Letters to the Editor

You Can’t Count on 7% Articles

This is an email that Rob Bennett sent me. (edited):

John:

Your recent series of articles has been spellbinding. I now have a new all-time favorite SWR article---the "You Can't Count on 7%--Dollars" article.

People have explored strategies for investing in individual stocks for many years. There is a wealth of literature available to help the investor choosing to select individual securities..

There is not nearly as much useful guidance available to help those who employ an indexing approach to investing..

On top of that, the time-period in which indexing has become popular has been a time-period in which we have experienced the strongest and longest bull market in U.S. history. As a result, 90 percent of what has been said re indexing is rooted in the nonsense assumption that changes in valuation have zero effect..

There are risks inherent in ANY investing approach. The risk of investing in individual securities is that you will choose the wrong securities..Indexing DOES allow one to avoid the risk of choosing the wrong securities. But at a cost. The cost is that the investor exposes himself to a new kind of risk--the risk of locking in an unappealing long-term return.

The magic of indexing is the lock-in effect. The buy-and-hold investor insures himself that he will do as well as the market as a whole. Some have come to believe that that is always a good thing--the "Stocks for the Long Run" paradigm says so. Obviously, this cannot be the case.

There can never be any one asset class that is always the best choice.

The lock-in effect is in some circumstances a benefit of indexing and in other circumstances a detriment of indexing. At today's valuations, it is a detriment..

Your latest article is the first that I know of that explores the key strategic considerations facing the indexing investor. There is no need for an indexing investor to choose particular stocks. What he chooses instead are different mixes of income streams. The strategic issue facing the indexing investor is--how much do I put in stocks today and how much do I put in non-stocks so that the long-term income streams generated..[help me] achieve my most important life, work, and money goals?

There are scores of considerations that must be taken into account in answering this question. Your article hits on a few of the most important. It thereby points the way to development of a wealth of valuable research that I expect that you and others will be putting forward in days and weeks and months and years to come.

I view this latest article as a breakthrough. I am highly encouraged. Thanks again for hanging in there as long as you have.

Rob

The Unedited Version

This is for those with the time. The entire text is worth reading.

John:

Your recent series of articles has been spellbinding. I now have a new all-time favorite SWR article---the "You Can't Count on 7%--Dollars" article.

People have explored strategies for investing in individual stocks for many years. There is a wealth of literature available to help the investor choosing to select individual securities (a strategy that has much to offer to those willing to put the necessary research work into the project).

There is not nearly as much useful guidance available to help those who employ an indexing approach to investing (usually because it is an easier approach and in some circumstances a safer approach than selecting individual securities). Indexes have only been available for a short time, so there has not yet been time for experts to study them in any depth.

On top of that, the time-period in which indexing has become popular has been a time-period in which we have experienced the strongest and longest bull market in U.S. history. As a result, 90 percent of what has been said re indexing is rooted in the nonsense assumption that changes in valuation have zero effect on the results likely to flow from an indexing strategy. To the extent that there is literature available to guide the indexing investor, it offers gravely flawed recommendations.

There are risks inherent in ANY investing approach. The risk of investing in individual securities is that you will choose the wrong securities. Indexing is often sold as a means of avoiding this risk. Indexing DOES allow one to avoid the risk of choosing the wrong securities. But at a cost. The cost is that the investor exposes himself to a new kind of risk--the risk of locking in an unappealing long-term return.

The magic of indexing is the lock-in effect. The buy-and-hold investor insures himself that he will do as well as the market as a whole. Some have come to believe that that is always a good thing--the "Stocks for the Long Run" paradigm says so. Obviously, this cannot be the case. There can never be any one asset class that is always the best choice. The lock-in effect is in some circumstances a benefit of indexing and in other circumstances a detriment of indexing. At today's valuations, it is a detriment. Few investors would want to lock in for their entire portfolio the long-term returns that follow from adopting an indexing approach today, given the far higher returns available by lowering one's stock allocation for a time and thereby permitting oneself to partake in the far more appealing returns available to those who invest in stock indexes at times of low valuations.

Your latest article is the first that I know of that explores the key strategic considerations facing the indexing investor. There is no need for an indexing investor to choose particular stocks. What he chooses instead are different mixes of income streams. The strategic issue facing the indexing investor is--how much do I put in stocks today and how much do I put in non-stocks so that the long-term income streams generated are likely to provide the best help to my quest to achieve my most important life, work, and money goals?

There are scores of considerations that must be taken into account in answering this question. Your article hits on a few of the most important. It thereby points the way to development of a wealth of valuable research that I expect that you and others will be putting forward in days and weeks and months and years to come.

I view this latest article as a breakthrough. I am highly encouraged. Thanks again for hanging in there as long as you have.

Rob

Earlier Letters

Mortgage Backed Securities
P/E10 Graph, Zvi Bodie's Book and more
TIPS and taxable (non-qualified) accounts
Safe Withdrawal Rates and Historical Surviving Withdrawal Rates

Have fun.

John Walter Russell
August 16, 2005