A Cheat Sheet for Ed Easterling’s Unexpected Returns

A Cheat Sheet for Ed Easterling’s Unexpected Returns –Insight #1: The Intermediate Term is the Great Unknown for Most Investors

There was a time when many investors focused on short-term stock investing results. That’s where all this silly bull vs. bear business came from. Bulls were those who expected stocks to do well in the next year or two or three. Bears were those who expected stocks to do poorly in the next year or two or three.

Unexpected Returns

We still often hear the bull vs. bear terminology. It doesn’t make a great deal of sense anymore, however. In recent decades, most investors have learned that the short-term is unpredictable. They have also learned that, while stock prices are unpredictable in the short-term, stocks generally do well in “the long run.” Most investors of today think of themselves as long-term investors. This is progress. We have advanced in our knowledge of how markets work and of how to use that knowledge to accumulate wealth over time.

However, we’ve been learning in recent years that we have not advanced nearly as far as we once thought we had. A huge flaw in the conventional investing wisdom of today has been discovered: The phrase “long-term” is poorly defined. Is the long-term 5 years? Is it 10 years? Is it 15 years? Is it 20 years? Is it 25 years? Is it 30 years? Is it 40 years?

Most of today’s investors do not expect to need to wait much longer than 10 years to see stocks provide reasonably solid returns. Most of today’s investors are due for a rude awakening in days to come. In the event that stocks perform in the future anything at all as they always have in the past, it could take a long time indeed for stocks to provide a return that justified taking on the wild short-term volatility of this asset class. Starting from today’s valuations, it is not hard to imagine it taking 25 years for stocks to provide a satisfying return.

Ed Easterling notes early on in Unexpected Returns that “while traditional investment philosophy mutes the details of highly relevant five- to twenty-year periods of market action by focusing on long-term average returns,” the focus of his book “is on intermediate-term time frames.”

One of the breakthrough ideas in John Walter Russell’s research has been his focus on the intermediate-term time-period. That’s where the action is today. Ed Easterling is planting his insights in the same fertile soil. Unexpected Returns is not yet another investing book parroting the same stale insights you have read or heard discussed dozens of times before. Easterling’s research tells us something new. Easterling’s research matters. Easterling’s insights are breakthrough insights.

A Cheat Sheet for Ed Easterling’s Unexpected Returns — Insight #2: The Old Buy-and-Hold Is Doomed

Regular readers of this site know that I am a big advocate of buy-and-hold investing. I am not at all an advocate of the conventional approach to buy-and-hold, however. The old buy-and-hold is dangerous stuff. It’s ready for the ax and I pray that we get the word out to as many middle-class investors as possible as soon as possible.

We Need a National Debate on the Realities of Stock Investing

Easterling is not a fan of the flawed approach to buy-and-hold. He says: “The conventional wisdom of buy-and-hold worked quite well — not because it is a timeless strategy but because it was the right strategy for the market environment over those two decades [the 1980s and 1990s]. By contrast, the conventional wisdom of buy-and-hold was devastating to investors during the 1960s and 1970s; it simply does not work in all environments.”

The old buy-and-hold is dead. Long live the new buy-and-hold!

A Cheat Sheet for Ed Easterling’s Unexpected Returns — Insight #3: Today’s Popular Understanding of Investing Risk Is Tragically Flawed.

Many of today’s investors have been led to believe that all they need to do to obtain higher returns is to take on greater amounts of risk. Um — it does not work quite like that. At times like today, riskier assets often promise lower returns than safe assets. It makes no rational sense, but then who said that us human investors must always be big on rationality when making our investment choices? If investing decisions were entirely rational, stock prices could never get to where they are today, could they?

Ed Easterling gets it. Here is what he says on Page 12 of Unexpected Returns: “Risk is not a knob that one turns to automatically receive higher returns…. They [investors] naively approach investments with a mistaken confidence in future returns by assuming that higher risk means only near-term volatility rather than permanent losses to their account…. History and the operation of rational markets have shown that stocks should return more than bonds over the very long term, but the degree of risk in stocks varies greatly depending on market valuations.”

Bravo, Ed Easterling! That’s a point that very much needs to be made, to be made clearly, and to be made often.

A Cheat Sheet for Ed Easterling’s Unexpected Returns — Insight #4: The Efficient Market Story is a Tall Tale.

Easterling doesn’t tell the readers of Unexpected Returns bedtime stories aimed at helping them sleep at night despite the excessive risk they are taking on in their oversized stock portfolios. He tells it like it is. He warns us that: “Markets are an efficiency process, not an efficient condition…. Over longer periods of time, prices tend to reflect the value of securities. In the short run, prices can vary significantly from the underlying value based upon the daily battle between buyers and sellers.”

That’s right. There are pockets of efficiency in the stock market. Investing decisions are not entirely emotional. Decide on a portfolio allocation at today’s prices with the thought that markets are entirely efficient, however, and you are cruisin’ for a bruisin’. The markets are just efficient enough to trick most of the popular investing experts into believing that it’s not necessary for investors to adjust their stock allocations in response to huge price rises.

A Cheat Sheet for Ed Easterling’s Unexpected Returns — Insight #5: The Accumulation Stage Is Shorter Than Most Experts Seem to Realize.

EdEasterling Is a Community Hero of the First Rank

Why is it that the focus of the conventional investing wisdom has been how stocks perform over time-periods of longer than 30 years (it is only for time-periods of over 30 years that it is reasonable to argue that stocks are always best “for the long run”)? In the real world, most investors are focused on significantly shorter time-periods.

In fact, “Most individuals are forced by the realities of life to work with a shorter time frame of about 20 years. They do not accumulate substantial assets until they are in their 40s, and need to begin drawing on those assets in their 60s.”

My view is that the typical investor’s most significant time-frame is often even shorter than that. Investors don’t save only for retirement. They save to have something to fall back on when hit by economic recesssions or corporate restructurings. They save to be able to afford college for their children. They save to move into bigger houses. They save to be able to start their own businesses. Portfolio losses of 50 percent or more, which should not come as a surprise to those investing heavily in stocks at today’s prices (this article was posted in March 2007), are going to put the strategies of many investors purporting to be following a buy-and-hold approach to a serious test.

A Cheat Sheet for Ed Easterling’s Unexpected Returns — Insight #6: Investors Need to Keep Secular Market Cycles in Mind When Planning Portfolio Allocations.

There are no allocation rules that work equally well for all investors. Some of us begin to accumulate investable assets when stock prices are low and long-term returns are highly attractive. Others of us begin to accumulate investable assets when stock prices are high and safer asset classes offer more appealing long-term returns. Should both types of investors be going with the same stock allocation early in their investing careers? Hardly. If the latter group wants to earn solid long-term returns from stocks, it needs to protect its assets until prices return to reasonable levels.

As Ed Easterling puts it in Unexpected Returns, “The cycles that occur during an individual’s period of investment will dramatically influence the returns that investor realizes.” For investors to ignore the strategic implications of this investing reality is folly.

A Cheat Sheet for Ed Easterling’s Unexpected Returns –Insight #7: Valuations Matter Big-Time.

Valuations matter. Where have we heard that tune before?

How to Stop Future Bull Markets

Easterling observes: “The highest-return 20-year periods peaked during the late 1990s bubble and contributed to the currently popular, and misguided, notion that stocks are always a good investment, regardless of price…. Periods that start with lower valuations tend to have higher returns, while periods that start with higher valuations tend to have lower returns.”

Our common sense tells us this has to be so. It’s hard to keep in mind when so many “experts” are only too pleased to tell us what we desperately want to hear rather than what we desperately need to hear. I think it would be fair to say that Ed Easterling takes his responsibilities to the readers of his investing advice a bit more seriously than do a lot of the more popular of today’s “experts.”

A Cheat Sheet for Ed Easterling’s Unexpected Returns — Insight #8: It’s Not Just High Returns That Cause Us to Underestimate the Risks of Holding Stocks.

Most investors raise their stock allocations far too high when prices go to the moon and then lower them far too much when prices go to the bottom of the ocean. The nice warm feeling of obtaining outsized returns for a long stretch of time during a secular bull market causes us to come to a flawed understanding of how stocks really work. Easterling explains that it’s not just the high returns of secular bulls that fool us. Volatility is relatively muted during long-running bulls too.

As he puts it, “The low volatility that characterizes bull markets contributes to the comfort and confidence many investors feel during those periods. As you might expect, the higher volatility that occurs during bear markets adds greatly to the discomfort and anxiety felt by investors who experience declining markets.”

A Cheat Sheet for Ed Easterling’s Unexpected Returns — Insight #9: It’s Not the Economy That Matters Most.

“Despite the general contention that the economy and the stock market are closely connected, the facts get in the way of confirming conventional wisdom.” So says Ed Easterling in his book Unexpected Returns.

A Cheat Sheet for Ed Easterling’s Unexpected Returns — Insight #10: Stocks Are a High-Risk Proposition at Today’s Prices.

Bull vs. Bear Market

Stocks are sometimes a good investment for the long run. Not today, though. The potential return is too limited. The potential downside is an ocean of pain.

Here’s how Ed Easterling puts it in his book Unexpected Returns: “There is a natural limit to the level of sustainable P/E ratios. Icarus could not fly to the sun, and P/Es cannot be sustained on a broad basis much above the low to mid-20s because of limits on the real growth rate of the economy and the market’s requirement that equities be priced to return more than bonds. It took a bubble in the late 1990s to break through this natural barrier temporarily. It is not a coincidence, though, that many of the secular-cycle tops over the last hundred years peaked with P/Es in the 20s.”

The Myth of the Rational Market — A Fine Book Missing a Fine Conclusion

The Myth of the Rational Market, by Juston Fox, is an important book. It does a fine job of explaining the analytical mistakes made by efficient market proponents that caused the economic crisis. However, it fails to describe how we need to change the investing advice promoted to middle-class investors to escape the crisis (this article was posted in December 2011) and to avoid future ones.

Myth of the Rational Market

Fox begs off, saying “This book offers no grand new theory of how markets truly behave.” I wish it did. The book does a great job of telling the story of how we came to find ourselves in the giant mess we find ourselves in today. But we need help in figuring out what to do to get out of the mess. I wish that Fox had devoted his mental energies to helping us discover where we need to go from here (I of course believe that the answer is to work together to bury Buy-and-Hold 30 feet in the ground, where it can do no further harm to humans and other living things, and to replace it with Valuation-Informed Indexing).

#1 Myth of the Rational Market — The Idea that Markets Are Properly Priced Is the Product of Recent Academic Research

The reality is that the dangerous idea that the stock market is efficient has been around for a long, long time. Fox points out in his Introduction that George Rutledge Gibson argued in 1889 that, when “shares become publicly known in an open market, the value which they there acquire may be regarded as the judgment of the best intelligence concerning them.”

Stock investors can bid stock prices up to whatever they want them to be. But how can they have confidence in prices set through an arbitrary process that takes little account of the economic realities? They assure themselves that the market is “efficient,” that the market as a whole is too rational to let emotion cause it to set stock prices improperly. We have been both indulging and rationalizing our Get Rich Quick impulse since the day on which the first stock market opened for business.

#2 Myth of the Rational Market — Investors Act in Their Self-Interest to Maximize Returns and Diminish Risk

The efficient market concept is rooted in the idea that investors act in their self-interest to maximize returns and diminish risk. If we cannot count on that much, none of the “science” supporting today’s conventional investing wisdom holds up. That’s the basic building block on which all Buy-and-Hold strategies are built.

Yet Fox puts forward in his book numerous examples of how reason failed the “experts” with the greatest faith in its power. One painful example of the phenomenon is put forward on Page 25. Irving Fisher, one of the experts advocating Buy-and-Hold strategies in the late 1920s, “held on to his Remington Rand stock as it dropped from $58 to $1.”

history of investing

The idea of holding stocks that represent a solid long-term value proposition makes all the sense in the world. That’s Warren Buffett’s insight: If you have made a good choice, you need to stick with that choice long enough to obtain the rewards that follow from it and that can take some time given the general irrationality of the market. Buy-and-Holders pervert Buffett’s insight by claiming that holding is always a good idea, even when the initial investing choice was a poor one. Nothing could be further from the truth.

This is why Buy-and-Hold often proves to be the worst of all possible strategies. Short-term timing doesn’t work. But short-term timers are at least able to sell when their bets go bad. Buy-and-Holders stick to bad choices until they have suffered enough financial devastation to force them to abandon their “hold forever” vows.

Sticking with an investment choice is a good thing only when the choice itself is a solid one. When it is not (and Buy-and-Holders have no way of knowing whether their choices are good ones or not since they do not evaluate the value proposition being offered by stocks at a particular time prior to buying), sticking produces the worst of all possible results — large losses locked in when stock prices are at a bottom and about to move up again soon.

#3 Myth of the Rational Market — There Are Scientific Studies Supporting Buy-and-Hold Strategies

Buy-and-Holders claims that their strategies are scientific. But it’s a funny kind of science that ignores investor behavior when analyzing what works in the stock market.

Fox observes on Page 28 that: “Like physicists ignoring friction in building their models of the world, economists became more and more comfortable with ignoring widely recognized realities of human behavior in order to build better models of it.”

He adds on Page 29 that: “Equations were memorized and passed on. The accompanying words, and often the real-world data against which the formulas were tested, were forgotten.” We had reason to doubt the legitimacy of Buy-and-Hold for years before it tanked our economy in September 2008.

#4 Myth of the Rational Market — We Have Proven That Market Prices Move Randomly

Millions of middle-class investors have to their misfortune been led to believe that this is so. The reality is quite to the contrary.

Fox describes Paul Samuelson’s work on Page 72. Samuelson wrote: “Randomness can only be defined negatively; namely, as the absence of any systematic pattern. A particular test can detect only a particular pattern or class of patterns, and complete randomness can therefore only be disproved, not proved.”

Randomness has never been proved. There are studies indicating that short-term timing does not work, or that, if it does work, it is hard to pull off. There has never been a study showing that long-term timing does not work. In fact, numerous studies show that it always works. If one form of market timing always works, the claim that market returns are random is false.

#5 Myth of the Rational Market — The Connection Between Risk and Reward Is Clear

Buy-and-Hold advocates say that investors should not be fearful of the risks associated with holding overpriced stocks because it is only by taking on considerable risk that investors can hope to achieve acceptable returns. The reality is that today’s understanding of the connection between risk and return is primitive.

As the book notes on Page 184: “While it was apparent that risk and return were related, it was equally apparent that some risks were rewarded more generously than others…. Profit came when you proceeded in the face of uncertainty.”

If that’s so (I do not believe it is), then Buy-and-Hold is dangerous. If returns are uncertain, Buy-and-Holders are taking a big chance. They cannot know that they will even in the long term obtain a decent return on their money. If they could, the uncertainty of their investment choice would be eliminated and they would no longer be entitled to a good return.

bias in investing studies

My personal belief is that investors are not compensated for taking on risk but for giving up the profit-generating capacity of their capital for a time. If that’s so, investors taking on little risk can in the right circumstances earn higher returns than investors taking on great risk. In that case, investors taking on the high risk associated with buying stocks selling at high prices are unlikely to be compensated for doing so.

#6 Myth of the Rational Market — The Efficient Market Concept Has Been Clearly Enough Defined to Help Investors Know How Best to Invest Their Retirement Money

Fox quotes University of Chicago Economics Professor Eugene Fama as explaining that: “In an efficient market, the actions of the many competing participants should cause the actual price of a security to wander randomly about its intrinsic value.” He then observes that “just how far security prices wandered from those intrinsic values remained an important topic for further research.”

In January 2000, stocks were priced at three times their fair value. If it is possible for stock prices to wander that far from intrinsic value, it can fairly be said that Buy-and-Hold is the purest and most dangerous Get Rich Quick scheme ever concocted by the human mind. Yet Fox’s comment suggests that the Efficient Market Concept was never clearly enough defined to rule out the possibility. Oops!

#7 Myth of the Rational Market — The Case for the Efficient Market and for Buy-and-Hold Is So Strong That Pretty Much All Experts Accept It

The reality is that Efficient Market proponents have long closed their minds to challenges to their ideas. “A new paradigm had been accepted, and those who didn’t want to work within it were no longer welcome,” Fox writes on Page 106. Science? Not in my assessment. Legitimate science yields a greater level of confidence in one’s work.

#8 Myth of the Rational Market — Investors Pursue Their Self Interest

The reality is that “we are often of two minds, one that impatiently demands satisfaction now and another that rationally weighs present and future rewards.” (Page 186)

That explains why stocks have always provided poor returns for the 20 years immediately following bull market tops. As we shift from pushing stock prices up to unsustainable high prices to pulling them back down to proper price levels, market returns are low not because the underlying companies are not generating profits but because we are paying back the debt we incurred to ourselves during the bull market years in which we impatiently demanded the immediate satisfaction delivered by insanely high stock prices.

Does Buy-and-Hold make sense in a world in which this is the reality? Can any middle-class investor hope to be able to retire at a reasonable age by investing heavily in an asset class priced to provide 20 years of poor returns? Are we pursuing our self interest when we follow Buy-and-Hold strategies or when we permit bull markets to develop or when we encourage others to follow Buy-and-Hold strategies and thereby to suffer losses so great as to bring on an economic crisis?

buy-and-hold myth

The future of investing analysis is coming to a better understanding of why investors often fail to pursue their self interest and developing tools to help them avoid the Get Rich Quick urges that throughout history have so often caused them to pursue self-destructive strategies.

#9 Myth of the Rational Market — The Research Said to Support Buy-and-Hold Should Give Confidence to Indexers

Leaving aside the question of whether the market really is efficient, there are no grounds to believe that Buy-and-Hold strategies can work for indexers. Fox states on Page 194 that: “Fama had proposed that the way to test the efficient market hypothesis was to see if stock price movements obeyed the dictates of the capital asset pricing model, but this was only a relative test. It might reveal whether stock price movements made sense in relation to each other and the overall market, but it was no help in showing whether the overall market was correctly priced or not.”

Now they tell us!

#10 Myth of the Rational Market — There Is No Good Alternative to Buy-and-Hold

The case for Buy-and-Hold is so weak that advocates have in recent years been driven to offering the most defensive case imaginable. We need to stick with Buy-and-Hold, the argument goes, not because the case for it is persuasive but because we do not have an acceptable alternative.

The Myth of the Rational Market makes reference to this argument on Page 298. It quotes Fama as saying: “I don’t know what asset pricing would look like in a world that really took behavioral finance seriously. If you really think prices are incorrect, what are you going to tell me about the cost of capital?”

Justin Fox

The sensible response is provided a but farther down on the same page. Dick Thaler, a behavioral finance advocate, acknowledges that “it’s going to be a big mess because human nature is a mess…. It’s a choice between being precisely wrong or vaguely right.”

We are today living through the effects of having for 30 years promoted a model for understanding stocks that the academic research reveals to be precisely wrong. I have hopes that the human misery is reaching a point at which we will as a society come to develop a hunger for one that is instead vaguely right.


My Take on Why Smart People Make Big Money Mistakes

Why Smart People Make Big Money Mistakes — We Fear Being Too Alive.

Why Smart People Make Big Money Mistakes

The book argues in its introduction (Page 26) that people are both too much like mules and too much like sheep. We are overconfident in our own abilities, which makes us close-minded. And yet we also rely too much on the opinions and actions of others in forming our own opinions; we are so open-minded that we are willing to go along with ideas that do not really add up. The authors argue that these two findings are in conflict and that the conflict cannot be reconciled. I think that the conflict can be reconciled.

We behave like sheep because we are disinclined to take personal responsibility for our decisions. Many of us would rather lose money as the result of decisions that we can attribute to an “expert” than stand a good chance of earning money as the result of decisions attributable to ourselves alone. To make a decision is to live. We are afraid to live.

To be alive is fun but to be alive is hard. A big part of the project of becoming a successful saver or a successful investor is developing the confidence to live life to the fullest. Bruce Springstein observed that: “It ain’t no sin to be glad you’re alive.” It ain’t no sin to go against the “experts” and invest in a way that truly makes sense.

We behave like mules for the same reason we behave like sheep. If you have the confidence to make an investing decision because of your personal confidence that it is the right way to go, you will likely have the grace to acknowledge that the decision was wrong if that turns out to be so. Decisions made in reliance on “experts” are hard to reverse because reversing them means acknowledging the flawed basis for the decision — it means acknowledging being a coward.

We run from life and we run from acknowledging that we run from life. Holy existential dilemma, Batman!

Why Smart People Make Big Money Mistakes — We Are Not Computers with Legs.

The idea of science is to explain the world as it exists. Too often the idea behind the junk that parades as science in InvestoWorld is to create imaginary worlds that are easier for the “experts” to understand than the real one that we actually live in. The authors observe on Page 34 that many economists believe that we should view money as fungible and thus are critical of our tendency to set up “mental accounts” of money being used for different purposes and subject to different money management rules. We’re right and the “experts” are wrong, this fine book tells us: “The average person, more self-aware, perhaps, than the average economist, knows that he or she is not as smart or as iron willed as economists maintain.”

Good for us! The experts do indeed go too far with their point. However, that doesn’t mean that they do not have a point worth considering. I don’t think we should apologize for setting up mental accounts. It’s a perfectly reasonable short-cut reasoning method to treat some money (retirement money) as more important than other sorts of money (vacation money). Still, it’s a plus to manage our money more rationally. By developing budgets and becoming more aware of where our money is going, we can more effectively direct it to the purposes to which we would most like to direct it.

We are not computers with legs and we should express the appropriate disdain for “experts” who treat us as such. There are some tasks that computers do exceedingly well, however. It is by combining the things that computers do well with the things that only humans can do well that we can come to be truly expert at the money management task.

Why Smart People Make Big Money Mistakes — Lacking Good Explanations, We Settle for Poor Ones.

Humans have a tendency to grasp for explanations for every puzzle. In a way, that’s a good thing. We are natural problem solvers and problems solved are lives enhanced.

Pride Comes Before a Stock Loss

The problem is that we are so driven to explain mysteries that we sometimes accept solutions that do not really make sense. I argue in my book Passion Saving against the common perception that our inability to save can be traced to our lack of willpower. I find this explanation insulting to the middle-class worker.

I was happy to see that the authors of Why Smart People Make Big Money Mistakes offer an alternative explanation of the saving problem on Page 39. The real reason why we find it so hard to save is that we tend to be cost-conscious only when making big spending decisions. We sweat a decision to buy a car or a house or a major appliance. But we tend to spend on small items like groceries and gas and movies mindlessly. These categories don’t seem like a big deal.

The reality, of course, is that it is the small everyday expenses that are the biggest deal of all. We spend only a small amount on each trip to the grocery store. But there are more opportunities to enhance the value proposition obtained from the money we earn by looking carefully at our spending on groceries than there are by looking carefully at spending on cars because we spend on groceries so much more frequently.

My suggestion is that we transform the small spending categories into a big mental deal by adopting saving goals of intense personal concern that we hope to achieve within a few years. What we need to do is to feel as dumb to make a mistake in our spending on groceries as we already do to make a mistake in our spending on cars.

We can stop beating ourselves up. It turns out that willpower doesn’t have much to do with saving.

Why Smart People Make Big Money Mistakes — We’re Rationalizers More Than Thinkers.

There’s a reason why every book in the bookstore isn’t a book on logic. Humans create novels and picture books and biographies and cartoon collections and all sorts of things other than logic books. Why? Because you can’t explain human behavior through the use of logic alone. We promise to love our spouses forever and yet we cheat. We pray for children and yet we let them down when they come. We owe everything to our parents and yet we resent them. We drink. We gamble. We pray. We hope. We overcome. We redeem ourselves and others.

We’re so complicated.

Here’s what Belsky and Gilovich say on Page 52: “The same outcome can often be described either in the vocabulary of gains or in the vocabulary of losses, and such unconscious and inconsistent coding has far-reaching effects.”

Reason vs. Emotions

You want an example? Please take a look at the “Banned at Motley Fool!” section of the site. A visitor from Mars who thought that humans were a rational bunch might presume that the idea of a safe withdrawal rate study is to identify what withdrawal rates are safe. It seems logical enough, eh?

What we have found instead is that the idea of the Old School safe withdrawal rate studies was to persuade unsuspecting retirees that withdrawal rates that are high risk are safe. The aim of these studies is not to help aspiring retirees. It is to destroy their hopes of achieving safe retirements.

That seems crazy, right? Too crazy to be true, right? That’s because it is too crazy to be true. That’s because the money behavior of humans is too crazy to be true. Any money management model that presumes logic on the part of humans misses the point by a country mile. We have seen on our boards in recent years that there are all sorts of motives pursued by humans recommending financial strategies that have very little to do with money.

What possible motive could an investing “expert” have for reporting a high-risk withdrawal rate as a safe withdrawal rate? How about wanting to be popular with the people he advises? And what possible motive could investors have for wanting to be provided with false safe withdrawal rate claims? How about the universal human desire to get something for nothing, to believe that it is possible to see the sorts of returns provided by stocks in the late 1990s and to not have those returns paid for by those who invest heavily in stocks in the years that follow?

How you ask a question determines the answer you obtain to it. If we were all Mister Spocks, all safe withdrawal rate studies would report the number accurately. I think it would be safe to conclude after six years of The Great Safe Withdrawal Rate Debate that we are not all Mister Spocks.

Why Smart People Make Big Money Mistakes — We View Our Lives as Stories, Not as Balance Sheets.

Someone who made $50,000 last year and is making $60,000 this year is happy. Someone who made $70,000 last year and is making $60,000 this year is grumpy. It’s not so that $60,000 is $60,000 is $60,000. We view our lives as stories, not balance sheets. Going from $50,000 to $60,000 is Moving On Up to the Deluxe Apartment in the Sky. Going from $70,000 to $60,000 is one step away from being forced to move into Ralph’s and Alice’s apartment.

Here’s Belsky and Gilovich on Page 75: “People stay in unsatisfying careers because of the time and money they invested in school, not because they enjoy the work or expect to in the future; we finish a bad book because we’ve already gotten so far, not because we’re anxious to see how the characters live; we sit through a boring movie because we bought the ticket, not because it’s a good flick.”

Live your life by different sorts of stories. Keep three books at your bedside table and view them as being in competition with each other for your attention; get excited about the freeing up of an opportunity to read Book #2 that comes into place if Book #1 happily fails to make the grade. Identify things that you learned in school that help you in the career that really does turn you on; your years in accounting are the edge that is going to help you make it in the restaurant business, no?

Behavioral Economics

Are you kidding yourself to go with the sorts of strategies I recommend here? You are. You’re kidding yourself in some way in any event; all humans kid themselves all the time. The trick is to gain some self-knowledge about how you kid yourself, to gain some power to control it, and to shape your self-kidding behavior in positive directions.

Here’s a secret: A sense of humor is essential to long-term success in your money life. Woody Allan captured the hearts of women he had no business asking to dance. Adopt a different take on things and you can attain financial freedom years sooner than you now think possible.

Why Smart People Make Big Money Mistakes — Human Inertia Is the Strongest Force on Planet Earth.

It’s hard to get people to do stuff. It’s hard to get them to visit a web site. It’s hard to get them to post to a discussion board. It’s hard to get them to buy a book. It’s hard to get them to change an investing strategy. I know whereof I speak re this one.

Belsky and Gilovich note on Page 96 that “whatever value you place on, say, a stereo at a store will likely be increased once it sits in your den for a few weeks.” Just as hard as it is to get you to buy, it’s that hard also to get you to return something you bought after you broke down and bought it.

What if we made it a habit to do things that are not habits? What if you made it a regular practice to read about political ideas you don’t agree with or to buy things with money-back guarantees with a strong intent to return them if they do not provide a good value proposition or to change some aspect of your daily routine each Wednesday? Human inertia is a powerful force. But it can be used for all sorts of purposes. It’s possible to become habitually unpredictable.

Why Smart People Make Big Money Money Mistakes — Even Our Attempts at Humility Cause Us to Become Overly Proud.

The book speaks favorably of both Index Investing (Page 208) and Value Investing (Page 195). Some see this as a contradiction. I do not. Investing in an index does not mean that you do not seek value in your investments; it just means that you like to assure value the easy way, through diversification. Those who feel that because they favor indexing they must stop thinking about the prices of stocks are the ones living a contradiction. Indexers talk all the time about how they avoid paying transaction fees. Transaction fees are generally tiny compared to the costs of ignoring prices.

The common theme is humility. Smart indexers acknowledge that there are benefits to picking individual stocks, but are humble enough to acknowledge that they lack either the time or skills needed to pick stocks effectively and thus settle for the “good enough” investing approach. Smart investors also acknowledge that prices cannot be ignored and are sure to adjust their stock allocations to reflect the change in the risk profile of stocks that takes place with significant valuation changes.

Picking stocks is smart if you really are one of those who can do it. If not, it only looks smart. Indexing really is smart for those able to acknowledge that it does not need to be superior to every other investing approach to qualify as a fine strategy and that valuations matter even for indexers. For conventional indexers, it only looks smart. Humans are too often drawn to looking smart over actually being smart (which is often the simpler and yet harder course — because it is the more humble course).

Beahvioral Finance Books

Why Smart People Make Big Money Mistakes — Smart Can Hurt As Well as Help.

List your three best decisions. Were those three decisions the product of intelligence? Or something else?

The book argues on Page 206 that: “Too much illusory information can be destructive,” noting studies that show that investors who tune out financial news do better than those who do not. How can having more information hurt? It can paralyze you, it can cause you to doubt things in which you need to have confidence, it can cause you to lose perspective.

Some people think that we should make decisions about dating and about raising children and about deciding where to live in more rational ways — that we should read more books on these topics and write out more lists of pros and cons of various options. I see it the other way. I think we need to become better able to rely on intuition when making decisions about saving and investing and career growth. We all “know” things that we do not know we know.

It is when we seek to rely only on what we know in a strictly intellectual sense that we create our biggest mess-ups. Smart people make big money mistakes because they are not as smart as they have come to think they are. There’s more than one way in which to be smart. We need to make use of all the forms of smartness when making decisions about how to make the most of our money, which are really decisions about how to make the most of our lives.

Why Your Money or Your Life Rocked the World

I remember the Saturday afternoon when I first read Your Money or Your Life, published in 1992 by Joe Dominguez and Vicki Robin.

Your Money or Your Life Rocked the World

I was desperate to make a shift toa more fulfilling type of work. But I had given up on the idea of sending out resumes and hitting up contacts hoping for a lucky break. I had tried that approach, seen it succeed, and then experienced the pain of losing the “good job” I had networked into to the recession of the early 1990s. I had decided that I wanted something more secure than a good job that could disappear with a dip in the economy or the hint of a corporate restructuring. I had determined that a longer-lasting solution to job dissatisfaction could be had from developing more effective money management skills. But I hadn’t yet been able to learn what I needed to fill in the details in my Passion Saving plan.

Flipping through the book at the Borders in downtown Washington, D.C., something in it called out to me “I am different.” But I had no idea how different until late that Saturday afternoon as I made my way towards the magic revealed on page 274. It was on reading page 274 that I experienced my epiphany. This was it! On that page were the lines that made money management finally make sense.

20 Magic Words

Here are the magic words that appear on that magic page of Your Money or Your Life: “Breaking the link between work and money in actual fact will exponentially expand the possibility of discovering your true work.” There’s a lot of meat in those 20 words, a lot to think over. It is those 20 words, and the implications of them explored in the rest of the book, that has made Your Money or Your Life the most influential personal finance book ever published.

Read the customer reviews of Your Money or Your Life at Amazon.com and the common theme you will hear is–“it changed my life!” Lots of authors aim to change people’s lives with their books. How many pull it off? Your Money or Your Life pulled it off because it revealed the connection between solving money problems and solving work problems. Looking back, one is tempted to say that the insight should long have been obvious to all. The reality is, it wasn’t. Your Money or Your Life has been a global bestseller for 13 years because it got to the root of the money management project and said something about it that had never been said before–the best reason to save is not to escape work but to free yourself to do a different kind of work.

Joe Dominguez Rocked the World

That insight changes everything. The old way of saving was to save to escape work. The Your Money or Your Life way to save was to free yourself to do the work you love. Your Money or Your Life turns the conventional saving rules on their head. When you are saving to escape work, you are saving for the years when your life is drawing to an end. When you are saving to free yourself to do the work you love, you are saving for the years when you still have plenty of steam in your engine. The Your Money or Your Life vision of saving is in an important way the opposite of the conventional saving vision.

Fear Is a Poor Motivator

That’s why it works. Trying to save to prepare for the end of life is a fear-rooted approach to money management. Fear is a poor motivator until it becomes pressing. So most middle-class workers save little in their 20s and 30s, a bit in their 40s, and then become serious savers only in their 50s and 60s. Saving early in life is more effective than saving late in life, but the saving guides that came along prior to Your Money or Your Life just did not set forth a message that had much impact on people in their 20s or 30s or early 40s.

Millions who found saving boring when it was framed in conventional terms found it exciting when the idea was reinvented in the pages of Your Money or Your Life. The book revolutionized the field of personal finance by putting forward the idea that saving should be a means not to escape work but to free one to do more rewarding work. When you change the motivation for saving, you change the nature of the money management project in a fundamental way. Fundamental changes cause explosions. It takes years or even decades to come to terms with ideas as far-reaching as the one that serves as the driver of the Your Money or Your Life vision.

I’ve read this book five times. Each time I read it I discover something new in its pages. It’s that deep. As popular as it has become, I doubt that many today fully appreciate how revolutionary a book it is. We are only beginning to see what it means in practical terms to integrate life, work and money goals. We will be walking the path that Joe Dominguez and Vicki Robin, the authors of Your Money or Your Life, pointed out to us for many years to come.

Where I Disagree

I don’t agree with every line written in the pages of Your Money or Your Life. I like stocks more than Joe Dominguez does (although I see why he focused on the risks inherent in stock investing more than do most money advisers urging a more conventional money management approach). I don’t agree with the views expressed in Your Money or Your Life regarding inflation (that its effects can be avoided through good money management practices). And the book is more negative on consumerism than I am (I agree that most of us spend too much, but I also think that the goods and services available to middle-class workers today enhance our lives in many ways).

Vickie Robin Rocked the World

Those things are details. What’s important about Your Money or Your Life is the revolutionary insight at its core, the idea that life, work and money goals should be integrated. When you spend your money, you are spending your life. Once you see the truth of that, you can never again think of saving as being the boring money allocation choice. Saving is the means by which you become free to pursue your most important life goals. Saving for someone following the Your Money or Your Life vision is as exciting as the dreams that drive his or her money management project.

The goods and services obtained through spending add a lot to life. But spending can only do so much. There are other things that we all need to be satisfied with our lives that can only be attained through saving. Joe Dominguez and Vicki Robin, authors of Your Money or Your Life, taught me that lesson.

It changed my life!

Work Less, Live More — The Retire Early Movement Grows Up

The book Work Less, Live More, authored by Bob Clyatt (Nolo, 2005), offers its reader a number of breakthrough insights on how to win financial freedom early in life. I briefly explore eight of them in the words below.

The first breakthrough insight put forward in Work Less, Live More is the idea that we need a new understanding of what constitutes “retirement.”

Work Less. Live More

I published my Secrets of Retiring Early report in June 2000. I remember feeling a bit nervous at the time about one of the themes explored in the report. At that time, the Financial Freedom Community was comprised of a single discussion board, the Motley Fool board. The board was going gangbusters at the time, but I thought that in some important ways the scope of discussions held there was too narrow.

I was using a newfangled understanding of the concept of “retirement” in my own Retire Early plan. I didn’t find much appeal at age 43 of retiring in the way that most other people did at age 65 — leaving the challenges and joys of the workplace altogether behind me at an age at which I still had lots of energy and dreams and ambitions seeking a means of expression. I didn’t want to prepare to die, I wanted to open up the possibility of living more fully.

I wrote about the concept that Bob Clyatt refers to in Work Less, Live More as “semi-retirement” in my report and anxiously awaited my hits from that segment of our community that views new ideas with suspicion and argues that everything worthwhile that there is to know about early retirement was figured out years ago.

I have indeed taken a good bit of abuse for that one from the “If You Don’t Retire Early My Way, It’s Not Really Early Retirement!” Crowd. But I have also obtained a good bit of gratifying feedback from fellow community members who have been quietly nursing “heretical” views along the same lines for some time.

It turns out that there are a lot of people who find a good bit of appeal in the money management ideas discussed at our boards, but who, like me, find not so much appeal in the idea of becoming old before their time. They like the idea of winning their financial freedom early in life, but want to make use of their financial freedom in ways that permit them to continue enjoying the positive aspects of the work experience (of which there obviously are many) for many years to come.

Those sorts of community members need to read Work Less, Live More. Bob Clyatt doesn’t just give his okay to a new understanding of what constitutes early retirement — he heartily endorses the concept. The title of the book is not Work Not at All, Live More. It is Work Less, Live More. I of course have no objection to the pursuit of the conventional approach to early retirement by those who view that approach as best for themselves. I am much pleased, though, to see the nonsense idea that there is one and only one “right” way to pursue early retirement finally and completely put to rest (I pray!) by publication of Bob Clyatt’s book. It is hard for me to imagine that there is any serious person who could argue that there is no place for “semi-retirement” (Clyatt’s phrase) or “Retiring in Stages” (my phrase) after seeing the persuasive case put forward for it in the pages of Work Less, Live More.

Retire Early Movement
Clyatt is arguing for a balanced, sane, reasonable approach to early retirement. I believe that publication of this book will give our movement a gentle push in a direction in which it very much needs to move. A movement needs new ideas to retain life, and Clyatt’s advancement of the semi-retirement concept supplies them. I see the publication of this book by a fellow Financial Freedom Community member (Bob Clyatt posts to the Early Retirement Forum under the screen-name “ESRBob”) as a sign that our small (but quickly growing!) movement is beginning to grow up. Good for us!

The second breakthrough insight put forward in Work Less, Live More is the idea that it is the non-financial aspects of the Retire Early experience that are the most important.

Semi-retirement is a powerful concept because it allows many middle-class workers to overcome dependence on corporate and government employers years or even decades sooner than they could if they planned never again to earn an income of any kind. The more important benefit, however, is the sense of purpose that it adds to one’s life to be putting together a plan to quest after new dreams instead of putting one together solely to escape the bad aspects of the corporate workplace.

Bob Clyatt says that the impetus for his early retirement was his desire to spend more time with his two boys. That’s a healthy Retire Early ambition, in my view. I get uneasy when I hear people say that their sole reason for pursuing early retirement is to escape boring staff meetings. I have sat through boring staff meetings, and I relate to the feelings of frustration noted by those who feel a drive to escape the experience. My concern is that escaping boring staff meetings is a negative goal rather than a positive one. My sense (based on reading many of the stories of the thousands of early retirees who have posted to our boards over the course of the past six years) is that the most successful Retire Early plans are those driven by a healthy balance of positive goals (things to aspire to) and negative goals (things to escape).

Wanting to spend more time with your family is a positive goal, as is a desire to do a new kind of work, or to get in better shape, or to do volunteer work. I feel myself drawn much more strongly to positive Retire Early visions than to negative ones, especially when the visions are visions being put forward by people in their 30s or 40s. People should still be questing in their 30s and 40s, not entering a stage of life in which their most pressing concern for the future is that Social Security not run dry.

The future of Social Security matters, to be sure. But we all should have things in our life that we have some control over that matter too. We should have things that we are doing that matter to us. In other words, we should have important work before us (whether done for pay or not). Non-retirees have that, and even most conventional-age retirees have that. I think that early retirees should seek to have that too.

Early semi-retirement, in Bob Clyatt’s view, “captures the best of both worlds: plenty of free time and the opportunity for good healthy living that early retirement offers, combined with the psychological benefits and long-term financial security of a modest amount of part-time work–a hybrid that works for large numbers of people.”

Early Retirement
I think that is exactly right. Remain dependent on a paycheck until you turn sixty-five, and you put yourself in circumstances in which you are likely to feel great levels of frustration in your 40s and 50s, when you know enough about how to do the work you do that you should be calling more of the shots than most non-owners are permitted to call in the modern-day workplace. Aiming for semi-retirement permits you to break free years sooner than you could aiming for full retirement while also allowing you to enjoy the positive side of the work experience for many additional years. Beat that combination, proponents of the old and moldy approach to early retirement!

Here’s the title that Bob Clyatt chose for Chapter Six of Work Less, Live More — “Do Anything You Want, But Do Something!” It needed to be said, and that phrase says it well. Do Anything You Want, But Do Something! — I’m going to be using that one in days to come. (Clyatt credits Warren Buffett with the coining of the phrase.)

The third breakthrough insight put forward in Work Less, Live More is the idea that investment returns must be predictable if you are going to plan to give up reliance on a regular paycheck.

I am known in our movement as the anti-Greaney (or the anti-”Intercst,” his posting screen-name) because of my criticism of John Greaney’s safe withdrawal rate study (published at the RetireEarlyHomePage.com site) as well as my criticism of the highly abusive posting tactics Greaney and his supporters have employed to block questioning of the flaws of the study. Often lost in the hullabaloo over my criticism of the Greaney study and his “defense” of it is my praise for the aspects of the safe withdrawal rate question that I believe Greaney very much got right.

After our community discussions showed beyond any reasonable doubt that the conventional methodology studies are analytically invalid for purposes of determining safe withdrawal rates (what Greaney actually calculated was the historical surviving withdrawal rate, not the safe withdrawal rate), it became fashionable in segments of our community to argue that it doesn’t matter because safe withdrawal rates are of no real consequence. “It’s all so much fortune telling,” we were told. Some argued that the safe withdrawal rate is only a “rule of thumb” and thus it is not important to get the math right.

I cannot recall an instance in which Greaney directly endorsed these “defenses” of his study put forward by others on his behalf. I always found this “defense” of Greaney to be insulting to him. What sort of defense of him is it to argue that the work he did preparing his study was a pointless exercise in “crystal ball reading?”

I say that Greaney got the safe withdrawal rate number wrong, but that at least he was engaged in a serious endeavor in trying to determine it. I view that as a step up from the position advanced by his presumed defenders, who are implicitly arguing that all the time that Greaney and thousands of other Financial Freedom Community members have spent exploring safe withdrawal rates was a waste.

How to Retire Early
Again, Bob Clyatt comes down on the right side of this important question in his new book Work Less, Live More. Clyatt devotes a good bit of page real estate to the safe withdrawal rate question. Not only that. He is not satisfied with passing along old and worn-out safe withdrawal rate claims. He presents new strategies for making use of safe withdrawal rate findings. He advances the ball.

The section of Work Less, Live More that deals with safe withdrawal rates is gravely flawed, to be sure. Like John Greaney before him and like Bill Sholar (owner of the Early Retirement Forum and publisher of FIRECalc) before him, Clyatt fails to include an adjustment for valuation changes in his safe withdrawal rate analyses.

I find this oversight astounding. Clyatt participated in discussions at the Early Retirement Forum in which the need to include an adjustment for changes in valuation levels was discussed. I even exchanged e-mails with him on this question!

I am really at a loss for words (how often does that happen?) as to what Clyatt was thinking in electing to walk down the same dark path that Greaney and Sholar elected to walk before him. I have said it in regard to the false safe withdrawal rate claims of Greaney and Sholar, so I think that I am obligated in fairness to say it in regard to Bob Clyatt too — these demonstrably false safe withdrawal rate claims are likely to result in hundreds of thousands of busted retirements in days to come (presuming that stocks perform in the future somewhat in the way in which they always have in the past). Causing busted retirements is not what our movement is all about. Don’t go to the dark side, Bob Clyatt!

In all seriousness, if either Bob Clyatt or Bill Sholar or John Greaney would like to write an article explaining why he believes it is okay to continue to push safe withdrawal rate claims that have been publicly shown beyond any reasonable doubt to be incorrect as a matter of “mathematical certainty” (William Bernstein’s phrase), I would be happy to publish the article at the PassionSaving.com site and include a link to it in this article. If all three elect not to take me up on that offer, I think it is fair to say that something extremely fishy is going on re this matter (something that this long-time observer of community interactions cannot help but attribute to behind-the-scenes efforts at “persuasion” on the part of Greaney).

Bob Clyatt

All that said, there is a bright side to the safe withdrawal rate material appearing in Work Less, Live More. The bright side is that Bob Clyatt is for the most part taking safe withdrawal rates seriously. A number of board communities have elected in their embarrassment over the Greaney matter to downplay the safe withdrawal rate topic. Clyatt is putting it back on the table with the publication of Work Less, Live More, and rightly so.

We have been talking about safe withdrawal rates since the earliest days of our movement, and my guess is that we will continue to be talking about them for a long time to come. Safe withdrawal rates matter.

(There was a spirited discussion of Work Less, Live More and the critical need to include valuation adjustments in safe withdrawal rate analyses held at the Vanguard Diehards board not too long ago.)

The fourth breakthrough insight put forward in Work Less, Live More is the idea that safe withdrawal rate analyses intended for use by early retirees should not call for diminishment of principal to zero over the course of the retirement.

This is big stuff.

The standard practice with safe withdrawal rate analysis has long been to determine the withdrawal rate that works presuming that the retiree is willing to see his portfolio diminish to nothing at the end of 30 years. The safe withdrawal rate for an 80 percent S&P portfolio used to finance a retirement beginning in January 2000 is 1.6 percent. This does not mean that a retiree could withdrawal an inflation-adjusted 1.6 percent of portfolio value each year and still be reasonably sure of having his initial portfolio value remain in place at the end of 30 years. It means that he can be assured that, even if a worst-case returns sequence (the worst that we have seen in the historical record, but nothing worse than that) pops up in his retirement, he will be able to take out 1.6 percent of portfolio value each year if he is willing to accept possibly having nothing left at the end of 30 years.

This reality is stated in the conventional studies. So there is no deception going on regarding this aspect of the conventional methodology studies (as there is with the studies published by those who are aware of the critical effect of valuation changes but who have failed to incorporate this factor into their analyses). Still, it is a highly problematic way to set things up.

The problem is that the safe withdrawal rate analyses require the retiree to stick with a buy-and-hold strategy at times when stock prices fall. If the retiree sells his shares when prices drop, all the assurances that safe withdrawal rate analysis is intended to provide go out the window. So it is extremely important that the retiree build into his plan enough of a margin of error to avoid feelings of panic during price downturns.

Early Retirement

The conventional approach — permitting portfolio value to drop to zero in a worst-case scenario — does not do the job. This way of setting things up is likely in many circumstances to cause panic at just the worst time. Clyatt argues persuasively for setting things up so that the initial value of the portfolio is preserved even in cases in which a worst-case returns sequence pops up.

Bob Clyatt argues that the conventional set-up is particularly ill-suited for early retirees, who may spend a good bit more than 30 years in retirement. That is a powerful argument, in my view. William Bernstein, author of the book The Four Pillars of Investing, stressed this point in comments he made recently at the Vanguard Diehards board in which he rejected out of hand the idea that it is safe for an early retiree to use one of the conventional methodology studies to prepare his or her plan (he was expanding on ideas earlier put forward in his book).

I know from posts I have seen put to the various boards that a number of community members are not aware that in a worst-case scenario their portfolios will be reduced to zero when they make use of a “safe” withdrawal rate. The studies do point this out. But not all community members read the texts of the studies carefully enough to pick up on the fine points. The practical reality is that a lot of people are being misled into thinking that their retirement plans are “100 percent safe” (a phrase used in the RetireEarlyHomePage.com study and often repeated by Greaney in his posts to the various boards) when in fact they are something a good bit less than that. Not good.

The case is closed on this one, so far as I am concerned. Analyses making prominent mention of the fact that the withdrawal rate identified as safe may cause the entire portfolio to be wiped out in 30 years are acceptable. But analyses that reveal the withdrawal rate that permits the retiree to preserve his original portfolio value in circumstances in which a worst-case returns sequence pops up are more properly termed “safe withdrawal rate” studies, especially when the primary users of the studies are early retirees. The whole idea is to be safe in one’s planning, is it not?

The fifth breakthrough insight put forward in Work Less, Live More is the idea that early retirees need to follow more diversified investing strategies than those termed “optimal” in the old and now discredited safe withdrawal rate studies.


Clyatt is highly critical of the conventional studies, which, while entirely discredited in recent years in Financial Freedom Community discussions, are still often cited in media accounts written by reporters who lack expertise in the early retirement field. Not only does he find fault with the idea of setting things up so that portfolio value can drop to zero in 30 years. He also argues that the conventional studies, which generally look at portfolios comprised of a high percentage of S&P stocks, are inadequately diversified. I would like to see more discussion of this question before reaching a firm conclusion, but I am inclined to agree with him, at least in part.

Bob Clyatt’s call for greater diversification reminds me of arguments that have been put forward by the Financial Freedom Community members going by the screen-names “Raddr” and “Ben.” Both of these posters have portfolios more diversified than the portfolios identified as “optimal” in the often-cited RetireEarlyHomePage.com study. My sense is that both the Raddr and Ben portfolios are a good bit more “optimal” than the one that claims that status for itself.

Bob Clyatt agrees that the 74 percent S&P portfolio that many community members once thought was the only way to go for those aspiring early retirees who did not want to reveal themselves “mentally ill” (this is the term that Greaney frequently uses to describe community members who employ allocations other than the one he recommends) is a far cry from optimal. I hope that the support he offers to community members who have dared to be different gives more of us the courage to stand up to the assaults of Greaney defenders in days to come. We need a greater diversity of viewpoints on our boards, and my hope is that the arguments put forward by Clyatt may help us move us to a place where the expression of a good number of Greaney-opposed viewpoints is both tolerated and encouraged.

We need new blood, and, to get it, we need to encourage those who put new ideas on the table. I think that Work Less, Live More will be welcomed by movement newcomers who have been reluctant to offer their sincere investing views because of the heavy-handed tactics that have often been employed by a number of the old-timers trying to bring back the summer of 1999. A hearty thanks from one community member to another for your efforts at doing that, Bob Clyatt!

The sixth breakthrough insight put forward in Work Less, Live More is the idea that the technology revolution is providing investors with insights that will make it easier in future days to customize portfolios in ways that best serve the long-term goals of the investor.

I believe that Clyatt is on the right track in a section of his book in which he refers to development of an approach to investing that he terms “Rational Investing.” I am not entirely persuaded by the arguments put forward in this section. My sense is that the ideas being put forward are not yet fully baked. But my sense is that Clyatt is grasping at something not too far off from the also-not-yet-fully-baked concept of “The New Buy-and-Hold” Investing Paradigm that is described in articles at another section of the PassionSaving.com web site.

I hope to be exploring Clyatt’s “Rational Investing” concept in a bit more depth in days to come. I believe that it is possible that some of his ideas could be incorporated into The New Buy-and-Hold Investing Paradigm as that paradigm is more fully developed.

We are in a transition stage in our understanding of how best to invest for the long term. A good number of informed investors are beginning to see that the Stocks-for-the-Long-Run Investing Paradigm is not going to live up to its billing. But the core idea of holding stocks for the long term has strong appeal (and rightly so). So we have been reluctant to make too quick and too clean a break with the old paradigm. Clyatt does not seem to me to have all of the pieces of the Retire Early investing puzzle in place. But it does seem to me that he is at least looking forward about as much as he is looking backward. I think he may be a significant help in our community’s effort to — oh, what’s that phrase again? — GROW UP!

The seventh breakthrough insight put forward in Work Less, Live More is the idea that the annual percentage withdrawal taken from a Retire Early portfolio should be a variable number rather than a fixed number.

Clyatt here is endorsing a version of the approach to safe withdrawal rate analysis that Peter Ponzo (“Gummy”) has argued for using the phrase “sensible withdrawal rates.” The community member who goes by the screen-name “SalaryGuru” or “SG” has also put forward some valuable input on strategies to adjust withdrawal rates and thereby render safe take-out percentages that otherwise would not be safe.

The variable-withdrawal approach makes sense. The flaw in the incarnations of it that we have seen thus far is that those who have argued for the concept have not adequately addressed the valuations question. Thus, we cannot have confidence in the numbers used in their analyses. The analytical approach makes sense, but the executions of it that we have seen thus far leave much to be desired.

The same flaws apply to the approach recommended by Clyatt. He revealed in a thread at the Early Retirement Forum that an early retiree using his approach might suffer a loss of annual buying power of 35 percent or more. Stop! Do Not Pass Go! That’s too big a potential loss in buying power for a retiree seeking safety in his early retirement plan.

I would very much like to see Clyatt put forward a reformulation of his variable withdrawal percentage approach that provided an acceptable measure of real-world safety. I must give the articulation of the concept put forward in Work Less, Live More a failing grade, however. It adds too much complexity for too little return pay-off.

The New Retirement

The eighth breakthrough insight put forward in Work Less, Live More is the idea that discussion-board communities are capable of doing serious work to advance knowledge of how to win financial freedom early in life.

There are a good number of community members who have told me that they think I am crazy to fight as hard as I do to protect our community from abusive posters. I am frequently informed that: “It doesn’t matter if the debates held are on the level or not because it’s only a discussion board!” Boo! Hiss! I’ve seen posters at our boards generate insights that cannot be found in any book in any library on the face of Planet Earth. I’ve seen posters at our boards put forward accounts of their personal experiences that changed the lives of their fellow community members in profound and positive ways. A Financial Freedom Community board is never only a discussion board, in my estimation. A Financial Freedom Community board is a wonderful and significant thing to be.

Bob Clyatt shares my excitement about the potential of this new communications medium. The first words on the Acknowledgments page of Work Less, Live More are a valentine to his fellow Financial Freedom Community members (as are the first words to the Acknowledgments page of my book Passion Saving). I haven’t seen this done before. But my guess is that it is something that we will all see being done not infrequently in days to come.

Discussion boards offer ways to generate and develop and test ideas that simply did not exist prior to the development of this exciting new communications medium. There are flaws to the discussion-board communications medium, to be sure. No one knows that better than I do. But the potential is there for discussion boards in general (and for Financial Freedom Community boards in particular) to change the world. Bob Clyatt (ot should I say “ESRBob”?) very much “gets it” re this one.

Eight breakthrough insights in one book — Good job, ESRBob! Now get down to the important business of fixing those “highly misleading” (William Bernstein’s phrase) safe withdrawal rate numbers set forth in your book, will you please?

Why Stocks for the Long Run Is Wrong

I like the book Stocks for the Long Run. It is a book focused on long-term buy-and-hold investing. I think that long-term buy-and-hold investing is where it’s at.

Stocks for the Long Run

It’s a book that relies on analyses of the historical stock-return data to determine what strategies work best in the long term. Again, I think that that approach is on the one. Valuation-Informed Indexing too is an approach rooted in a study of what the historical stock-return data tells us about how to invest successfully for the long term.

It’s certainly been proven an influential book. Stocks for the Long Run isn’t just a book, really. It’s a phrase that calls to mind a powerful idea. Money magazine published an interview with Jeremy Siegel which described him as “the intellectual godfather of the 1990s bull market” and which said that “his 1994 book Stocks for the Long Run sealed the conventional wisdom that most of us should be in the stock market.”

The powerful idea at the core of Stocks for the Long Run is that stock investing becomes less risky with time. That’s a profound truth, especially for middle-class investors (the investor group most concerned about the risks of owning stocks).

The other side of the story is that Stocks for the Long Run is chock full of analytical errors. There’s a whole big bunch of sloppy thinking in evidence in the pages of this text. The errors have had at least as much of a negative influence on investors as the insights have had a positive one. The same book that helped millions accumulate tubfulls of wealth in the 1990s is in all likelihood going to cause millions to lose tubfulls in the not-too-terribly-distant future. This is a dangerous book.

Stocks for the Long Run is an insightful book. Stocks for the Long Run is an influential book. Stocks for the Long Run is a dangerous book. All three things are so.

This article points out the worst of the analytical errors made in the book so that you can avoid the traps likely to do harm to investors who place their confidence in the book’s highly popular (for now) but also highly dubious “findings” about how stocks perform in the long run.

Dubious Claim #1 (Page 22 of Stocks for the Long Run) — “The superiority of stocks to fixed-income investments over the long run is indisputable.”

Is there something in you that makes you want to question an investing claim that someone puts forward as “indisputable”?

If you classify Treasury Inflation-Protected Securities (TIPS) as fixed-income investments (most think of them as a type of fixed-income investment, although the return provided varies with changes in inflation), Siegel’s claim here is false.

Jeremy Siegel

I own 30-year TIPS paying a real return of 3.5 percent. William Bernstein has calculated the expected long-term return of stocks purchased at extremely high prices at 3.5 percent real. An investment class that provides 3.5 percent real without risk is superior to an investment class that provides 3.5 percent real by requiring the investor to take on a good bit of risk.

You cannot buy TIPS paying 3.5 percent real today. But a strong argument can be made that Siegel’s claim remains false. Bernstein’s 3.5 percent number is rooted in an assumption that stocks will remain at the absurdly high prices that apply today indefinitely into the future. Assume that stocks will perform in the future at least somewhat as they always have in the past, and today’s TIPS return beats today’s most likely 10-year stock-return number. Stocks will likely do better going out 20 years, but probably not by enough to make up for the added risk taken on in owning them. It is only when you go 30 years out that stocks purchased at today’s prices appear superior. Few of us own investments solely for what they will do for us 30 years out.

Siegel got it wrong.

Dubious Claim #2 (Page 26 of Stocks for the Long Run) — “For many investors, the most meaningful way to describe risk is by portraying a ‘worst case’ scenario…. The fact that stocks, in contrast to bonds or bills, have never offered investors a negative real holding period return yield over periods of 17 years or more is extremely significant.”

Siegel is here playing the same conjurer’s trick that is employed in conventional-methodology safe withdrawal rate studies. He is right that many of us want to know what can happen to our money in a worst-case scenario. For obvious reasons. It is only by knowing what happens in a worst-case scenario that we can plan for the future (hoping that a worst-case scenario will not turn up but structuring our plans so that we can “get by” even if one does). However, the analytical approach employed by Siegel does not reveal how stocks will do in a worst-case scenario.

The approach he follows is to look at all 20-year holding periods in the historical record and refer to the one yielding the worst result for stockholders as the “worst case.” It is of course accurate to say that this is the worst case historically. But Siegel makes clear that the purpose of his analysis is to inform investors as to what is the worst-case scenario that they are likely to face in the future. This he does not do.

There have been few times in the historical record in which stocks have been at the valuation levels that apply today. Stocks have historically performed far worse at times of high valuations than they have at times of low or moderate valuations. Siegel errs in concluding that it is “extremely significant” that stocks have never provided a negative real return over 17 years. The primary reason why that is so is that there have been so few cases in the historical record in which stocks have been as overpriced as they are today. With so few tests of the 17-year rule for purchases made at these valuations (which are the only sorts of valuations at which the 17-year rule is exposed to a serious test), this finding is little more than an historical curiosity.

Siegel’s core point — that stocks become far less risky when held for long time-periods — is important and true. He exaggerates the extent to which this is so by placing too much confidence in the results obtained in the tiny number of cases in which stocks have been at today’s price levels. The impressive thing is not that there has never been a negative return over a 17-year time-period. The impressive thing is that, with so few relevant cases on record, stock investors have already been placed in circumstances in which they had to wait 17 years for a positive return. That’s disturbing news indeed for those going with high stock allocations today.

Causes of Bull Market Insanity

There’s a good chance that the 17-year rule will be broken sometime around the Year 2017. A regression analysis of the historical stock-return data reports that the worst-case 20-year return for those buying stocks at today’s prices is a negative 1.4 percent. There was a greater than 20 percent chance of a negative return over 20 years for those who invested in S&P stocks in January 2000. At that time, the most likely return over 20 years was only 1 percent real.

Jeremy Siegel got it wrong.

Dubious Claim #3 (Page 30 of Stocks for the Long Run) — “There is no compelling reason for long-term investors to significantly reduce their stockholdings, no matter how high the market seems.”

I’d bet $7.25 that Jeremy Siegel lives to eat those words.

Buy-and-hold investing is what works. There is no worse mistake you can make than to sell when prices are low. The investor who maintains the same stock allocation when prices are sky-high as he does when prices are at low or moderate levels all but insures that he will be forced to sell when prices are low. Siegel here is dooming many of his readers to failed buy-and-hold strategies.

The average price drop that we have seen on the three earlier occasions when prices got to the la-la land levels where they reside today is 68 percent. For an investor with a 30 percent stock allocation, that’s an overall portfolio loss of about 20 percent. Some middle-class investors might be able to take a hit of that size without selling. Few can take a hit much bigger than that without selling.

Is Siegel arguing that we should never go with stock allocations of greater than 30 percent? Surely not. At moderate valuations, the historical stock-return data can be used to make a case for a stock allocation of as high as 75 percent (I tentatively recommend a stock allocation of about 50 percent at times of moderate valuations). To limit your stock allocation to 30 percent at all times would be to leave large amounts of money on the table.

However, to go higher than 30 percent at times of high valuations would be to take on a big risk of selling when prices are down, the worst thing you can do. Investors should be lowering their stock allocations when prices go sky-high.

Siegel got it wrong.

Dubious Claim #4 (Page 30 of Stocks for the Long Run) — “If investors can identify peaks and troughs in the market, they can outperform the buy-and-hold investor. But, needless to say, few investors can do this.”

Siegel does not believe in long-term timing. But it is the same historical stock-return data that he uses to find supports for the things he believes in shows that long-term timing (unlike short-term timing) works.

One reason why long-term timing works is that there is no need for the long-term timer to “identify peaks and troughs.” Who cares what the peak is? Who cares what the trough is? That is the sort of thing that concerns (and trips up) short-term timers.

My sense from his words here is that Jeremy Siegel has never seriously examined the long-term timing option. If that is so, he should not be making the sort of statement that he makes above. Many investors have been misled by this sort of claim, and, in the event that stocks perform in the future anything at all as they always have in the past, many will be hurt in days to come by the misunderstanding of the realities that it encourages.

Jeremy Siegel got it wrong.

Dubious Claim #5 (Page 30 of Stocks for the Long Run) — “As difficult as it is to sell when stock prices are high and everyone is optimistic, it is more difficult to buy at market bottoms.”

Cause of Bull Market

Siegel is here suggesting that those who go with high stock allocations when prices are high will be able to avoid selling when there is a big price drop, but that those who took money out of stocks in anticipation of the wonderful value propositions that will open to them when prices fall will be so shook up by the price drop that they will be paralyzed into not following through with their plans.

Someone is going to be buying stocks when prices fall hard, right? There’s a buyer and a seller for every transaction.

Who is more likely to buy — the investor who has been wiped out by the price drop or the investor who has experienced only a small hit because he acted on what he learned from the historical stock-return data about how valuations affect long-term returns? The question should answer itself. When those who ignore valuations are anxious to sell, those who pay attention to valuations will be excited to buy. Not buying when prices are too high is the best indicator of an ability to buy when prices are outstanding.

Jeremy Siegel got it wrong.

Dubious Claim #6 (Page 37 of Stocks for the Long Run) — “Based on the historical returns on stocks and bonds…conservative investors should have nearly 90 percent of their portfolio in stocks, while moderate and aggressive investors should have over 100 percent in equity. This allocation can be achieved by borrowing or leveraging an all-stock portfolio.”

And I hear on discussion boards from time to time that my investing advice is “loony and irrational”!

I mentioned above that 68 percent is the size of the average loss experienced on the three earlier occasions when we traveled to today’s la-la land valuation levels (this article was written in December 2006). Do you want to know how Siegel gets his super-duper calculator to generate “findings” like those quoted above? He assumes that no one sells when he or she experiences a 68 percent price drop!

Do you know anyone who would not sell stocks after experiencing a 68 percent price drop? Neither do I. My strong hunch is that neither does Siegel.

He didn’t let that stop him from writing the words quoted above, however. Siegel spent many, many years engaged in schoolbook learning. Every now and again, it shows.

Jeremy Siegel got it wrong.

Dubious Claim #7 (Page 81 of Stocks for the Long Run) — “To imply that these historical yardsticks [the reference is to valuation assessment tools] constitute the “right” or “fair” value for stocks also implies that the historical returns to equity have been “right” or “fair” to the shareholder. But since stock returns have far exceeded the returns on other financial assets, such a conclusion might not be justified. Higher valuations could occur as investors correctly recognize the superior returns on stocks.”

Influential Investing Books

The four most dangerous words you will ever hear from an investing analyst are — “It’s different this time.”

Every time prices get out of hand, you can count on someone coming forward to tell us not to be concerned because it’s going to turn out different this time.

Every time that there are large numbers of investors who conclude that it’s going to turn out different this time, it ends up turning out the same as all the other times (with many of those investors swearing off stocks for life as a result of the “surprise” hit they endure).

One good thing you can generally say about academics is that they aren’t trying to sell you anything. In this passage, Siegel sounds to me less like an academic and more like a stock salesman.

Could it be different this time? Sure, anything could happen.

When I was a kid, I used to listen to Phillies games during an era in which they regularly lost close to 100 games per season. I used to imagine when they were only two or three runs down in the ninth that there was a good chance that Cookie Rojas would get a walk and that Johnny Callison would hit a line-drive single and that Richie Allen would put one over the wall. I would reassure myself: “It just might turn out different this time!”

I was twelve years old.

Jeremy Siegel got it wrong.

Dubious Claim #8 — (Page 192 of Stocks for the Long Run) — “When reviewing the causes of major market movements, it is sobering to realize that less than one-quarter can be associated with a news event of major political or economic import.”

This claim is true enough on its face. However, it appears that Siegel’s point in putting forward these words is to lead his readers to believe that stock returns are unpredictable. Stock returns are not unpredictable. Stocks returns are backed by the earnings of the underlying companies. U.S. companies have been generating profits large enough to support an annualized real return of about 6.5 percent real for a long time now. When the annualized return goes well above that for a substantial stretch of time (as it did in the 1980s and 1990s), look out below in the years that follow!

Bull Market of the 1990s

Siegel is right that it is a waste of time trying to figure out the causes of short-term price changes. He is wrong to suggest that we cannot understand the cause of long-term returns. If you are willing to assume that the U.S. economy will remain in the future roughly as productive as it has been in the past, you are able to predict (with a reasonable degree of accuracy) your long-term return from any of the various starting-point valuation levels.

Jeremy Siegel got it right, but put forward an unwarranted suggestion that understanding where long-term stock returns come from is a hopeless endeavor.

Dubious Claim #9 (Page 182 of Stocks for the Long Run) — “Individuals have a deep psychological need to find fundamental explanations for why the market is doing what it is doing. It is very discomforting for many to learn that most movements in the market are random and do not have any identifiable cause or reason.”

For good reason.

You betcha we feel a “deep psychological need” to understand why stocks behave the way they do. It’s our life savings that we put at risk when we invest in stocks. It sure would be nice to know why stock prices rise in crazy ways at some times and drop in crazy ways at other times.

Siegel is dismissive of investors’ desire to understand why stocks behave in the seemingly crazy ways they do. He wants us to accept his claims that stocks are always best and stop trying to figure out why.

That would be a terrible mistake for us to make.

The trick to successful investing is holding stocks for the long run. Only those who are confident in their investing choices can pull it off. Only those who understand how stock investing works can count on having the required amount of confidence when their strategies are not working out as they hoped.

Confidence matters. Understanding is the foundation of a lasting confidence.

Siegel got it wrong.

Dubious Claim #10 (Page 272 of Stocks for the Long Run) — “Most of us have no chance of being as good as the average in any pursuit where others practice and hone their skills for many, many hours. But we can be as good as the average investor with no practice at all.”

Bull Market Myths

The average investor doesn’t obtain the sorts of long-term returns that Siegel points to in his book. Most of the long-term numbers presented in his book are mythical long-term numbers for most middle-class investors. To obtain those sorts of returns, you need to become a long-term buy-and-hold investor. It ain’t easy to do. It’s hard to do. Siegel doesn’t come close to revealing to us what it takes.

Siegel discusses a lot of numbers in his book. The numbers are important. Emotions are more important. Siegel discusses emotions hardly at all.

Siegel’s book is a product of the longest and strongest bull market in the history of the United States. It focuses on the easy side of stock investing — the numbers side. It all but ignores the hard side of stock investing — the emotions side.

Siegel got the focus wrong.

The Money article linked to above states that: “Stocks for the Long Run sealed the conventional wisdom that most of us should be in the stock market.” Let’s unseal it!

Let’s build on the genuine insights put forward in this book while avoiding the dangerous traps its sets for those of us seeking to become buy-and-hold investors not just on paper but in the real world too. Let’s build on what Jeremy Siegel got right while helping to enhance the middle-class investor’s gravely flawed understanding of the many important points that Stocks for the Long Run got wrong.

What You Must Know About Irrational Exuberance

All middle-class investors should read Robert Shiller’s book on Irrational Exuberance. It tells us things about how stocks work that are rarely reported on by less informed or less objective or less courageous investing analysts. This article provides a “cheat sheet” to the most important of Shiller’s insights for those who don’t have time to read the book.

The first thing that you must know about Irrational Exuberance is that the rationalizations that are used to argue that today’s bull market prices are not a cause for alarm are nothing new.

George Gibson argued in a book published in 1889 that, when “shares become publicly known in an open market, the value which they acquire may be regarded as the judgment of the best intelligence concerning them.” That’s essentially the “insight” that is today referred to by defenders of bull market excesses as the “Efficient Market Theory.”

Irrational Exuberance

It’s not really an insight, it’s a rationalization. People who believe in the Efficient Market Theory don’t believe in it because the historical stock-return data makes a strong case for it. The data makes a strong case that the primary influence on prices is emotion, not reason.

And it’s not that some Big Brains have in recent decades discovered something that nobody knew about before. Those who believe do so because they want to believe. Confidence in the Efficient Market Theory is achieved by an act of will.

It was the same story in the days before The Great Crash. Here are some words put forward by Joseph Lawrence in 1929: “The consensus of judgment of the millions whose valuations function on that admirable market, the Stock Exchange, is that stocks are not at present over-valued…. Where is that group of men with all-embracing wisdom which will entitle them to veto the judgment of the intelligent multitude?”

People have been cooking up rationalizations for investing in overpriced stocks since the first stock market opened for business. The important thing to know about such theories is that confidence in them crashes along with prices in the wild bear markets that always follow wild bull markets.

The second thing you must know about Irrational Exuberance is that those who follow more sensible investing theories do not believe that it is possible to make gobs of quick money by knowing that stocks are overpriced.

Defenders of the bull market excesses often paint cartoonish portraits of those who reject the Efficient Market Theory. They suggest that, if the market were not efficient, it would be possible to get rich quick simply by investing in a valuation-informed manner. It’s not so.

Here’s what Shiller says: “If indeed one knew today that the market would do poorly over the next 10 or 20 years, but did not know exactly when it would begin to do poorly…there would be no way to profit significantly from this knowledge.”

Looking at how valuations have affected long-term returns in the past permits you to protect yourself from the worst effects of bull market excesses and to obtain stronger value propositions from your investing dollars. But Valuation-Informed Indexing is no Get Rich Quick scheme.

Valuation-Informed Investing is common-sense investing. It stands a good chance of paying off in the long run. Its most ardent supporters don’t claim that it does more than that.

The third thing you must know about Irrational Exuberance is that there is lots of academic research pointing out the holes in the Efficient Market Theory.

Shiller explains on page 179 that: “There is no shortage of systematic evidence that firms that are ‘overpriced’ by conventional measures have indeed tended to do poorly afterward. Many articles in academic finance journals show this, not by colorful examples but by systematic evaluation of large amounts of data on many firms.”

Robert Shiller Book Irrational Exuberance

Please don’t be taken in by silly and misleading claims that “everyone knows that” the stock market is efficient. It is common practice for lots of people to say such things during wild bull markets. If lots of people did not say such things during wild bull markets, wild bull markets could not remain in place for long. But it is false to say that “everyone knows that” markets are efficient. There are many knowledgeable people who have seen through the rationalizations of the bull market excesses that have become popular in recent years (this article was written in October 2006).

The fourth thing you must know about Irrational Exuberance is that the pain that we are in all likelihood going to experience as a result of the bull market excesses could be severe indeed.

The loses that investors are likely to suffer as stock prices make their way back down to reasonable levels “could be comparable to the total destruction of all the schools in the country, of all the farms in the country, or possibly even all the homes in the country,” according to Shiller.

Not good.

The fifth thing that you need to know about Irrational Exuberance is that the blame for this pain is properly placed not on the average investor but on the “experts” who failed to warn us of the risks of getting carried away by our emotions and who in many cases actually encouraged us to get carried away.

I have many times during The Great Safe Withdrawal Rate Debate had conversations with middle-class investors who sense that they are not being told the straight story about the dangers of stock investing today and who are seeking the pieces of the puzzle missing from the story being told by those who defend the bull market excesses.

Some of the people identified as “experts” simply do not know any better. Others do, but fail to speak up because they know they will be criticized by defensive extremists. I am not without sympathy. I doubt that there is anyone alive today who knows better than I how vicious those who defend the bull market excesses can be when hard questions are posed to them about their claims. Still, I think it is shameful for those who know about at least some of the holes in the now-popular rationalizations to fail to speak up about what they know. It is the job of a stock analyst to share with the public what he or she knows about how stocks work, whether the information shared happens to make most people who hear it pleased with the analyst or not.

I strongly endorse Shiller’s argument that: “The market is high because of the combined effect of indifferent thinking by millions of people, very few of whom feel the need to perform careful research on the long-term investment value of the aggregate stock market, and who are motivated substantially by their own emotions, random attentions, and perceptions of conventional wisdom.”

Investor Emotions

Those who put themselves forward as “experts” must be held to a higher standard than the typical investor, who has fifty claims being put on his or her time on a daily basis. Most investors of today are placing their trust in the experts to tell it at least reasonably straight and most of the experts are letting them down. As Shiller says, “It is a serious mistake for public figures to acquiesce in the stock market valuations we have seen recently, to remain silent about the implications of such high valuations, and to leave all commentary to the market analysts who specialize in the nearly impossible task of forecasting the market over the short term and who share interests with investment banks or brokerage firms.”

Wake up, stock experts!

The sixth thing you must know about Irrational Exuberance is that the media is generally not a reliable source of investment insights.

The media likes to focus on continuing stories that regularly produce new fodder for media discussion. The stock market is a great topic because it produces fresh “news” on a daily basis.

That’s so when you understand stock investing only on a surface level. It is not true when you develop an informed understanding of how stocks work. The daily price changes are pointless noise. The media focus on the part of the story that matters least (the daily price changes) and ignore the story that matters most (the long-term risks to middle-class wealth presented by today’s valuation levels).

Shiller observes that: “Sometimes the article is so completely devoid of genuine thought about the reasons for the bull market and the context for considering it that it is hard to believe that the writer was other than cynical in his or her approach.” Precisely so.

I feel a need to add that it is not necessarily the reporters who are cynical. Reporters need to write what their editors tell them to write and editors need to instruct their reporters to write what their publishers want to see appear in the paper. I made a living as a corporate journalist for many years. My primary goal in seeking financial freedom early in life was to be able to provide in the articles I write the context readers need to derive a significant benefit from reading them.

Alternative Investment Strategies

Don’t count on the media to do your homework for you. Don’t count on a stock broker to do your homework for you. Don’t count on big-name experts to do your homework for you. Pick up a copy of Irrational Exuberance and begin the project of educating yourself as to how stocks really work.

The seventh thing that you need to know about Irrational Exuberance is that it is not possible to prove beyond any doubt that the stock market is not efficient.

It is one thing to say that there is a lot of historical data showing that the market is not efficient. It is something else again to say that we can prove beyond any doubt that the market is not efficient. As Shiller observes, it is often all but impossible to prove a negative.

Given how risky an asset class stocks are, and given how much it increases the risks of stock ownership for middle-class investors to come to believe that the market is efficient, the burden should be on those arguing that the markets are efficient to make their case, not on those pointing to the evidence showing that they are not to prove that it is so.

One of the arguments that has been advanced to get discussion of the Valuation-Informed Indexing approach banned at a number of discussion boards is that it is “dangerous” for people to be able to hear the counter to the claims of those arguing for the Efficient Market Theory. I see it just the other way around. Stocks are a risky asset class. Those arguing that investors should not give serious consideration to the risks that go with owning stocks present more of a danger than those arguing that investors should take a look at the historical stock-return data before putting too high a percentage of their portfolio in overpriced stocks. We are living in Humpty Dumpty World when it is viewed as “dangerous” to allow discussion of the risks of a high-risk asset class at a time when the risk attached to investing in it is at its highest level in history.

The eighth thing that you need to know about Irrational Exuberance is that most stock investors hold contradictory views about how stocks work.

As part of an explanation that compares how Ponzi schemes become credible in the eyes of many of the people invested in them and how overvalued stock markets come to be seen as not too dangerous in the eyes of many of the people invested in them, Shiller observes: “That others have made a lot of money appears to many people as the most persuasive evidence in support of the investment story associated with the Ponzi scheme–evidence that outweighs even the most carefully reasoned argument against the story.”

If I had five dollars for every time a poster at a discussion board participating in The Great Safe Withdrawal Rate Debate said in response to a hard question about what the historical stock-return data really says that “I’ve made a whole bunch of money investing in stocks, buddy, why should I listen to anything you have to say on the topic?” I would be able to afford to take my kids to Disney World for a month. Humans are inclined to trust real-world results above theory. With both Ponzi schemes and bull markets, the real world results are solid.

Until the day comes when they are not.

Stock Valuations Investor Emotions Why it is that people cannot see through the illusions in time to save themselves from taking a big financial hit? One big reason is that “people have learned that when experts tell them something is all right, it probably is, even if it does not seem so.” Another is that “in everyday living we have learned that when a large group of people is unanimous in its judgment on a question of simple fact, the members of that group are almost certainly right.”

Please note that the fact that other investors have confidence in stocks and the fact that many experts have confidence in stocks are not reasons for ignoring valuations. Human beings are not computer with legs. Our actions are not motivated only by reasons. They are motivated by feelings too. Investing is primarily an emotional endeavor, and only secondarily a rational one.

The ninth thing you must know about Irrational Exuberance is that most stock investors do not hold their beliefs about stocks with much conviction.

Things won’t change because people come to see the illogic of their beliefs. What impresses people about stocks in a positive way is seeing people make money by investing in stocks. What will impress people about stocks in a negative way is seeing people lose money by investing in stocks. The cure for irrational exuberance is the widespread suffering of huge financial setbacks. There’s no other way to get from where we are to where we want to be.

How is it that people will give up their belief in the Efficient Market Theory and all that other jizz-jazz? That one’s easy. Few people ever believed in that sort of thing anyway. People say they believe in it because they feel a need to say something when questioned about their behavior. The Efficient Market Theory is a rationalization that comes after the decision to invest in stocks (a decision that results from the observation that lots of other people have made money doing so) has been reached.

Revolution in Stock Market Investment Advice

Here’s how Shiller puts it:

“People widely believe that the stock market is unforecastable and that market timing is futile. But they also believe that, if the stock market were to crash, it would surely come back up. Such views are clearly inconsistent…. People do not much worry about the apparent contradictions among the views they hold. There is a willingness to free ride here — to suppose that the experts have thought through the apparent contradictions and therefore to assume that the experts know why they are not in fact contradictions at all…. People’s thinking about the arcane field of investments is surely clouded with many half-thought-through ideas that may be mutually contradictory, or at least have not been put into any coherent analytical framework.

Get ready for the clincher.

“The significance of the fact that contradictory views are held simultaneously is that people have no clear attachment to many of their views. Therefore we cannot attach too much credence to investors’ stated belief that the market will surely come back after a crash, for the circumstances of the actual crash could bring to the forefront other, contradictory views that would explain away a lack of market resilience. Investors would then react in ways that could not have been foreseen based on their previously expressed confidence.

The tenth thing you must know about Irrational Exuberance is that the Indexing Revolution may have made things worse.

The increased popularity of investing through indexes and mutual funds rather than through the purchase of individual stocks has in some ways made stock investing more emotional (while in some other ways making it less emotional). For stock investing to be rational, investors need to be informing themselves of the economic realities of their investment choices. For those investing in individual companies, the need to do this is obvious. For those investing in indexes or funds, it is not so obvious. People are tempted “not to, as they see it, waste their time and effort in exercising their judgment about the market” since they believe that they can count on the experts who keep the market efficient to do the job for them.

New Investing Ideas
I see indexing as a plus. But I think it has made investing too abstract an enterprise for many investors. Indexers tend to lose sight of the economic realities that generate the profits on their investments because they are not required to engage in independent study of them.

This Book Saves Marriages — The Complete Tightwad Gazette

Woody Guthrie imprinted his “Mission Statement” on his guitar — “This Machine Kills Fascists,” it said. If Amy Dacyczyn were to follow Guthrie’s lead, she would need to carve onto the back of her book The Complete Tightwad Gazette the words “This Book Saves Marriages.”

It’s the only wedding present I give anymore. In the unfortunate event that any of the couples to whom I have given this gift becomes divorced in days to come and then the two spouses remarry, I’ll give them both second copies on the thinking that the fact that the first marriage failed is a sign that they didn’t read the first copy carefully enough.

Tightwad Gazette Saves Marriages

Good writing is not about stringing together fancy words. Good writing is about changing lives for the better. I cannot offer higher praise of a book than to say that it saves marriages. Amy Dacyczyn is a Hero of the First Order in the Financial Freedom Community (and just think, she earned that title without even once mentioning safe withdrawal rates). No one has accomplished as much for our movement as Amy Dacyczyn.

If you are interested in attaining financial freedom early in life, you need to buy a copy of this book and read every page. To entice you to do so, I will offer you in this article a small sampling of its riches.

Sample Insight #1 from The Complete Tightwad Gazette — Effective saving is a radical act (Volume One, Page 3)

Dacyczyn tells the story of how she was listening to a voicing of the conventional woe-is-me money message on a daytime talk show and became angry enough to shout back at the television that “it is not true…it was still possible to raise a large family and buy a house without two full-time incomes.”

We “buy” ourselves options by saving effectively. Money is power. When you hold onto it rather than letting it pass through your hands, you liberate yourself. Our influence over many aspects of our lives is greatly limited. You don’t get to decide how tall you are, or how healthy you are, or whether you can sing well. You have a great deal of influence over how much of the money you earn you commit to savings.

Sample Insight #2 from The Complete Tightwad Gazette — Those seeking to save effectively need a support network (Volume One, Page 12)

Dacyczyn notes that she remained in Weight Watchers after she had attained her weight-loss goal to benefit from the support group. We are all influenced by what we see other humans doing. When everyone else is making poor eating choices, we feel tempted to do so too. It’s the same when everyone around us is making poor money choices.

A big reason for the low savings rate is our natural human desire to want to feel that we belong.

Sample Insight #3 from The Complete Tightwad Gazette — Even those of us who don’t think we follow budgeting rules follow budgeting rules (Volume One, Page 15)

People often say that the reason why they don’t keep budgets is that they cannot stand being governed by rules about what they can do with their money. The reality is that nearly all of us follow some sort of spending rule. Dacyczyn explains that, during her single years, she maintained a checking account balance of between $1,000 and $1,500. When the balance exceeded $1,500, she felt free to spend. When the balance dropped below $1,000, she felt pressure to watch her spending carefully until the balance headed back upwards.
Complete Tightwad Gazette Saves MarriagesWe all follow spending rules. The difference is that some of us write them down. Some of us make conscious choices as to what we will spend money on. Those of us who do that attain a larger number of our most important life goals.

Sample Insight #4 from The Complete Tightwad Gazette — A Price Book is essential (Volume One, Page 31)

Dacyczyn urges that you keep a list of prices that are the best that you have found available for grocery items. Take the Price Book with you when you go shopping and you know whether a “sale” price is a good price.

Sample Insight #5 from The Complete Tightwad Gazette — The conventional money advice is not good enough (Volume Two, Page ix)

“Traditional financial and consumer writing offers safe, halfway advice….I knew that people could achieve the ‘impossible’ with a little discipline and a willingness to do things that mainstream thinkers deem too extreme.” So says Amy Dacyczyn.

I hate seeing the word “extreme” used in money discussions. What is “extreme” depends on your financial circumstances and your life goals. Few of us can help but be influenced by suggestions we hear that our money decisions are “extreme.” But it is not possible for media messages being transmitted to millions to take our personal circumstances into account.
Saving Money Saves MarriagesI needed to take some “extreme” measures to achieve my life goals within the limited number of years given me to travel through this Valley of Tears. I’m glad I did.

Sample Insight #6 from The Complete Tightwad Gazette — Theory alone and practical implementation steps alone are both boring (Volume Two, Page 4)

Amy Dacyczyn says: “Tips alone are boring, as is process alone, but the combination tends to be far more interesting.”

People seeking money advice often want to be told what to do in three easy steps. Due to the demand for this sort of information, a lot of people have made an effort to supply money tips. There’s a place for that sort of thing. The trouble is, money tips don’t usually do much good.

The problem with most money tips is that they only apply in a limited number of cases. To save effectively, you need to develop a new way of making money decisions. You need to go deeper than tips. You need to look at why it is that you spend and how it could come to be that you would elect more frequently to save rather than to spend.

Pure theory is boring too, though. The good side of tips-oriented thinking is that it keeps things grounded. Dacyczyn is right that the most interesting stuff is the stuff that sets forth a strikingly fresh idea and then shows how it can be implemented in a particular circumstance through use of a tip.

Sample Insight #7 from The Complete Tightwad Gazette — You need to sweat the small stuff (Volume Two, Page 20)

Most people think for a good bit of time about buying a car or a house. Most people spend little time thinking about expenses that come up every day. It’s the little expenses that matter most. There are a lot more of them and they come up more frequently.

Sample Insight #8 from The Complete Tightwad Gazette — Having lots of money is not the point (Volume Three, Page vii)

After Amy Dacyczyn made it big, she quit. She could have milked her thrift-advice-giving business for a whole big bunch more money. But her unconventional money ideas steered her clear of the trap of letting her business come to own her.
Frugality is Healthy Living“I prefer the luxury of freedom from a job to the luxury of material goods…. All along, I have pointed out that both earning and saving money should be means to an end, not ends in themselves. The end that I plan to pursue for the next several years is being a full-time mom to my six kids.”

Sample Insight #9 from The Complete Tightwad Gazette — Early retirement is an option for many (Volume Three, Page 253)

“Financial independence is possible for a surprisingly broad range of people,” says Amy Dacyczyn. She notes that many middle-class workers do not concern themselves with learning about how to be frugal because they earn enough that they don’t feel a “need” to be frugal.

This observation highlights the damage that has been done by general acceptance of the Sacrifice Saving approach to money management. Frugality is viewed by many as a necessary evil, something to be employed only when there are no good alternatives. It’s that kind of thinking that causes us to throw away so many exciting opportunities to live bigger and bolder and better.

The Complete Tightwad Gazette is safe for the entire family

Frugality is not something you turn to when you are blocked into a corner. It is something you embrace when you have a vision of a better life that you want to see brought to fruition before the sand runs out of the hourglass.