Guest Post

It is quite unfortunate that the majority of investors approach investing with the mind set that they need to find stocks that will provide the greatest return in the shortest possible time. The entire day trading industry is built upon this need for instant gratification. Brokers are all too happy to fill this need by offering low trading commissions and beautiful charting and trading tools. As is often the case, constant portfolio turnover and churn is where the real money is for the brokers. “Making it up in volume” may not work for Detroit any more, but it works very well for the discount brokerage industry.

Investors who get seduced by these tools and the hope of a quick profit, tend to significantly under perform the market. Step back for a moment and consider this: The total market return (for example an index such as S&P 500) is the sum of the returns of all the individual investors in that market, institutional investors such as funds, less the commissions and fees they pay out to their brokers.

The problem is that of the three main participants in the market, individual investors are the only ones who are completely dependent on good stock picking for their profits:

1. Brokers: They typically do not care about which stocks are up and which are going down. As long as their customers are buying and selling, they make money in form of commissions and the spread between bid and ask. The greater the trading activity, the better it is for them.
2. Funds (mutual funds, pensions, hedge funds, etc.): Fees and expense ratios are the main source of income. Hedge funds do have a part of their fees tied to performance, but they are also guaranteed a part of their income as a percentage of Assets Under Management (AUM). Performance plays a role in attracting new customers but it is unlikely that the fund company will operate under loss as long as it has a good size asset base.
3. Individual investors: Completely dependent on the returns of their investments for their profit.

The intermediaries provide a service and get paid for it. Nothing wrong with it, except that the goals of an individual investor and the brokers/fund companies are not necessarily aligned at all times. The stock market may or may not be efficient, but I can tell you this – the industry is extremely efficient at extracting every cent of profit from the investing public – that is, from YOUR investment returns.

Fortunately, Successful Long Term Investing is Not Complicated

Your investing success depends on you, and no one else. No one has the same incentives as you do. It is not complicated, but unless you have a well defined process and the discipline to stay with it, it is going to be very hard. It also requires a change in the way most of us think about investing and stocks. Stop thinking about rate of return and beating the market and start focusing on a solid investment plan and process and your returns will take care of themselves. Use the following principles and you will be on your way to create a good plan that works for you.

1. Invest in businesses, not stocks – A stock is just a way of gaining a part ownership in a business. Do not think of a stock as a bet. Only buy stock in a company that you will be happy to run yourself if you were to own it outright. So you will need to think about profits, customer loyalty, growth prospects and competition. You should really consider all aspects of the business before you invest in it. Spend more time choosing your investments than you would, for example, in choosing a new microwave oven.
2. Do not over pay – It is one thing to buy a company that is profitable and has a strong competitive position. It is another to buy it at a price that will ensure profits for you. If you pay a premium for your stock, that is when the stock is overvalued, the company may continue to rake in profits and cash flow for the next ten years and your stock may not move. This is because over time, all stock prices approximate the intrinsic value per share of the company. However, at any given instant of time, the stock prices may be out of whack with the value as it is more dependent on the investor sentiment and the demand/supply of the stock in the market. You may want to read my thoughts on how to buy stocks at a discount to understand better how this process works.
3. Ignore the market, turn the TV off, cancel CNBC – If you are following the two principles laid out above, you are more 80% there. However, if you are the kind that panics when the market does, you are likely to sell off your good stocks at the worst possible time. If the investment merit of the stock has not changed, there is no reason to sell it. It is just better to tune out the unnecessary noise.
4. A down market is an opportunity, a buoyant market is scary – When your barber starts giving you stock tips, it is most likely the time to sell. When the IPO market heats up, sell. When everyone sells their stocks and hides their cash under the mattress, buy. When the number of new investing blogs in a year exceed the number of new “frugal” blogs, sell. You get the idea. The trick is to buy low and sell high. The days after the Lehmann Bros collapse were some of the best days to scoop up sound and profitable companies such as American Express.
5. Do not, and I mean this, do not be afraid of cash – It is surprising how so many investors feel compelled to buy a stock, any stock, if they have cash sitting in their brokerage account. The only valid reason to invest in a stock is if you have researched the business and decided it has investment merit. When the market is overvalued and there is a paucity of good investment values, it is prudent to stay in cash. Buying an iffy stock that eventually loses money is neither macho, nor sexy.
6. Get in with the correct process – The correct process, and the mind set for successful investing, is not to buy stocks that will go up. The correct process is to buy ownership in a company that makes money for its owners without overpaying for the share. Sure there may be times when you judge wrong, and there may be times when you have to be patient for years to profit, but if you do this long enough, with good number of stocks, you will eventually win out over the market and the average unenlightened investor. If you do not use the correct process, just know that there are many businesses out there just waiting for you to hand them your hard earned money.

If you have stayed with me so far, you are probably asking this obvious question: How do I find time and help to research the stocks and the businesses in the manner you are suggesting? In the old days, only investors with considerable assets, who could afford a full service broker and their custom advice, bought stocks. Today, technology and new financial products such as funds and etfs have brought in many new investors in the market and discount no frills brokers have thrived. The fact is, if you can’t afford good advice, you will have to make time to research your stocks. There is no way around this. Even if you have a good advisor, I recommend you do not buy any stock that you do not understand yourself. Then by all means take advantage of low commissions offered by discount brokers.

Shailesh Kumar, perhaps better known as Arohan, runs the popular value investing site Value Stock Guide where he doles out stock advice and recommends undervalued stocks to buy to new investors and stock market grey beards alike.

Related Posts:

This is the Best Time in History to be a Stock Investor
Your Favorite Investing Expert is NOT Your Friend
Am I Crazy For Being Out of the Stock Market for 14 Years?
Most Stock Investors Are Gambling With Their Retirement Money
Risk-Free Stock Investing?
Get Rich Quick – What is it?

Beyond Buy-and-Hold #71

By Rob Bennett

When it comes to Buy-and-Hold investing strategies, I’m tough. I describe Buy-and-Hold as the purest and most dangerous Get Rich Quick strategy ever concocted by the human mind. I say that it was the heavy promotion of Buy-and-Hold that was the primary cause of the economic crisis. I point out that the academic research has been showing for 30 years that there is precisely zero chance that Buy-and-Hold could ever work for any long-term investor.

Yowsa!

I must really hate Buy-and-Holders, huh?

No. That’s not even close to being true.

As negative as I am re Buy-and-Hold, I am just that enthusiastic re Valuation-Informed Indexing. I say that we could bring the economic crisis to a quick end by opening up the internet to honest posting re Valuation-Informed Indexing strategies. I often cite research showing that we could all retire five to ten years sooner if only we would make the switch to Valuation-Informed Indexing. I note that the historical stock-return data shows that switching to Valuation-Informed Indexing reduces the risk of stock investing by 80 percent.

Guess which group of investors it was that laid the foundation for the discovery of Valuation-Informed Indexing?

It was the Buy-and-Holders!

The way to financial liberation

Our economic crisis is a tragedy. It’s not just that we have seen so much human misery. it’s that all of that human misery was 100 percent avoidable. We are a blessed people. We have learned more about how stock investing works over the past 30 years than we learned in all the years that came before that time-period. What we have learned promises to liberate millions of us from the chains of paycheck dependence. Lucky, lucky, lucky us!

Our good fortune was the product of years of hard effort on the part of — the Buy-and-Holders! It was the Buy-and-Holders who came up with the idea of using the academic research as a guide to how to invest. Valuation-Informed Indexing is the end result of that powerful idea. It was by following the academic research where it led that we were able to develop the principles of Valuation-Informed Indexing.

But wait.

Didn’t the Buy-and-Holders get it wrong? Wasn’t it their idea that there is no need to lower your stock allocation when prices rise to insanely dangerous levels that caused this mess?

Yes, the Buy-and-Holders did mess up. Big time.

But who hasn’t?

Do you know any field of human endeavor in which the pioneers got it all right on the first try? I can’t think of one. We shouldn’t be surprised that the Buy-and-Holders messed up big time. We should have expected it all along. That’s what usually happens when the humans go about making huge advances in their understanding of some matter of importance. Mess-ups are a part of the process.

Mess-ups are a good thing

I wish we could all start seeing it that way. If we could, we would see the defensiveness that has been holding us back from spreading the word about all of our exciting breakthroughs disappear. If we could just accept that mess-ups are a natural part of the learning process, we could help the Buy-and-Holders come to see that Valuation-Informed Indexing is not so much a refutation of their years of hard work as it is a vindication of them and a fulfillment of them.

The two most important breakthroughs in the history of investing analysis were Fama’s showing that short-term timing never works and Shiller’s showing that long-term timing always works. Put them together and you have the safest and best strategy for investing in stocks ever concocted by the human mind. Had Shiller published his research in 1971 instead of 1981, the book A Random Walk Down Wall Street would have been titled A Valuation-Informed Walk Down Wall Street and we would have spared ourselves all this anguish.

Does it really matter all that much? Does the fact that we achieved the second great breakthrough in 1981, a few years after the defective strategy had been widely publicized, mean that the Buy-and-Holders were all just a bunch of dummies?

I sure don’t see it that way. Shiller would not have done the research he did had the work that at one time seemed to support Buy-and-Hold not been done first. Shiller’s work was a reaction to Fama’s work. Shiller’s work did not do away with the need for Fama’s insights, it amplified them by filling in parts of the story that Fama missed and that we needed to know about to put Fama’s insights to productive use.

The Buy-and-Holders are not dumb people. The Buy-and-Holders are not bad people.

We hurt them when we tolerate the continued promotion of Buy-and-Hold. Each time the economic crisis worsens, the Buy-and-Holders feel worse about themselves and the investors who were ruined by their investing strategy become more angry about what was done to them.

We owe the Buy-and-Holders a big debt. The best way to honor that debt is to help them see that the future is Valuation-Informed Indexing. And that they merit a whole big bunch of credit for developing the insights that over time led us to the magical place at which we now stand.

Rob Bennett is known for his unconventional job search tips. His bio is here.

Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Most Stock Investors Are Gambling With Their Retirement Money
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

Beyond Buy-and-Hold #70

By Rob Bennett

I was talking with a friend of mine at the Financial Bloggers Conference in Chicago. He’s a Buy-and-Holder. He told me what I need to do to get reinstated at the various boards and blogs that have banned me for pointing out the dangers of this popular investing strategy.

I need to pull back a bit. It’s okay for me to say that valuations matter, people can deal with that. But I need to not post so often. It really gets on people’s nerves when they see me participating in every thread in which the valuation issue comes up. And my posts are so long! I need to write shorter posts less frequently and not take such strong stands. It wouldn’t hurt if I would stop describing Buy-and-Hold as a Get Rich Quick scheme, for example.

Okay.

He’s right, of course. The Buy-and-Holders would love it if I followed that advice.

The investment strategy of the future—maybe the near future

But my goal is to bury Buy-and-Hold 30 feet in the ground, where it can do no further harm to humans and other living things. I would like to see all of the experts in this field endorsing Valuation-Informed Indexing, which I view as the investing strategy of the future. I look forward to the day when The Stock-Selling Industry is spending hundreds of millions of dollars promoting investing strategies that work.

What are the chances that those things are going to happen if I stop speaking out strongly in opposition to Buy-and-Hold or do so less frequently? I think it is safe to say that the chances are pretty darn small. If I follow the advice of my Buy-and-Hold friends, I will be more popular. But I will also be ineffectual! I will not achieve my goals. I can see how that sounds good from their point of view but I am not able to see how it could be seen as a good thing from mine.

Now, I’d like to make a point coming at things from the other direction.

Have you ever heard me offer the sort of advice that was offered to me to the Buy-and-Holders? They outnumber me by 10 to 1 on every board and blog at which I have posted. Have I ever once asked that they post less frequently or less forcefully? I don’t do that.

I enjoy it when Buy-and-Holders engage in a vigorous effort to make their case. It keeps my on my toes when they do that. There have been numerous times when I have learned something important from interactions with my Buy-and-Hold friends in which they were stating their case as forcefully as possible.

Why is it that the Buy-and-Holders and I have such a different take on things?

Telling the truth is never easy—especially when it comes to investing habits

It’s because I am confident in what I am saying. I don’t say that I know it all. There have been a few occasions when I have learned things through my interactions with Buy-and-Holders that caused me to change my thinking on an issue. I don’t think I am arrogant. But I am confident that I am on the right track.

There are two reasons.

One, I root my investing beliefs in the academic research, which in turn is rooted in the historical stock-return data of 140 years. That’s objective stuff, real stuff. It gives me confidence to know that my views are rooted in something real.

The Buy-and-Holders cannot say that. Their views are rooted in the research of the 1960s and 1970s. But they have never corrected their model to reflect Shiller’s finding in 1981 that valuations affect long-term returns. They know that, of course. It makes them feel shaky re just about everything they say.

Two, my primary goal is to learn how investing works. If I had a conversation with a Buy-and-Holder that convinced me that I had made a mistake, I would just correct the mistake. I don’t feel a need to defend anything because Valuation-Informed Indexing is something new enough that I think everyone understands that it remains subject to revision.

Again, the Buy-and-Holders cannot say that. The Stock-Selling Industry has been pushing Buy-and-Hold relentlessly for years now. If it turns out that there is something to the 30 years of research now backing up Shiller’s findings, this investing model was responsible for causing a huge amount of human misery. The Buy-and-Holders feel that it is too late to make corrections in their investing strategy. Their take is that too much damage has already been done.

So we are playing two different games. I engage in conversations with Buy-and-Holders because I want to teach and learn. They are not open to learning experiences. To acknowledge that it is possible for them to learn something, they would need to acknowledge that they do not know it all today. They cannot bear to acknowledge such a thing. If people accept Buy-and-Hold, they are happy. Those who do not immediately accept the strategy must either be bullied into coming around or be removed from the discussion.

I owe a lot to the Buy-and-Holders. I have learned a great deal from them. They changed our understanding of how stock investing works in fundamental ways and I think we all should be grateful to them.

As a friend, I must tell them that I think they made a terrible mistake when they abandoned the learning project. It is not a healthy situation on a discussion board or blog when one side is trying to shove its viewpoint down the throats of everyone. It’s when people of different viewpoints engage in honest and warm give and take that boards and blogs really take off.

Rob Bennett acknowledged in an article on learning from mistakes that he never should have bought that Leo Sayer album. His bio is here.

Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Most Stock Investors Are Gambling With Their Retirement Money
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

Beyond Buy-and-Hold #69

By Rob Bennett

As we learn more about how stock investing works (and as we permit ourselves to talk over what we have learned), we will need to change the language we use to discuss the subject.

Are you a bull?

Or are you a bear?

If you are a smart investor, you are neither.

The designations “bull” and “bear” were meaningful in the days before there was academic research showing that short-term timing (changing your stock allocation because of a guess as to where stock prices are headed) doesn’t work. In the days when large numbers of investors believed that guessing where prices were headed was the way to buy low and sell high, the most important thing to know about an investor was whether he was a bull or a bear.

”Bull” and “Bear” no longer matter

For educated investors, it doesn’t matter. If you don’t believe that there is any way to tell in which direction stock prices are headed, why would you be a bull or a bear? To indulge in guesses of either type is against your self interest. Why bother?

But wait.

I have been at a zero stock allocation since the Summer of 1996. I say that stock prices will likely fall another 65 percent over the course of the next few years. I’m the meanest of growling bears. There’s no question about that, is there?

There’s a question.

I’m not a bear. Why not? Because I’m not guessing. When I say that stock prices are headed downward, I am going by what the academic research says. Valuation-Informed Indexing is a research-based approach, not a guessing game approach.

Holy self-contradiction, Batman! Didn’t I say above that timing doesn’t work? Now I’m saying that timing is a research-based concept. It is.

Long-term timing in the stock market always works

The same historical data that shows that there has never in history been a time when short-term timing worked also shows that there has never in history been a time when long-term timing did not work. Long-term timing always works. Investors who understand what the academic research says always engage in long-term timing.

I cannot tell you that stock prices are going to fall this week or this month or even this year. To do that would be to practice short-term timing. It cannot be done. Or at least so says the research.

It’s something different to say that prices are headed down and down hard in years to come. We now have 140 years of historical data showing that those sorts of predictions always work out .

So it’s not right to say that I am a bear. Being a bear has always been about taking guesses. When you say that stock prices are going to fall because of what the academic research says on the subject, you are not a bear. That’s not what the word means.

What are you?

The point of investing is not to be a bull or a bear, but an informed investor

I would say that you are an informed investor. Going by what the research says is smart investing.

How about the bulls and bears? Are they dummies?

I don’t want to insult anyone. Can we say that they are not informed about what the research says, at least according to my assessment? That sounds a little softer.

And how about the Buy-and-Holders? They follow the research showing that short-term timing doesn’t work but ignore the research showing that long-term timing always works. They are partially informed. They know enough about what the research says to be dangerous. But it is to their credit that they care about the research and I believe that in time they will come around to following not only the pre-1981 research that supports Buy-and-Hold but also the post-1981 research showing how dangerous it is to fail to practice long-term timing.

The rules of the investing game are changing. People have a hard time not thinking of those who say prices are headed downward as bears. There were many decades of investing history in which that is what you called people who believed prices were headed downward.

The label doesn’t fit in a day in which informed investors root their assessments of which way prices are headed not in guesses but in research showing how stock investing really works. I am not a bear. I’m just some fellow who thought that the Buy-and-Holders were smart to root their strategies in what the research says and who came over time to believe that those of us who follow data-based strategies should take into consideration not only the research published before Shiller published his breakthrough findings but also in the research published in the three decades since that day.

You can ask me where I think stock prices are headed and I’ll tell you. But I will never engage in any guesswork. It’s not my thing. I’m not a bear any more than I am a bull. I am an investor who informed himself about what Shiller’s research says and who came to believe that the man is on the right track.

Rob Bennett has written extensively on what causes stock price changes. His bio is here.

Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Most Stock Investors Are Gambling With Their Retirement Money
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

Beyond Buy-and-Hold #68

By Rob Bennett

One of my critics makes a great point in a recent Bogleheads Forum discussion of the Valuation-Informed Indexing concept. A poster going by the name “nisiprius” says: “I just don’t believe that a few simple rules based on numbers that are easily available to everyone will substantially improve your risk-adjusted returns.”

I say that the typical middle-class investor could retire five to ten years sooner if he were willing to switch from Buy-and-Hold to Valuation-Informed Indexing. I say that the heavy promotion of Buy-and-Hold was the primary cause of the economic crisis. I say that we would eliminate 80 percent of the risk of stock investing by letting investors know about the 30 years of academic research supporting this approach.

Yet the only difference between Buy-and-Hold and Valuation-Informed Indexing is that Buy-and-Holders choose a single stock-allocation percentage that makes sense for them at all times while Valuation-Informed Indexers change their stock allocations in response to big valuation shifts. Could this one strategic change really make such a big difference? That’s more than a little hard to believe, isn’t it?

It’s hard to believe.

The power of addiction

But let me tell you a story about my coffee addiction. I drink ten cups of coffee each day. I wish I didn’t. If I am busy doing something in the morning and don’t get to coffee for a few hours, I get a massive headache. I am certain that this coffee addiction is not good for my health. Until I went to college, I didn’t drink any coffee whatsoever. I sometimes wonder how it is that I got on this road that led over time to a situation where I am drinking ten cups of coffee every day.

It wasn’t a conscious choice. There was never a thought in my head that I really should increase my coffee consumption from one cup per day to ten cups per day.

It happened gradually and without me taking much notice of it. Once I had a habit of drinking one cup per day, going to two cups per day did not seem like a big deal. Once I had a habit of drinking two cups per day, going to three cups per day did not seem like a big deal. You get the idea.

This is how it works with stock valuations. Stocks were priced insanely low in 1982. Then valuations went up a bit. But it didn’t matter because prices were so low. Then valuations went up a bit more. But it still didn’t matter because prices were at fair value. Then valuations went up a bit more. But it still didn’t matter because stocks offer a strong value proposition even when they are selling at prices a bit above fair value.

Then there came a day when stocks were priced at three times fair value. At that point, the most likely annualized 10-year return on stocks was a negative 1 percent real. IBonds were at the time offering a guaranteed return of 4 percent real. So middle-class investors who stuck with stocks lost 5 percentage points of return for 10 years running. Do the math and you see that Buy-and-Holders ended up losing 50 percent of their accumulated wealth of a lifetime as a result of their addiction to Buy-and-Hold strategies.

Buy-and-Hold and the economic crisis

We lost so much wealth in so short a time-period that we are now scared to death to spend money. So tens of thousands of companies are going out of business and millions of workers are being laid off. Lots of people are losing confidence in a political system that permits such massive wealth destruction to take place. We are likely within a few years of going into the Second Great Depression.

No one knew this was going to happen when we first began thinking it might be a cool idea to follow Buy-and-Hold strategies any more than I knew that someday I would be suffering from a terrible coffee addiction on the day I drank my first cup of coffee following my Political Science 101 class back at old Temple University. These things catch up with you over time.

Some people think it can never change. Buy-and-Hold investing strategies have been causing stock crashes and economic crises ever since the first stock market opened for business. So some people think we can never do better. Some people think we are doomed to repeating the fatal mistake of ignoring valuations over and over and over again.

I don’t buy it.

Change may be hard, but it’s never impossible

It’s true, though, that it is awfully difficult to persuade people that valuations make a huge difference after they have been ignoring them for so many years. If we are going to become effective investors, we are going to need to start watching valuations even at times when we are not living through an economic crisis. We need to make watching valuations as important a priority as we make looking at the price of things we buy before we put money down on the table. If our free market system is to survive, we need to begin buying stocks in the same way we buy all other goods and services in this Consumer Wonderland we have created for ourselves.

How is it that one number — the P/E10 value — matters so much?

People say that the P/E10 value reveals the level of overvaluation present in the stock market at any given time. That’s so. But there’s a different way of looking at it. Stocks can never become overpriced so long as investors are acting rationally. The sensible thing to do would be to price stocks properly. So what P/E10 is really telling us is how emotional investors are being at any given point in time.

P/E10 protects us from ourselves!

If we made it a practice to use P/E10 to set our stock allocations even when prices had not yet reached insanely dangerous levels, prices could never get to insanely dangerous levels. Using P/E10 takes the emotion out of stock investing.

It’s one thing we are talking about here. It really is hard to accept that making one change could make such a huge difference. But the one thing we are changing is whether investors act emotionally or not. Change that and you really do change the nature of the stock investing game in a fundamental way.

Rob Bennett has written extensively on what causes stock price changes. His bio is here.

Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Most Stock Investors Are Gambling With Their Retirement Money
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

Beyond Buy-and-Hold #67

By Rob Bennett

I was talking by telephone with a supporter of mine the other day. He generally shares my views on investing. He likes my stuff. He thinks I have made important contributions. He also thinks I am a bully.

Well, not exactly.

He really did use the word “bully” in the conversation. He also used the word “intimidating.” He said that he didn’t think that either word properly described me. He wasn’t able to think of the precise word that fits. But those were the two that came to his mind.

If I am not quite a bully, I am something close to it. This is according to a friend of mine! This is according to a supporter!

How did I respond when he said that?

I said that I certainly acknowledge that many people feel that way about me.

I don’t. I don’t feel that way even a tiny bit. But lots of smart and good people do. The evidence that this is so is so overwhelming that it would be foolish of me to deny it. Lots of people think I am a bully. You probably do.

Why?

Hanging the “bully” label on someone we don’t agree with

One, I argue my case forcefully. I make no apologies for this. My view is that it is my job to do this. When I decided to become a journalist, I did not send in applications to journalism school. I sent in applications to law school. The journalists who I most admired were people who were able to learn all there was to know about a subject of public importance and then tell the story in a compelling way. I am a bit of a wimp in my personal life but not in my professional life. I want my articles to say something important and I want them to be well argued and forcefully argued.

Arguing a case forcefully is not viewed as bullying by people who agree with you. But it is often viewed that way by people who do not agree with the message being conveyed. I hit hard, never at people, only at ideas. But the people who hold those ideas sometimes feel as if I am hitting at them and so my stuff can be a bit hard to take to those who have never before heard the point of view I expressed put forward to them.

The other thing that makes me seem bullying is that I use numbers to make my case.

All of the work that I do in this field is rooted in the academic research of the past 30 years. I don’t say “it is my opinion that those who went with high stock allocations from 1996 forward will live to regret it,” I say “those who went with high stock allocations from 1996 forward will live to regret it in the event that stocks continue to perform in the future anything at all as they have always performed in the past.” Those are hard words to hear if your retirement plans are riding on the question of whether you were right or not to follow Buy-and-Hold strategies over the past 16 years.

I cause people to experience hurt feelings. That’s what it comes to.

I don’t like it that that is so. Not even a little bit. A friend of mine from the days before I wrote about investing commented that I used to be “a puppy-dog poster” and wondered what happened to me. The subject matter changed, that’s what happened.

The puppy dog fellow is the real me. But that fellow is a guy who wants to help people win financial freedom as early in life as possible. Doing that when writing about stock investing in the wake of the most out-of-control bull market in history is not a smart way to pick up Mr. Congeniality awards. No one who tells the truth about stock investing is going to be widely perceived as warm and cuddly at a time when stock prices are where they are today.

There’s a price to be paid for having strong opinions

Would I have more success if I made more of an effort to be cuddly and friendly and warm?

In one sense, yes. More people would like me if I did that.

The trouble is that there are so many others taking it that way. Most people in this field are willing to get the numbers wildly wrong if it will make their readers or listeners or clients happy with them. I want to help people achieve financial freedom early in life. I see people throwing away their chance at the brass ring by over-investing in insanely overpriced stocks and “experts” telling them that they are doing the right thing and it makes me want to throw up.

I look forward to the day when I will not be perceived as a bully anymore. When we get to a point where we are all trying to rebuild the economic and political system we destroyed during the Buy-and-Hold years, I am confident that people will again view me as a puppy dog because I will once again be able to show warmth and friendliness and gentleness without upsetting people by also reporting mathematical truths that it pains them to hear.

Until then —

Ruff! Ruff! Ruff!

Stand back! There’s a mad dog on the loose! And he’s a comin’ to get you!

Rob Bennett has written on how to escape the rat race. His bio is here.

Rob Bennett has written on how to escape the rat race. His bio is here.

Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Most Stock Investors Are Gambling With Their Retirement Money
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

Beyond Buy-and-Hold #66

By Rob Bennett

I believe that the case against Buy-and-Hold is rock solid. Common sense tells us that it cannot possibly work. There is now 30 years of academic research confirming what common sense tells us. That research is based on 140 years of historical stock-return data. What more could you ask?

Lots of people are asking for more. Buy-and-Hold remains popular. My articles stating the case against it remain unpopular.

I have exchanged a number of e-mails with a fellow who is a big believer in Buy-and-Hold but also not entirely unsympathetic to my case for Valuation-Informed Indexing in an effort to better understand what is going on in people’s minds. This fellow has looked at the research and acknowledges that is appears generally solid. Still, he is not a convert. Buy-and-Hold seems right to him.

He was fair-minded enough to tell me that, following one of our recent e-mail conversations, he laid in bed for a time asking himself what it would take to persuade him that Buy-and-Hold does not work. That’s the question I most need answered. So I listened carefully to what he told me.

The “this time it’s different” philosophy

He told me that he does not really trust much of the historical stock-return data used in the research that shows that Buy-and-Hold cannot work. Why? That data is old. In recent decades, Buy-and-Hold has done well. It’s the recent data (from 1980 forward) that has the greatest influence on his thinking. To the extent that the data from 1870 through 1980 tells a different story, he discounts it.

I don’t think it is just this one guy. I think this may be the most important reason why so many people have a hard time understanding how stock investing really works. We are all most heavily influenced by what we see going on around us today and in recent days. Stuff that happened 40 years ago or 80 years ago or 120 years ago is old news. It doesn’t seem relevant to our current-day concerns.

I agree to a point. The economy obviously has an effect on stock market developments. And the economy of 2011 is not the economy of 1870. It makes sense to give developments taking place in recent decades more weight in trying to figure out how to invest for your retirement.

The flaw in that thinking

However, there is also a serious problem with this line of thinking.

Buy-and-Hold is rooted in the idea that it is economic developments that determine short-term stock returns. The economy improves, and stock prices go up. The economy gets worse, and stock prices go down. Since the economy is changing every day, it is possible to test the validity of the premise of the Buy-and-Hold model on a daily basis.

Given that the model is either being confirmed or discredited on a daily basis, one could argue that it is possible to gain a good sense of whether Buy-and-Hold works based on three decades of experience. Since recent data is indeed more relevant than data from long ago, it makes a certain amount of sense to permit recent stock-market history to be your guide in deciding whether to go with a Buy-and-Hold strategy or not.

The trouble is that Valuation-Informed Indexing is rooted in a different premise. Valuation-Informed Indexers believe that it is investor emotions that determine stock prices in the short term. This is why long-term returns can be predicted. Long-term returns are determined by the economic realities. So, all that you need to know to be able to predict returns effectively is how far returns have strayed from what they would be if it were the economic realities that were the dominant influence in the short term. That lets you know in which direction returns are headed and how big the move in that direction is likely to be.

The complete bull/bear cycle

Valuation-Informed Indexing cannot be tested on a daily basis. It cannot be tested on a weekly, monthly or yearly basis either. It takes 10 years for the return predictions that make this strategy work to become statistically significant. It takes 35 years or so for an entire bull/bear cycle to play out.

So there is no way to gain a sense of whether Valuation-Informed Indexing is a good model or not without taking into consideration at least 35 years of data. And it’s hard to have much confidence in conclusions based on viewing of only a single cycle. One cycle could of course be a fluke. I am convinced because the cycle that should always apply if Valuation-Informed Indexing is a valid model has repeated over and over again throughout the entire history of the U.S. market. But even I would like to see more cycles (there are three complete cycles now in the record and a fourth cycle that will be complete after the next stock crash).

From the Buy-and-Hold perspective, there is lots of evidence supporting the belief in the dominant model. Stocks have done well from 1980 forward. They obviously have not done as well from 2000 forward as they did from 1980 through 2000. But the overall record is not a bad one. Buy-and-Holders don’t like what they have seen from 2000 forward but don’t feel that 12 years of bad returns is enough to discredit a model that was supported by 20 years of good returns before the 12-year run of bad returns kicked in.

The deciding years will likely be the next five. If the Valuation-Informed Indexing model is valid, we will be seeing another price drop of about 60 percent from where we stand today. A stock crash of that magnitude would be a fourth confirmation of the Valuation-Informed Indexing model. It’s hard to dismiss a model that has been able to predict stock returns far in advance for 140 years and for four complete bull/bear cycles.

If stocks perform well for the next five years, the shaken confidence of the Buy-and-Holders will be restored and the Valuation-Informed Indexers may need to go back to the drawing board.

We’ll see what happens. You know what I am expecting to see. But the full truth is of course that none of us knows for sure.

Rob Bennett has written about what he likes and doesn’t like about Robert Kiyosaki. His bio is here.

Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Most Stock Investors Are Gambling With Their Retirement Money
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

Beyond Buy-and-Hold #64

By Rob Bennett

We go to markets to buy things. We go to casinos to have fun.

Why do we invest in stocks?

We tell ourselves that we invest in stocks to provide for our retirements. We refer to the place at which stocks are bought and sold as a “market.” I think we are kidding ourselves.

Actions speak louder than words. The behavior we engage in when buying stocks is more akin to the behavior we exhibit in gambling casinos than it is to the behavior we exhibit when buying things.

Seeking value

What is it you are most worried about when participating in the car market or the banana market or the computer market? You want to obtain a good value proposition. You don’t want to overpay.

How many people do you know who worry when they are buying stocks that they are overpaying?

That’s why the stock market is such a mess today. That’s why we are in an economic crisis today.

We flatter ourselves when we suggest that today’s stock market is a true “market.” That’s not even close to being true. And it’s our fault. For the stock market to become a true market, we all need to start caring about price. I know how much opposition there is to this idea. I’ve been making the case for why we need to build a real stock market for nine years now and I have run into some strong headwinds.

There are places where value doesn’t matter, but the stock market isn’t one of them

You don’t worry about price in a gambling casino. You know the moment you walk in that the value proposition is poor. That’s not the point. You’re there for kicks. Gambling is an emotional thing, not an obtaining-value-for-your-money thing. Like the stock market is for most of us.

How is it that we have gotten so messed up in our thinking about stocks? If you took a poll, the number of people who would say they intend to gamble with their retirement money would be tiny. We all want to obtain value for our investing dollar. So why don’t we do what it takes? Why don’t we look at valuations when setting our stock allocations?

The root problem is that it is only in recent years that we have come to learn how stock investing works. We were living in the dark ages before Shiller published his research in 1981. We are now gradually getting up to speed on the realties. We picked up on so many bad ideas in earlier days that it is taking us some time to appreciate what Shiller’s research is telling us.

How to determine stock values

Are car prices predictable?

They are. If you are buying a used car, you can look up the model and year on Edmunds.com and gain a good idea of how much you will be charged for that car. If the dealer tries to charge more, you know to take a walk.

That’s how stock investing would work if everyone understood Shiller’s research. The P/E10 value tells you how overpriced or underpriced stocks are at the time you are thinking of buying. Knowing whether the price being charged is in the right ballpark or not tells you whether to buy or not and how much. Becoming an effective stock investor is just that easy.

But this idea is so controversial today!

What’s the story?

The story is that, in the days before indexing, stock returns were not predictable. Long-term market timing doesn’t work with individual stocks, only with indexes. Our experience for hundreds of years was with individual stocks. Since our experience has always been that stock returns are unpredictable, we came to believe that that is some sort of law of stock investing.

Shiller showed us what we need to do to take away the risk of stock investing and we ignored him. His solution didn’t match what we thought was the problem. What do we want out of stocks? Higher prices! Shiller doesn’t do anything to encourage higher prices. He shows that price jumps now always cause price drops in years to come. Instead of helping us solve our problem, he did this boring and useless thing of showing how to predict long-term returns and thereby take 80 percent of the risk out of stock investing. What a doofus!

How true markets work

The reason why car prices are predictable is that the car market is a true market. Markets set prices. Look at the price identified by the market as proper and you are on your way. No gambling required.

This stock market identifies the proper price too. It tries to be a real market. All that you need to do to know the real price of stocks is to take the nominal price and add or subtract for the effect of overpricing or underpricing. But how many of us do that?

We don’t do it because we like the surprise element of stock investing. There’s a part of us that enjoys those crazy bull markets and the crazy bear markets that follow from them. We all have an urge to gamble residing in our hearts. Otherwise, casinos could not remain in business.

I enjoy a poker game with the guys. I enjoy a day at the racetrack. I’m not anti-gambling.

I don’t gamble with my retirement money, however. When I invest, I want to know my return before I put my money down on the table. I am a Valuation-Informed Indexer. I shun Buy-and-Hold.

Rob Bennett is known for his unconventional saving advice sayings. His bio is here.

Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Your Retirement Plan is in More Trouble Than You Realize
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

Beyond Buy-and-Hold #63

By Rob Bennett

If stock prices continue their 12-year march downward, we are going to end up in the Second Great Depression. So we would all like to see a turnaround. The thing with which there is a difference of opinion is the question of what we need to see to bring on this happy event.

Buy-and-Holders believe that it is economic developments that cause stock price changes. If that is so, what we need is an economic recovery. That’s obviously a good thing. So, from a Buy-and-Hold perspective, we all just have to wait for and hope for an economic recovery.

Stock prices are the root of economic crises

Valuation-Informed Indexers have a very different understanding of how stock investing works. We don’t believe that it is economic developments that determine stock prices but that it is stock prices that determine economic developments. Once stocks become insanely overpriced, a crash becomes inevitable and, once a crash becomes inevitable, an economic crisis becomes inevitable because the price crash subtracts so much spending power from the economy.

It makes no sense for Valuation-Informed Indexers to wish for an economic recovery. We cannot realistically expect to see that until stock prices stabilize. We need to be rooting for a stabilization in stock prices.

What could bring that about?

Emotion and stock prices

Overvaluation and undervaluation are the product of investor emotion. Rational investors would price stocks properly. So the market can become stabilized only when investor emotionalism is diminished.

Now –

What would be the effect of a price increase? Would a price increase make investors more or less emotional?

A price increase would make investors more emotional. It’s only when stocks are priced properly that investors can assess stocks rationally. From the standpoint of Valuation-Informed Indexers, we need a price drop.

The trouble is that investors have already suffered years of poor stock performance. Another price drop is going to bring on investor depression. Once prices have fallen to fair-value levels, conditions will be in place to cause prices to fall to levels far below fair value.

How far can the stock market fall?

It’s no accident that prices have fallen to one-half fair value in the wake of every major bull market in U.S. history. That’s roughly a 65 percent price drop from where we stand today.

How many Buy-and-Holders do you think will be sticking with their high stock allocations in the wake of another 65 percent price drop?

Perhaps three? Perhaps two? Perhaps one?

Perhaps zero?

Has there ever been a Buy-and-Holder who stuck with his high stock allocation through an entire bull/bear cycle? If there has been, I’d be grateful if someone would pass along his name. I have certainly never heard of one being identified. The fact that none of the advocates of Buy-and-Hold has ever been able to identify a single investor who stuck with the strategy for the long term has always made me skeptical of whether this Buy-and-Hold business is as realistic as its proponents make it out to be.

The best of times for stock market investors

There’s a word in the investing literature used to describe the state of play that arrives when the last Buy-and-Holder gives up the ghost and sells his stocks at huge losses: Capitulation.

There’s a reason why the market can turn up again only after capitulation has been achieved. The thing that sends prices wildly up in bull markets is investor emotion. The purpose of a bear market is to wash the emotion out of the market. So long as there are still people claiming that Buy-and-Hold can work, capitulation has not been achieved. For our economy to recover, losses must first get bad enough to persuade the last Buy-and-Holder to give up the ghost.

The idea that Buy-and-Hold can work is a logical impossibility. Wishing for a world in which all Buy-and-Holders do not suffer financial wipeouts is like wishing for the discovery of a perpetual motion machine. We can all easily see the appeal of the concept. It is not possible for any of us to imagine an alternative universe in which the fantastic dream could be made concrete and practical and real.

I am hoping for the Buy-and-Holders to sell soon. Not because I don’t like them. Not because I intend to laugh at them. Not because I long to say “I told you so.”

I am hoping for the Buy-and-Holders to sell soon because it is when the last Buy-and-Holder sells that we can begin rebuilding our economic system after the damage done to it during the worst of all bull markets we have ever endured as a nation. I am sick of the human misery we see all about us as a consequence of the temporary triumph of Get RIch Quick thinking. I want to stop waiting for more inevitable bad scenes to play out and resume enjoying economic growth extending its bounty far and wide.

I don’t wish for an economic recovery. Because I view that as a vain wish.

I wish for a collapse of belief in Buy-and-Hold. Because I believe that’s what we need to see for the conditions to fall in place that will permit the greatest economic recovery ever seen in our history.

Rob Bennett believes that by studying the historical return data we can advance our understanding of how stock investing really works. His bio is here.

Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Your Retirement Plan is in More Trouble Than You Realize
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

By Kevin M

After the briefest of pauses, the stock market is back to swinging back and forth and showing no clear direction either way–Europe-itis is to blame once more. On Friday the European Union was assuring the world that it had matters well in hand—by Monday the world was back to not believing any of it. The global markets responded accordingly by whipsawing back and forth.

As much as we might wish otherwise, the signs are screaming out for of more of the same. Rising stock markets are based on calm and predictability, and both are in short supply—hence the volatility. And volatile markets typically settle in unhappy places. Consider the large stock slides in 2000-2002 and again in 2007-2009; I believe we’re at just such a point again today. Where this run ends is anyone’s guess, but there’s enough uncertainty out there to support an argument for just about any scenario we can imagine—and most of them are bad for our finances.

DISCLAIMER: I’m not an investment expert, nor do I write often about specific investment strategies. As a “certified outsider”—I don’t work in an investment related capacity, don’t stand to gain from a bear market and am not out to sell you anything—this is just the opinion of a peon. But sometimes peon status gives you the ability to see what insiders don’t, won’t or can’t. As a peon, I have no agenda!

That said, I offer my opinions on the current state of the investment universe, and steps we can take that might minimize the damage that I think is coming.

Cash and cash equivalents

The equity markets have been largely supported by historically low interest rates. After all, why put money in interest bearing investments when the rate of return on them is less than 1%? If these were normal times, that thinking would make abundant sense but the times are anything but normal.

Now is the time to ignore the low interest rate issue, and load up on cash investments. We’re not looking for return with cash, we’re looking to use it to 1) lower our exposure to risk investments and 2) to have funds available to buy up stocks at bargain basement prices once the market hits bottom. Think of holding cash as “keeping your powder dry”—when you put it in those terms it sounds a lot more on the edge.

Cash represents liquidity, and the time to build it is when investment prices are relatively high. Liquidity will only be harder to come by once stocks start to fall in earnest.

Bonds

Investors often use bonds as either a way to achieve higher rates of return in a low rate environment, or—because of the inverse relationship between interest rates and bond prices—as a way to capitalize on still lower rates in the future.

On the first point—looking for higher returns—the only way to get higher returns in a low rate environment is either by extending the term of the securities, or by accepting those of lower quality. Both strategies add risk to your portfolio at a time of increased overall volatility.

As to the second point—capitalizing on still lower rates–since interest rates are now at record lows, the likelihood of them going still lower looks like a sucker’s bet. If anything, volatility will magnify those risks causing you to lose money on your bonds.

In the current economic climate and interest rate environment, bonds may be only slightly less risky than stocks (maybe). This includes not only corporate bonds, but also municipals and foreign government bonds. All carry increased risk, and as we’re now seeing in Europe, many governments are at risk of outright default. That’s not a diversification from stocks in any sense of the term.

If you’re looking for longer maturities with complete safety, consider US Treasury securities. You can purchase Treasury Notes (terms from two to ten years) or Treasury Bonds (terms up to 30 years). Both offer rates higher than short term securities, but the notes carry far less risk in the event of an increase in interest rates (a bond trader once told me that a bond with a term of 20 years or more is no better than owning a stock!). Corporations and states can default on their bonds, but since the U.S. Government has the power of the printing press, one way or another you’ll always get paid!

You can buy U.S. Treasury Securities through brokerage firms or through Treasury Direct in denominations as little as $100. This is probably the only safe “bond play” in a volatile market.

Dividend stocks

I’m personally of the opinion that high price markets accompanied by high volatility are prime candidates for a quick exit, but I’m also aware that many people don’t agree with that thinking. So for the benefits of those who believe that stocks hold a place in any investment environment, here are a few thoughts.

Rob Bennett has written on this site that he’s been out of the stock market since 1996 and I completely agree with him. I’ve been out for most of that time as well. The same ultra low interest rates that have driven the equity markets to insane levels are also the prime force behind the worldwide explosion of debt since about the same time—hence the debt crisis.

Now that interest rates have hit bottom, a major re-alignment is playing out. Yet stocks remain at the upper end of their all time trading range! There’s a disconnect here, but I think it’s about to be resolved in a way that will make most investors quite uncomfortable. I think the only reasonable plays in the market will be special situations, one of which is dividend stocks.

Dividends can not only provide a cash flow that helps you to survive a major market decline, but they also can put a floor on the price of a stock. Even if the price of the stock falls in a market slide, dividend paying stocks will be prime candidates to be scooped up by bottom feeders looking for bargains and thus more likely to recover quickly.

Dividend stocks are some of the best investments in any market, but especially in volatile ones. Dividend Stocks Online specializes in high yield dividend stocks and is a good place to start looking for high paying stocks.

Value stocks

Another special situation in stocks is value stocks. These are stocks that for one reason or another have fallen out of favor with the markets, and so their prices trade at low levels relative to earnings, book value or even companies in the same industry. Sometimes entire sectors fall out of favor. In bull markets, value stocks don’t hold much appeal, but in bear markets they begin to stand out. This is often because bear markets bring a changing of the guard—a new “Nifty Fifty” if you will.

Value stocks are often prime candidates for bottom feeders. In bull markets, everyone is looking for high performers; in bear markets when few stocks are performing, underperformers with good fundamentals suddenly come back in demand.

Still whether we move into dividend paying stocks or value stocks, now is the time to lower our equity holdings, preferably to minority positions. The less we have in stocks, the less we have to lose.

Be ready to “bottom feed”

I’ve mentioned “bottom feeders” a couple of times in this post and for good reason: that’s precisely what I think we need to be preparing ourselves to be in the coming months!

The whole point of moving into cash and treasuries and lower risk stocks is to be ready with the cash AFTER stocks drop substantially in price. It’s a matter of positioning ourselves as bear market beneficiaries—able to buy stocks at bargain prices. And when we do, dividend and value stocks should be high on the “buy list”.

Where do you think the financial markets are heading, and what are you doing to prepare for it?

Related Posts:

Risk Free Stock Investing?
Your Retirement Plan is in More Trouble Than You Realize
Why Near-Zero Interest Rates Are Hurting the Economy
Why Stock Market Timing Scares Us
Ten Financial Mistakes You Can’t Afford to Make
A View From the Economic Cliff