The good news is that we know more about safe investing today than we have known at any earlier time.
The bad news is — It’s difficult indeed for us to share what we know with each other!
The incredible reality is that, at a time when most middle-class investors are desperately seeking to learn about safe investing strategies (this article was posted in March 2010), a Social Taboo has developed blocking reasoned discussion of the wonderful things we have learned from the academic research of recent decades. This article describes both the research findings and the Social Taboo that has thus far blocked you from learning about them.
Safe Investing Taboo Secret #1 — You Must Consider the Price Being Charged for Stocks Before Buying Them
Many people believe that they must give up on obtaining a good return to invest safely. No! Or they believe that there are complicated rules that must be mastered by those seeking to learn how to invest safely. No again! Safe investing is simple investing and rewarding investing. It all can be reduced to five words — valuations affect long-term returns.
That really is it. That really is all that you need to know. We have data on U.S. stock performance going back to 1870. Do you want to guess how many times investors who purchased stocks at low or moderate prices obtained poor long-term investing results? The answer is — it has never yet happened. Now do you want to guess how many times those who purchased stocks at prices of two times fair value obtained good long-term results? That too has never yet happened. If there is one Iron Law of safe stock investing, it is — Never, ever, ever, ever consider buying stocks without first looking at the valuation level that applies for them at the time.
This is so obvious that in ordinary circumstances I would be worried that I would be insulting your intelligence by pointing it out. These are not ordinary circumstances. Stocks were selling at insanely high prices for the entire time-period from 1996 through 2008, and prices remain on the high side today. So what have the experts been telling you during that entire time-period? That stocks are always a good buy, that things will work out in the long run so long as you don’t try to “time” the market (taking price into consideration is of course a form of timing since those who understand the importance of valuations are of course going to go with higher stock allocations at times when the long-term value proposition for stocks is good than they are when the long-term value proposition for stocks is poor), that Buy-and-Hold is what works and that practicing Buy-and-Hold means staying at the same stock allocation regardless of price changes.
Safe stock investing is easily available to all of us. The academic research has been telling us for 30 years now that paying attention to valuations is what works. And yet the people who we think of as “experts” in this field have been telling us precisely the opposite story; they have been telling us that we do not need to look at price, that it might even be a bad thing to take price into consideration, that taking price into consideration is a form of timing, and that we must not go there.
Is the promotion of Buy and Hold Investing part of a great conspiracy to bankrupt the middle class? Are the experts dumb? Or too lazy to read the literature as it comes out? Or are they just flat-out corrupt?
The answers are “no,” “no,” “no,” and “no.” But I do think it is fair to say that we live in strange investing times when 90 percent of the big names in the field advocate the opposite of what really works. That’s why this article does not end with my description of the first taboo secret. To have confidence in that secret, you are going to need to come to an understanding of why today’s investing advice is so mixed up and confused and misleading and dangerous.
Safe Investing Taboo Secret #2 — Our Understanding of How Stock Investing Works Is Primitive
Presuming that you are persuaded that buying stocks only when they are available at reasonable prices is the key to safe investing (I am highly confident that this is so, but I implore you not to make any investment decisions according to what I say — please scrutinize my claims as part of the process of forming your own take on these questions), you are faced with a puzzle. Why doesn’t John Bogle say what Rob Bennett says? Why doesn’t Money magazine say what Rob Bennett says? Why don’t Motley Fool and Morningstar and the Early Retirement Forum say what Rob Bennett says? They don’t, you know. In fact, I am banned at those places because I reported to the middle-class investors who visited there Taboo Secret #1, that they must take price into consideration when setting their stock allocations. The “experts” who posted at those sites didn’t take too kindly to the idea of Old Farmer Hocus spilling the beans.
It’s because they are not as “expert” as they like to pretend to be. None of us are. Taboo Secret #2 is that we just don’t know all that much about how stock investing works.
In a purely rational world, that would cause us all to speak with a great deal of humility. It would cause us to be careful to avoid dogmatism, to remain open to new ideas and alternate points of view. Unfortunately, that’s not always the way the humans operate. Perhaps you’ve noticed.
We want to get this investing thing right. Not knowing everything scares us. So do you know what we do? We fake it. We act more confident than we feel. We put on a show by using big words and citing stacks of studies (often irrelevannt ones) to cover up the fear we feel in telling people how to invest when we don’t really know for sure.
I can tell you what I believe is a safer way to invest. But I too cannot be entirely sure. To gain confidence in the findings of the new research, we need to have a national debate on what really works in investing. For the experts who have advocated Buy-and-Hold, that would mean — ssshhh! — acknowledging that they just might have gotten some things wrong. It’s not done! Not in this field!
It’s only the confident who can admit mistakes. The Catch-22 is that we cannot learn what we need to learn without first admitting that we have gotten some things wrong and we cannot bring ourselves to admit that we have gotten some things wrong for so long as we are paralyzed by the fear of what it means that we don’t know it all yet. So we just keep on doing the Buy-and-Hold thing, which is the opposite of what the academic research of the past 30 years says works. Oh, my!
Safe Investing Taboo Secret #3 — While Primitive, Our Understanding of How Stock Investing Works Has Improved Greatly in Recent Decades
The good news is that we know today a lot more about safe investing than we did before the development of the Buy-and-Hold Model. The Buy-and-Hold Model was at one time rooted in science. The most popular investing strategies of today are not the product of guesswork. They are the product of academic research in which the historical stock-return data is studied by academics seeking to learn in a systematic way what really works.
We have learned wonderful things as a result of this new approach. We have tapped into six important insights: (1) that short-term timing (changing your stock allocation with the hope of seeing a benefit within a year or so) does not work; (2) that it is best to ignore the short-term noise of stock price changes and market commentary; (3) that stocks on average provide the best long-term returns; (4) that it is important to limit transaction costs; (5) that stock picking is hard for investors who do not have the time or inclination to put a great deal of effort into the project; and (6) that successful investors stick to a plan for the long term.
The middle-class dream of truly safe investing is within our grasp today.
Safe Investing Taboo Secret #4 — The Dream of Making Safe Investing Strategies Widely Available to Middle-Class Investors Has Been Delayed By an Unwillingness Among “Experts” in the Stock-Selling Industry to Acknowledge Mistakes Made Many Years Ago
Our move to science-based investing advice came with a risk for the investing “experts” employed by The Stock-Selling Industry. Scientific learning is an ongoing process. It is common for academics to get things wrong on the first try and to admit mistakes and return to the drawing board. Most of the “experts” that you hear quoted on television and on web sites and in magazines are loathe to admit mistakes. They feel that it is “unprofessional” to get things wrong. So they are more inclined to fake it than it return to the drawing board and come up with better ideas when the old ones are found to be wanting.
This has become a huge problem in regard to promotion of the Buy and Hold strategy. Buy-and-Hold (staying at the same stock allocation at all times) makes sense only if there is no such thing as overvaluation. If stocks can become overvalued, investors obviously need to lower their stock allocations when they do because an overvalued stock market is a stock market headed for a price crash. The risk of investing in stocks is obviously far greater when a crash is imminent than it is when a crash is unlikely. In the event that overvaluation is possible, investors seeking safe investing strategies need to rule out the possibility of following a Buy-and-Hold approach and instead need to be sure to always lower their stock allocations once prices rise to insanely dangerous levels.
The academic research revealed to us in 1981 that overvaluation is a real phenomenon (the Buy-and–Hold model was developed at a time when the academics believed otherwise). So the “experts” should have been warning middle-class investors about the dangers of Buy-and-Hold for the past 30 years. Unfortunately, the shame that the “experts” feel over failing to do this grows greater as the economic crisis caused by the failure to warn investors of the dangers of Buy-and-Hold causes more and more human misery. What a mess!
Safe Investing Taboo Secret #5 — Buy-and-Hold Appears to be Nearing a Collapse
Since the crash, those who are familiar with the academic research showing that there is precisely zero chance of Buy and Hold ever working for the long-term investor have become more vocal about the new (to us — but known to the “experts” for 30 years now!) academic findings. As the economic crisis worsens, it seems likely that it will become possible for enough middle-class investors to learn about the new research for the process of rebuilding our destroyed economy to begin.
I’ll point you here to just one example (you’ll find many more if you explore other sections of the site) of how things are changing. Andrew Smithers recently wrote an article on the research findings that will be permitting us all to learn about safe investing strategies in days to come. He said: “When tested, however, the Efficient Market Hypothesis failed, as real equity returns do not follow a ‘random walk with drift’ but exhibit negative serial correlation. This meant that sustained periods of real returns, which were above the very long-term average, were followed by below average returns and vice versa.
This evidence obviously meant that the EMH, as applied to the stock market in aggregate, must be discarded or modified. Attempts at modification have failed. No one has yet produced a version of the EMH which can be tested and fits the evidence. Thus, the EMH must logically be discarded, as a valid hypothesis must be testable…. It is therefore possible, contrary to the EMH, to know whether markets are overvalued.”
There’s light at the end of this very dark tunnel!
Safe Investing Taboo Secret #6 — The New Research Points to Some Extremely Encouraging Insights
Once we open the internet up to honest posting on the realities of stock investing, I believe that we will see responsible political and economic leaders step forward to launch a national debate on the realities of stock investing. We have been discussing these issues in the Retire Early and Indexing discussion-board communities for eight years now, and we have developed some tentative insights that suggest many exciting safe investing strategies of the future.
Stock investing is always risky, right? Is that not what most people believe? Once you give up on the Buy-and-Hold Model, it becomes clear that this is not necessarily so. Rob Arnott has said that today’s conventional investing wisdom is rooted in “myth and urban legend” and the idea that stocks must be riskier than other asset classes appears to be one of the many ideas developed during the Buy-and-Hold Era that will not stand the test of time.
Why is it that we think of stocks as being risky? It’s because, in the days before index funds, investing in stocks meant investing in the fortunes of one particular company. Any one business enterprise can fail and that possibility meant that the entire investment amount of the middle-class investor would be put at risk. With the introduction of index funds, it is no longer necessary to take such chances. When you buy an index fund, you are investing in the future of the entire U.S. economy, not in the prospects of any one particular company. The odds of a wipeout are considerably less.
Index-fund investing is exceedingly risky today because most index-fund investors are following Buy-and-Hold strategies. However, once it becomes possible to let people know about the research of the past 30 years, the risks associated with failing to take valuations into account go “Poof!” The research indicates that valuation-related risk is about 80 percent of the total risk of stock investing. So, as we move to the promotion of Valuation-Informed Indexing strategies, the risks associated with stock investing are likely to be greatly minimized. All you have to do to tap into the benefits is to survive whatever number of stock crashes it takes for the investing “experts” to acknowledge the mistake they made in thinking that there was no need to take valuations into consideration!
Safe Investing Taboo Secret #7 — The Tools You Need to Make the Move to More Effective Investing Strategies Are Available to You Today
Simple and safe investing strategies are here today for those willing to make the small effort needed to become familiar with them. I recommend that you take four steps:
1) Learn how to work The Stock Return Predictor,
an investing calculator that reveals the most likely 10-year return on stocks purchased at any of the possible starting-point valuation levels. The Predictor tells you the price tag attached to the stocks you are buying. You wouldn’t buy a car or a comic book or a sweater or a banana without first looking at the price tag, would you? I don’t think you should be willing to buy stocks without first looking at the price tag either;
2) Review the materials a the Index Investing section
of the site. If Buy-and-Hold is the past of stock investing, Valuation-Informed Indexing is its future. Read enough articles to learn the basics (be sure to read the article on “The Case Against Valuation–Informed Indexing”!) and check out other sources to determine whether for you these ideas stand up to scrutiny or not;
3) Listen to a few of the podcasts made available at the “RobCasts” section of the site. Those with a particular interest in safe investing might want to begin with Podcast #72, “When Stock Losses Are True Losses and When They Are Not.” That one explains that not all losses are created equal. Losses that are temporary in nature do not make investing more risky in any significant sense. Losses that are long-term in nature should be avoided by those with a desire to follow safe investing strategies (shouldn’t that be all of us?); and
4) Please tell your friends and neighbors and co-workers about the investing ideas explored at this site and do what you can to get the Ban on Honest Posting lifted at the various boards and blogs. The sooner we launch the national debate on the new investing realities, the better off we all will be. There is no such thing as safe investing at a time when the reckless promotion of Buy-and-Hold strategies is pushing us ever closer to a Second Great Depression. We all should be united in trying to get the information out to people that they need to hear to regain confidence in our markets and in our economic and political leaders.
Safe investing is a reality today for those who truly want it. Please ask questions and share experiences with your fellow community members as you begin the exciting process of exploring these new investing ideas!