October 8, 2008 Letters to the Editor

Updated: October 11, 2008.

Rob's podcasts/Valuation buy levels

I received this letter from Wayne.

Two things, first I have listened to Rob's podcast 1-14. I am sorry but they are extremely repetitive. Rob sounds very wounded and I suggest he get over it. I heard more than enough on that. I agree 100% with all of the main points. It is possible that nobody wants to listen because Rob does not put forth a detailed plan on how valuation should be added to the passive style. He hints at how to do it, but there is not a solid method. That makes it impossible for people to study in depth. I suggest he gets off the "old school" of complaining about the past and move to the "new school" of actually coming up with a baseline plan so the discussion can begin.

Second I have a question for you. Have you studied which levels of PE10 have worked best in the past for allocating money into stocks?

I know looking for the best levels based on history is curve fitting but a starting point would be helpful for me.

I love your information, (as well as Rob's by the way) it is a great work.

Thanks

HERE IS MY RESPONSE

Thank you. You will be pleased to learn that I did this in the early days of this site. I also made sensitivity studies that show that the details are not overly important. We know that history will not repeat itself exactly. Judging from the past, it will come close enough.

Refer to Current Research A and Current Research B. They describe optimal “switching” algorithms. I call one Switching A or SwAT2. I call the other Switching B or SwOptT2.

The one caveat is that these algorithms are optimal when starting at a time of high valuations. The market has come down considerably so that alternatives may do better in the future.

A good description of Switching B is in “Safe Withdrawal Rates with Switching,” which is referenced in Current Research A.

“I started with the optimized four threshold, five allocation switching algorithm (with three adjustable allocations). The P/E10 thresholds are 9-12-21-24. The allocations are 100%-50%-30%-20%-0%. When P/E10 is below 9, the stock allocation is 100%. When the P/E10 is between 9 and 12, the stock allocation is 50%. And so on.”

Safe Withdrawal Rates with Switching

A good description of Switching A is found in Current Research B.

“1) The stock allocations are 75%-40%-25%. (The calculator sees this as 100%-75%-40%-25%-0%.)
2) The P/E10 thresholds are 11 and 21. (I put 2-11-21-80 into the calculator so that the stock allocations of 100% and 0% never get selected.)”

Although these are excellent algorithms, they are not the best. In Current Research I: Latch and Hold, I found that adding a little memory helps. When stocks fall to compelling valuations, it makes sense to hold them a little bit longer on the way up than a simple threshold suggests. The result was better algorithms without straining the limits of credibility (i.e., without excessive data mining errors).

I reported:

“Latch and Hold dramatically improves the upside of (stock allocation) switching when starting in times of typical and bargain level valuations. Latch and Hold retains the advantage of switching versus fixed allocations in times of high valuations.”

Later, I developed a series of Retirement Trainers that eventually led to the Scenario Surfer. I found that training was far better than mechanically defined algorithms. That is why Rob Bennett and I both prefer to refer to the Scenario Surfer than previously defined algorithms.

That is also why Rob sounds so vague.

I learned from the Scenario Surfer to keep a minimal stock allocation of 20% at all except the very highest valuations (P/E10 below 30) because sometimes it is necessary. It does not happen often, but there are possible stock returns sequences consistent with history that would make a small allocation necessary.

Wayne followed up with these words, which I appreciate.

Thanks for the great response to my email. Stocks are finally getting a little more interesting these days!

Rob on "Rob's Podcasts"

I received this letter from Rob Bennett.

I'd like to make a few comments in response to Wayne's comments re my podcasts.

I am grateful to Wayne for putting forward his thoughts. That is obviously helpful. I am also happy to hear that he understands that valuations affect long-term returns and why this needs to be taken into account when developing investing strategies.

There is no question but that my podcasts are "repetitive." For good or for ill, this is very much by design. There are really only five words that need to be said -- Valuations affect long-term returns. Everything else just follows logically from acceptance of that idea. And there is nothing at all remarkable about the idea. The idea is universally accepted as true.

So why is there a need to say anything at all? That's the key question.

The answer to that is that there is a huge emotional resistance to the idea. So the job is to overcome that resistance.

I have spent a long time trying to determine how to overcome the emotional resistance. I have come to believe that the biggest reason why people have come to believe that Passive Investing might work for the first time in history is that they have heard this idea repeated so many times that they have come to believe it must be so. How many times have we all heard that timing doesn't work? People will let in the knowledge that valuations affect long-term returns when they have heard that idea as many times as they have heard the idea that timing doesn't work. Those who promote Rational Investing need to work hard to get the message repeated as many times as in as many ways as possible. Many people need to hear an idea expressed many times and in many different ways before it clicks for them.

I don't agree with Wayne that I sound "wounded" on the podcasts. I deplore Passive Investing and the promotion of it. And I feel anguish over the financial pain that it has caused middle-class investors and over the damage it has done to the various Retire Early and Indexing discussion-board communities. Many of the people who have seen their Retire Early hopes crushed are people who I know personally. These people are my friends. So there certainly is an emotional element to this for me. I think it would be odd indeed for me not to feel something for these people and over what has been done to them. I don't go along with the idea that expressing concern for what has been done to these people amounts to being "wounded," however. There are certainly many times on the podcasts at which I express excitement about the wonderful investing insights that we have developed in the first six years of our discussions and where I express hopes re where the entire community will be taking them in days ahead.

I have received a good number of e-mails expressing the concern that Wayne expresses that my advice is too "vague." I don't agree but I acknowledge that the view that it is too vague is held by a good number of people. I attribute this to one of the failings of the Passive Investing model.

It is possible to look at the historical data and to develop precise rules based on what you see. I see value in this in some circumstances. But I think there can be danger in it in other circumstances too.

What stock allocation should someone be at today, with the P/E10 value at 15? There is not one good answer to that question, there are several. If I put forward a view that there is one good answer, it seems to me that that serves to cut off debate, to suggest that someone has found "the answer" and that that's that. That's the last thing that I want to do.

There is a reason why Passive Investing became so popular. One of the reasons is that it is an investing strategy that provides clear answers to a host of questions. The answers provided are almost always wrong, but they are clear. Is that a good thing? I believe that clearly and confidently asserted wrong answers are the worst sorts of answers of all. I work hard to avoid falling into the trap that caused Passive Investing enthusiasts to put forward such answers.

I try to take things in just the opposite direction. My aim is to provide tools to help people come up with the answers themselves. An investor who looks at the historical data himself (or at a calculator based on the historical data) is going to do a far better job of determining what answer is right for him than some "expert" who knows nothing about his life circumstances. And the person who develops the answer for himself is going to have much more confidence in that answer. Confidence is critical when trying to stick to a buy-and-hold strategy over the long run.

I see Rational Investing as being the opposite of Passive Investing in every way. It's not just that it takes valuations into account. The process followed in analysis is different. Passive Investing is a closed system. "Experts" come up with "answers" and those answers are dogmatically asserted and not to be questioned. I see this as a terrible way of going about things. I view Rational Investing as an approach that calls for regular reconsideration of all ideas put forward. That requires an effort to always see things from more than a single point of which, which can translate in some cases into something that might be referred to as "vagueness."

I certainly am not vague about the core principles. I say that valuations always affect long-term returns, that to fail to make changes in one's stock allocation makes buy-and-hold impossible. Where I am "vague" is when I am asked precisely what allocation an investor should be going with at a particular P/E10 level. I don't think that there is any one allocation level that all investors should be going with. I believe that an investor's financial circumstances and life goals and emotional outlook always need to be taken into account.

The point here is that I don't think that people appreciate how different Rational Investing is from Passive Investing. Many try to apply the thinking that applies with the Passive Investing model to the new model. That doesn't always work. The two models are rooted in very different ideas of what it takes to become a successful investor.

I am grateful that Wayne listened to 14 podcasts. Anyone who works through that much "repetition" is a friend in my book whether he vows not to listen any further or not. I also thank Wayne for putting forward his thoughts here. He helps us all by doing that. As noted above, it is clear to me that Wayne is not the only one who believes the things he has said here. These are ideas that people need to be pondering as they examine the Rational Investing model and consider what it signifies.

I agree with Wayne that stocks today offer a far more "interesting" value proposition for the long-term investor than they have for a long, long time.

Rob (The Wounded One -- just joking!)

HERE IS MY RESPONSE

Wayne needed a starting point, something specific, something tangible to put him into the ballpark. He needs to have confidence in his scenario surfer results.

I have thought about this. I have a suggestion.

There is a lot of merit in straw man case studies. You mention individual circumstances, but you do not provide any examples. You should. And you should analyze them in detail.

I think that this would be of great benefit. I think that it would fill in a gap. People need to see your thought processes in action.

More of Rob on Rob's Podcasts

I like your idea about providing thoughts on how investors in various different particular circumstances might want to adjust their strategies as we move to various different P/E10 levels. There would indeed be value in this. I'll try to work in some podcasts or articles or blog entries that explore this theme.

My problem with spending too much time on this sort of article at the moment is that I believe strongly that communities provide a better work product than individuals. I could put forward my personal views on the various questions. But my views not informed by the views of other community members are never going to be as sharp as my views informed by the views of other smart people. Our communities have been destroyed by the goons. So I feel that Job #1 is to rebuild the communities.

I place my focus on explaining why Rational Investing is superior to Passive Investing with the aim of attracting people into the community who see the merit in Rational Investing. We need to build up to a level where the growth of the community is self-sustaining. At that point, there are no limits. The thing just grows and grows and grows indefinitely.

I hear in your words a suggestion that the community might grow more quickly if I devoted a larger percentage of my time to the sort of article described above. You might be right. I need to give that some thought. My take until now has been that the primary goal should be to address the basics until a large number of people are clear on them and only then move on to more advanced questions.

What you are saying probably does apply re Wayne. He has bought into the Rational Investing model. I can see why he would want more detail on how that model works. His take makes perfect sense to me. My concern is that we not leave anyone behind. I am always asking myself "What is it that we have not said that could get more people participating in the discussions?" My sense is that many accept Passive Investing only because it is popular and because so many experts endorse it. I am always seeking to explain to such people how it is that such crazy ideas could fool so many people, including many "experts". That's what leads me to constant exploration of the emotional element of the Passive Investing model, which appears to me to be the thing that causes Wayne (and presumably a good number of others) to view me as "wounded."

It's a strange story we have to tell. One model beats the other in every possible way in an objective sense. Yet the inferior model remains popular. I'm trying to help people to flip the switch that needs to be flipped for them to see the appeal of the new model. I'm focusing on one angle. Wayne and perhaps you see more merit in a different focus. I cannot say for sure. My instincts push me in the direction that I have been pursuing. But I am not at all certain that I am right re this one. I'd love to hear more people provide feedback.

HERE IS MY RESPONSE

The Passive Investing model is totally discredited. Those stuck in the past are paying the price.

The market drop has done the heavy lifting for you. Supporters of the Passive Investing model are fleeing for their lives. They want something better and they want it now.

We are moving into the post bubble era. The market has farther to fall. We do not know how much. Individuals need guidance right away.

Letters to the Editor in 2008

Letters to the Editor in 2007

Letters to the Editor in 2006

Letters to the Editor in 2005