your investments and you lose the compounding benefits available to those who manage investment risk effectively. Compounding magnifies the good and bad effects of all money choices.

Miracle of Compounding Returns

The compounding returns phenomenon truly is a powerful force. Suggestions that it is always a force for the good are misleading. You want to develop a full enough understanding of the compounding returns phenomenon to ensure that it is almost always working for you and rarely working against you.