Reality #1 of Investing Today — We are Poorly Informed About the Basics.
Discussion boards permit us to learn things about investing that we couldn’t learn from books or speeches. One thing I’ve learned is that most middle-class investors of today do not possess a sure understanding of the basics –where stock returns come from, what causes prices to change, the distinction between the forms of timing that work and the forms that do not work, that sort of thing. I’ve become a big believer in stressing the basics over and over and over again.
Reality #2 of Investing Today — The “Experts” are Only Slightly Better Informed Than We Are.
We middle-class investors have an excuse; we’re busy and learning about investing is not our favorite thing to do with our time. The bigger problem is that the big-name experts are not all that much better informed than we are re the basics. They have mastered lots of advanced stuff. But not the fundamentals. Yowsa!
Reality #3 of Investing Today — We Have Placed Too Much Trust in the “Experts.”
The typical middle-class investor assumes that the “experts” are far better informed than he is. He doesn’t know enough about the realities himself to see the flaws in the conventional advice. And he doesn’t realize how great the pressures are on the experts to tell investors what they want to hear rather than what they need to hear. Most “experts” would be better characterized as expert salesmen or expert politicians than as expert investors, but few middle-class investors are cynical enough to appreciate the extent to which this is so.
Reality #4 of Investing Today — Complacency Has Become a Dangerous Habit of Thought.
Most of us are not too concerned about the flaws in the conventional investing wisdom. The huge bull market lasted long enough to make complacency a habit of thought.
Reality #5 of Investing Today — Our Complacency Is Coming Under Increasingly Strong Challenge.
Our complacency has been challenged by eight years of poor performance for stocks. But most of us presume that the years of poor performance are setting the stage for a new bull run rather than that they are the early years of an inevitable return to reasonable price levels. We are only recently beginning to form strong doubts over what we were told during the huge bull market as to how stock investing works in the long run.
Reality #6 of Investing Today — There Are Big Price Drops to Come.
The fair-value P/E10 level is 14. We are now (this article was posted in January 2008) at a P/E10 level of 24. Given the lack of understanding of the fundamentals, the trip down to fair-value price levels is likely to cause widespread investor disillusionment, which may mean a drop to price levels far below the levels that represent fair value. Investor emotion brings prices down to unreasonably low levels as often as it brings them up to unreasonably high levels.
Reality #7 of Investing Today — Buy-and-Hold Is About to Endure Its First Real-World Test.
Buy-and-hold has become a wildly popular investing strategy. It has never yet been tested by a real-world bear market. It seems likely that buy-and-hold will be subjected to its first real-world test in the not too distant future. Given the lack of effective preparation that the “experts” have provided, my strong hunch is that most investors following buy-and-hold strategies will suffer a crisis of confidence.
Reality #8 of Investing Today — The Key to Successful Buy-and-Hold Investing Is Becoming Informed about the Effect of Valuations on Long-Term Returns.
It’s not buy-and-hold that is at fault. It is the failure of the “experts” to inform us of the effect of valuations on long-term returns. Buy-and-hold is a solid idea that has been poorly formulated in its initial incarnation.
Reality #9 of Investing Today — P/E10 is the Answer.
I believe that an appreciation of the P/E10 valuation-assessment tool is the answer for investors confused about how long-term stock investing works. The idea that investors should maintain the same stock allocations when prices reach la-la land levels never made sense; it became popular because the “experts” so often point to P/E1, a terribly flawed valuation-assessment tool. Once P/E10 is used to assess valuations, long-term stock investing begins to make sense; the prices we pay for stocks really do affect the long-term value proposition obtained from them, just as common sense tells us it must.
Reality #10 of Investing Today — The Hardest Obstacle to Getting to Where We Need to Go is Getting the “Experts” to Acknowledge Their Mistakes.
The information we need to become effective long-term investors is readily available to us today. However, most big-name “experts” remain unwilling to acknowledge the flaws present in the investing advice they offered during the huge bull market. Our biggest problem going forward is that old human reluctance to saying out loud those three one-syllable words “I” and “Was” and “Wrong,” words that can fairly by characterized as the three hardest to pronounce in the entire English language.