The Financial Freedom Blog – November 2006

Here are some words from a post that a plenty nice and plenty smart fellow named “JohnDCraig” put to the Vanguard Diehards board this morning:

“Rob would criticize such a reply as being non-responsive or worse. He would say that Bogle should tell investors to lower their stock allocations by X%. Rob is wrong IMO….Jack doesn’t know where the market will go in general; as such he cannot give general AA advice, and much less individual advice. For him to do so would be presumptuous and arrogant.”

Here is the complete text of my response:

“You’re right, John [about me viewing the presumed Bogle reply as non-responsive or worse].

“And if I saw someone doing 95 MPH in a 65 MPH zone, I wouldn’t write him a note explaining how I thought that it might be possible that in some future day he might look back on all this and wonder why he didn’t give consideration to the idea of examining the rationale for the stated speed-limit and exploring whether there might be ways of incorporating the thought processes used in crafting the stated speed maximums into his own driving-speed decision-making processes.

“I’d yell out the window — Slow down, fella!

“I guess you can take the boy out of Northeast Philadelphia, but you can’t take the Northeast Philadelphia out of the boy.”

The Great Safe Withdrawal Rate Debate has been raging at a number of discussion boards for close to 54 months now. But you can figure out the whole thing by reflecting a bit on the words put forward in those two posts. The arguments put forward in those two posts are the entire debate in a nutshell.

I hereby invite John Bogle to a dinner of tomato pie and cold beer at Tony’s Place (at Frankford and Levick). My money says that we’ll have this safe withdrawal rate matter cleared up before he reaches out to beat me in a grab for the last slice.

Since Bogle has received the rare honor of having been declared a “saint” before he even died, I think it is only fair to let him know in advance that the official theme song of The Great Northeast (so named by its own inhabitants) is entitled: “You Can’t Get to Heaven on the Frankford El (Because the Frankford El Goes Straight to Hell).”

People there have a tendency to say it the way they mean it and to mean it the way they say it. Sylvestor Stallone and I graduated from the same high school. Some people think it’s rude to offer straight talk on investing topics. Stuff ’em, you know?

If you haven’t experienced tomato pie, I would guess that you would be wanting to do so soon. There’s not much sense in me going on and on about it. It would be like trying to tell a stranger about rock and roll.

Yo, Adrian! More on This Topic

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November 13, 2006 02:33 – So Sad (To See a Good Employee Turn Bad)

There are probably as many workers who fail at their jobs because they no longer present a challenge as there are who fail at their jobs because they are not up to the challenge.

Here are five stages traveled by many a worker heading down the path from good employee to bad:

1. Overwhelmed. Most employees start a new job frightened at the prospect of having to learn not only how to handle the content of the job but also the corporate culture;
2. Happily Challenged. Within six months, the employee is at a point at which she is still being challenged but not to such an extent that she cannot enjoy the experience;
3. Smooth Sailing. After another six months, the employee reaches a point at which she is confident in her ability to handle the job. She still enjoys the work. But there is not as much challenge in it anymore, and she is not learning as much;
4. Bored. It can take several years before the employee reaches a point at which she can do the job in her sleep. This is the point at which the employee must actively begin looking to move to a new challenge. If she does not, her attitude will enter a downward spiral; and
5. Miserable. If a new challenge is not found in time, the employee will become unhappy with herself and therefore unhappy with the company at which she is employed. The quality of her work will decline as she will not care enough about the work being done to do it well.

Of course, if a new challenge is tackled, the cycle can start again at Stage One. More on This Topic

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November 16, 2006 07:45 – We Can’t Say What Stocks Will Do in the Short-Term — Or Can We?

Valuation-Informed Indexers practice long-term timing, but abstain from efforts to predict how stocks will perform in the short-term future. While the economic realities insure that (and the historical stock-return data confirm that) long-term timing strategies can be employed profitably, stocks can do just about anything in the short-term. So we don’t even try to guess what is going to happen with stocks in the next year or two or three or four.

That’s the general rule.

John Walter Russell recently added several articles (please scroll down to the section of the Notes page entitled Short-Term Price Fluctuations) to his Early-Retirement-Planning-Insights.com site showing that it’s not entirely true that we cannot know anything about how stocks will perform in the short-term future. Stock prices might rocket upward or stock prices might drop shockingly lower. We cannot engage in short-term timing and expect to be able to profit from it. But we can form rough assessments of the likelihood of those two possibilities and others by looking at how valuation levels have affected how stocks have performed in the past.

Russell writes: “Bargain prices (P/E10 less than 10) protect your downside throughout all time frames. Attractive, but reasonable prices (with P/E10 between 10 and 15), generally limit the worst-case outcomes to two years. P/E10 levels between 15 and 20 do not protect you against deep dips. In fact, once P/E10 rises above 15, you should prepare yourself for 50% price drops as a matter of routine.

This is important stuff.

When people warn you not to buy stocks at times of high valuations (like today), they are usually trying to protect you from suffering the bone-crushing losses typically experienced by investors who go with high stock allocations at such times. Some investors are reluctant to lower their stock allocations, however, because they don’t want to give up the chance of obtaining the mouth-watering returns that were earned by stock investors during the time-period in which valuations were in the process of rising to nosebleed levels.

What Russell’s research is showing us is that this is a wrongheaded way of thinking through the pros and cons. Stocks not only are far more likely to dish out bone-crushing losses when they get to the sorts of valuation levels that apply today. They are also less likely to provide solid positive returns. When prices reach extremely high levels, the value proposition of stocks is diminished in every possible way.

This new research does not argue in favor of short-term timing. Short-term stock results remain generally unpredictable. Remember what happened when prices reached nosebleed levels in 1996? We didn’t experience a big drop in prices in the following three years. We instead experienced a blow-off topping of the mad Bull Market of the 1980s and 1990s. Stock prices didn’t return to fair-value levels in the late 1990s. They went into completely uncharted territory, reaching valuation levels never before experienced in the U.S. market.

So please do not start to think that you can predict the short-term direction of the market. The historical evidence is that you can’t do so effectively, and learning that lesson the hard way can delay attainment of your financial freedom goals by years.

The other side of the story, though, is that the potential downside of engaging in long-term timing appears to be even less than what we had come to believe it was from our discussions in the first 54 months of The Great Safe Withdrawal Rate Debate. Long-term timers missed out on some of the gains of the late 1990s. But those gains are temporary, and even the temporary gains that those ignoring valuations enjoyed in the late 1990s are the exception, not the rule. The upside potential for stocks when prices are high is not strong.

When you consider how frightening the downside potential is when we get to the sorts of valuation levels that apply today (the average percentage drop in prices for the three earlier times when we traveled to the valuation levels that apply today is 68 percent), it’s hard to argue that the small chance of benefiting from a freak occurrence like the one we saw play out in the late 1990s justifies going with a high stock allocation.

If you have a hard time accepting the reality that valuations affect long-term returns, please consider calling one of those 800 numbers that you often see on the billboards inviting you to pay a visit to a gambling casino. Going with the same allocation that you felt comfortable with when stocks were selling at reasonable prices is a risky sort of business indeed. More on This Topic

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November 20, 2006 07:00 – We’re Lovers, Not Fighters

Jesus wasn’t much of a joke-teller. C.K Chesterton argued that this is because, if Jesus told jokes as well, it would have been too much for us to take.

My explanation is that He focused on a form of humor that is different from the funny ha-ha stuff that first occurs to us when we call to mind the concept of the joke. Jesus was the best there ever was at telling parables. Parables are similar in many ways to jokes. They don’t make us laugh. But they approach truth from an unexpected angle and are often more successful at communicating it as a result. Jesus put his joke-telling energies into the creation of parables.

I’m going to tie this back to money stuff, just you wait and see.

Life itself is a paradox. You see this little guy who looks a little like you running around the house acting stupid and you wonder “How the heck did he get past the guards?” Then you remember how there was this cool girl who knew the lyrics to a particular song that was important to you in some way and that you figured that that must be a sign of something or other and so you asked her to marry you and then one thing sort of led to another over the years. It’s a joke, no?

It’s deadly serious. I’m not like those people in the famous Dylan song who make the mistake of thinking that life is but a joke. But we are not able to make complete logical sense of it through the use of words. All coherent statements of logical truth are ultimately lies. It’s only with a joke or a parable or a song lyric that you can point to as many sides of a topic at one time as you need to to be able to tell a complete truth.

This all comes to mind as a result of the comment that was posted to the blog on Friday asking if the name of the latest section added to the site (“For Dolphins Only”) is a joke. A joke? Yes. Just a joke? No.

I ain’t no bear. I tell the straight story about the risks associated with owning stocks today and there are people who feel drawn to call me a bear in response. That makes me feel like the girl in the Elvis Costello song who informed an admirer: “You can call me anything you like, but my name is Veronica.” My name is Rob (or hocus, if you know me from Retire Early World) and I ain’t no bear.

“You gotta line up with some kinda animal if you are gonna talk about stocks!” they yell back. “You are not a bull. You must be a bear. Admit it!”

Uh, right. I see what you are getting at, of course. Um — that makes sense.

So I say I’m a Dolphin. I opt out of the nonsense. I choose not to play the too stupid game. Was it a boy who came up with the bull vs. bear thing? I have a funny feeling.

I invest for the purpose of winning financial freedom early in life. It’s not a football game for me. It’s not like where you’re sitting on the sofa on a Sunday afternoon thinking about the candidates’ debate and anyway you look at it you lose. “Which side are you on anyway?” thinking is a bore, no?

Dolphins are cute. Sleek too. They swim around. They’re playful. People say they’re smart. They call out to each other in a way that is almost like talking. They remind me of going to the beach (you can see Dolphins from the shore line at Cape May).

If I must adopt a mascot to serve as a shorthand way of expressing our investing insights, I choose the Dolphin. It seems to me that Dolphins just might be able to get to some exciting places to which both Bull and Bears either can not or dare not go.

Call me a Dolphin or don’t call me. That’s my take.

I’m not kidding.

I’ve never in my life been more cereal. More on This Topic

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November 30, 2006 15:31 – Where the Monkees Went Wrong

The Monkees had a needlepoint on the wall of the beachside bungalow they lived in that argued that: “Money Is the Root of All Evil.”

It was a 60s show, and that was a 60s take on things. I’m a child of the 60s, for good or for ill, and I put a lot of stock in what Peter and Mike and Mickey and Davey had to say on just about any subject. When they spoke out against the Vietnam war, I figured it was probably a bad war. When the camera turned on the needlepoint saying that money is the root of all evil, I nodded my head in the affirmative.

They were saying that money sorta stinks and I took the message to heart. I spent the next 20 or so years handling money as if I were afraid that some of the stink would stick to me if I held onto the stuff too long.

Here’s a money tip that might save some mixed-up kids (like the old me) and even some mixed-up adults (like the new me) a bunch of heartache: The stuff doesn’t stink.

It’s not entirely fair to blame the Monkees for all our money troubles. This idea that money stinks has its roots in the Bible. My guess is that Mike (the smart Monkee) inherited the embroidery from his mother and his mother was obviously not a child of the 60s. Maybe she read the Bible. Maybe it’s God’s fault.

Did you know that Mike Nesmith’s mother was a secretary and that she invented White-Out and that he ended up with more money from that than he did from being in the Monkees? Talk about some guys getting all the lucky breaks!

Anyway, the idea that money stinks has been with us for a long time. This idea got a lot of emphasis in the 60s and a lot of us children of the 60s carry it around in our heads. It influences how we go about earning money and saving money and investing money. The ideas that form your worldview have a big influence on where your life takes you over the years.

Don’t think that a belief that money stinks up the joint won’t affect how much of the green stuff you accumulate over a lifetime. Those who understand why it doesnt stink do better financially in the long run than those who turn up their noses at it. How could it be otherwise?

What the Bible really says is that the love of money is the root of all evil. It’s a mistake to fall in love with money. When you fall in love with money, it causes you to do weird stuff that you otherwise wouldn’t do. So the Bible’s take is a perfectly good take.

Use money.

Use it to do good stuff. If you are using money to educate your kids or to buy your wife (or husband) flowers or to fix the roof or to have beers with a friend, you’re using money for a good purpose. There’s nothing stinky about money being used for that sort of purpose.

Play a game of word association. What words and phrases come to mind when you sit back and ponder the concept of money?

Is it words and phrases like “greedy” or “miser” or “cheat” or “workaholic” or “knife your buddy”? That’s not a good sign if you are hoping to win financial freedom early in life. Winning financial freedom early in life takes money. If you have a negative feeling about money, it’s less likely to find its way into your pockets.

You are in better shape if it is words and phrases like “freedom,” or “fulfilling work” or “important work” or “security” or “fun” that come to mind. Those are the words and phrases that those following the Passion Saving approach should be calling to mind when they think money thoughts.

I love money because of what it can do for people I love. I am not in love with money itself. I’m a 60s guy with a paid-off mortgage.

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