December 1, 2008 Letters to the Editor

Updated: December 3, 2008.

Two Letters from Michael

Hi John, Michael here

I've sent you a couple notes/questions over the last few weeks/month. Again, great site and very thought provoking....I would like to engage in a bit of intellectual back and forth - if this is the wrong forum to do so, please re-direct me to a better place. But in particular, 2 of the more pressing thoughts/observations I have had over the last couple of weeks navigating your site are:

1) Would it be reasonable to expect cuts in dividends over the short/medium term to be greater than historical "worst case" (the 25% cut you cite) due to the very fact that it MAY be not only the companies that are "sick" that need to cut dividends but in fact the healthy companies may very well decide to cut dividends for fear of not being able to roll their debt/bank lines? Ie, if this really is the worst shape the financial sector has been in since the depression and with risk aversion at such extreme levels (and anecdotal evidence everywhere of good companies not being able to access debt) would it not seem likely that sick and healthy companies alike cut dividends to preserve capital? And would it be reasonable to expect an overall dividend cut worst than we've seen before? (I previously sent you this question)

2) In many places you cite the superiority of Valuation Informed investing over fixed re-balancing and the intuition behind that seems very sound. I've been playing around with the 30 SWR calculator and given the fact that I am 38 it would be reasonable for me to look at Year 30 balances of 100% (since I probably will need to provide for a much longer retirement than 30 years). Interestingly, assuming a 2.5% TIPS level, a 100% Year 30 balance, and a 14 PE10, then an 80% fixed stock allocation results in a higher SWR than Switch A or B. And just to test the behavior under different scenarios, assuming a 0% balance the Switch A does in fact result in a higher SWR than a fixed 80% AND in the 15 Year calculator for either a 0% or 100% Year 15 balance you are again better off with the Switch A than the 80% fixed allocation. So, I am trying to understand the intuition of why for longer periods and for higher terminal stock balances, the Switching mechanism is not the preferable strategy - any help? If my horizon is really probably more like 45-50 years, is the effect even more pronounced? Ie, should I just put it all in equities and forget it? Doesn't seem like the most logical answer given, again, the seeming soundness of the Valuation Informed indexing....help??

Sorry - just found the Letter Index

Hi John - just saw that you did in fact respond to my earlier post on dividend cuts. Thanks. I guess just one follow-on. I am less concerned about financial companies themselves cutting dividends than I am about the relative health (or lack thereof) of the financials causing dividend cuts in otherwise healthy NON financials due to those non financials being worried about those sick financials not lending to them and therefore wouldn't it be prudent to cut dividends?? No need to respond unless you come out differently than you did before.

HERE IS MY RESPONSE

Thank you, Michael. I always appreciate receiving your comments. They are excellent.

I believe that the Treasury and Federal Reserve will succeed at restoring liquidity and loosening credit. I believe that the non-financial firms will do OK. Obviously, this is only my opinion. But they have been worried about deflation for several years now (according to John Mauldin).

Whether they will be able to contain future inflation is in doubt. I believe that they can. I am not sure that they will be willing to do so at the best moment.

You raise an outstanding question regarding Valuation Informed Indexing and Switching A and Switching B.

The answer is that I developed both Switching A and Switching B for times of high valuations, roughly P/E10=26. You can see some of the details in Current Research A and B (especially Current Research B).

Neither Switching A nor Switching B is optimal after valuations have returned to today’s levels.

There are two ways in which I can approach the problem of what to do today. One is to modify my procedures using the previous historical sequence approach. I have not chosen to do so yet, but I may in the future.

The other is to take advantage of the Scenario Surfer. Rob Bennett and I are developing a calculator which will allow us to do just that. We are very close to getting it online. I expect to use it first.

I appreciate your intellectual back and forth immensely and I invite others to join in. Understand that I am not a professional. I am a retired electronics engineer and I enjoy research. I do not accept payments or donations of any kind.

A Note to Wayne re "the Jerks"

I received this letter from Rob Bennett.

I saw Wayne's recent comment re "the Jerks" and wanted to offer some words in response.

First, I wanted to respond to Wayne's comment that: "I have always believed valuations matter. I sincerely appreciate your work in this area because your thoughts gave me the strength to stick to those beliefs even when it didn't feel wise at times." You have hit it precisely on the head with this comment, Wayne. This is the magic of Valuation-Informed Indexing. It works because it makes sense. The idea that valuations do not matter does not make sense, and, thus, we can never possess true confidence in an approach that ignores valuations. We need to root ourselves in reality if we are to become successful buy-and-hold investors. Valuation-Informed Indexers become more confident over time while Passive Investors become less so.

I also wanted to say a few words re Wayne's request to: "Let Rob know he was right. I hope those jerks who have been giving you guys a hard time are enjoying their own cooking!"

I was very pleased to see those words, Wayne. Your earlier comment that you gave up listening to my podcasts because I sounded "wounded" hit me hard because it was so clear from your other comments that you possessed a sincere interest in the Valuation-Informed Indexing concept. If you reacted that way, there obviously have been many others reacting that way. I need to avoid turning those people off if I am to succeed in bringing these ideas to the attention of the world at large.

I'd like you to understand where I am coming from. I am highly confident that Valuation-Informed Indexing is the way to go for most investors. The puzzle in my mind is why this concept was not developed many years before I came onto the scene; I think it would be fair to say that it didn't take an I.Q. of 140 to come up with these ideas. So why have we been hearing so much bad investing advice and so little good investing advice in recent decades?

I am convinced at this point that the explanation is that we live in communities and that to a large extent we even think as communities. We do not sit in rooms by ourselves and dream up grand investing strategies. We listen to what those around us say. This issue must be addressed if we are ever to learn how to invest successfully. The job is not only to learn ourselves how to invest. We also need to learn how to help others learn how to invest. What others are saying about investing at a given time influences our own thinking. We need to change not only our own thoughts but the entire investing community's thinking.

The point here is that we need to examine how it is that people come to believe what they believe about investing. We cannot discuss just numbers, we also need to explore emotions. There aren't many people doing this today, so it probably comes off as odd to some to see me do so much of it. I believe it is essential work. I don't think it suggests so much that I am personally "wounded." Perhaps it suggests that the community of investors as a whole is wounded. We have made very serious mistakes. We have caused lots of people lots of pain. We need to recover from the hurt (hurting others hurts us too, of course). The first step is working up the courage to confront our demons.

It is not at all unfair for you to refer to the abusive posters as "jerks." I of course do the same thing when I refer to them as "goons." There is another side to the story, however. The jerks/goons were tolerated by entire communities of humans. Does that not suggest that all of us have a bit of jerkiness/goonishness within us? I sure think so.

One of the responsibilities of a community is to step in and stop individuals who have a tendency to jerkish behavior from giving in to these urges. The community as a whole failed to do this. We let the jerks/goons down. We hurt the jerks/goons in a serious way by doing so. Yes, they hurt us. We hurt them too. Both things are so.

My job is to heal these wounds and to thereby help the various communities achieve their full potential. I have two big rules that I follow. One, I refuse to post dishonestly. That cannot be the right thing to do, so I draw a bold line re that one. Two, I try to be as charitable to the jerks/goons as possible given the demands of Rule One. They are people. They got some things wrong. They behaved poorly. They possess a light within them that needs to be brought out. They would like to rise higher. They would like to be making constructive contributions again. Part of the job for us Normals is to help bring on the day when that becomes possible again.

The Bogleheads.org board is owned by dogmatic Passive Investing enthusiasts. That of course has caused problems. The other side of the story is that there have been some wonderful threads there since the price crash. People who once possessed a strong belief in Passive Investing or in the Efficient Market Theory or in the Old School safe-withdrawal-rate studies are beginning to have doubts. This is an extremely encouraging development. We want to do everything we can to encourage reconciliation between the Passive Investing Dogmatists and the Doubters/Normals/Non-Dogmatists.

We need to be firm on Rule One. No person of intelligence and integrity should be willing to post at a board that bans honest posting (unless part of his or her posting agenda is to change that state of affairs). That said, those of us who believe that valuations matter and that the markets are not instantly efficient also need to be accepting of the reality that there are many smart and good people who continue to this day to believe in the Passive Investing model. In an intellectual sense, Passive Investing is the enemy. For purposes of community-building, it is dogmatism that is the enemy, not Passive Investing. We all should always make an effort to extend the hand of friendship to Passive Investing enthusiasts. We can learn valuable things from these people. We have in the past and we will again in the future.

The Rational Investing model is not so much a rejection of Bogle's thinking as it is an extension of Bogle's thinking. Bogle got many important things very right and one important thing very wrong. We always need to strive for balance in our comments. The most effective way to get the word out on our findings is to have Bogle endorse them. We obviously are in a better position to bring that about if the Bogleheads.org forum is debating our ideas on a daily basis. We always need to be thinking about how it is that we make that a reality. We don't want to condemn those who have been guilty of excessive dogmatism in the past. We want to help them to understand that we are all on the same side, that we are all investors trying to figure things out for the purpose of achieving financial freedom as early in life as possible. One of our goals is to win Mel Lindauer over as a friend.

I want you to know where I am coming from, Wayne. I talk about the things that I talk about because I think they matter. I act out of love. Always. If I ever fail to do so, I betray myself. And I betray the Rational Investing model. The Rational Investing model is rooted in love. Some will say that's too gooey a thing to say at an investing site. They are wrong. These sorts of things need to be said. It is our failure to recognize the need to say such things in the past that has led us to the dark place we find ourselves in today.

Thanks for having the courage to put some words forward, Wayne. You help lots of people when you do that. There are lots of people out there trying to figure this stuff out and having a hard time of it and their confidence is enhanced when they hear someone like you say the things you said. On top of all that, seeing your post provided me a nice lift to my spirits!

HERE IS MY RESPONSE

Thank you, Rob.

Wayne’s letter is Thanks for your website! in the November 21, 2008 Letters to the Editor. He has written several.

November 21, 2008 Letters to the Editor

Letters to the Editor in 2008

Letters to the Editor in 2007

Letters to the Editor in 2006

Letters to the Editor in 2005