Much of today’s stock investing advice can fairly be described as less than top-rate stuff. Stocks are good, we are told. After “buy” comes “hold,” they say. Don’t worry about losses, things are sure to work out in the long run, according to the conventional wisdom. As Neil Young once observed in song: “Everybody knows this is nowhere.”
What’s gone wrong?
Explanation #1 for why today’s stock investing advice is so poor is that it’s a logical impossibility that most investing recommendations could be top-rate at a time when valuations are what they are today.
We live in highly unusual times. There have been only three times in the history of the U.S. stock market in which stock prices have reached the level of overvaluation that applies today (this article was written in October 2006, with the P/E10 level at 27). My guess is that most investing advice was poor in those earlier trips to la-la land as well. If you think it over a bit, I think you will see that it hardly could have been otherwise.
If most of the investing advice put forward at a time of extremely high valuations was solid, it would recommend that investors lower their stock allocations to protect at least a portion of their life savings from the price drops to come. If most investors followed that advice, it would bring prices down to more reasonable levels. Good advice about overvaluation, if it becomes popular enough, solves the overvaluation problem!
Times at which we hit a P/E10 level of 28 are times when investors’ emotions overrule investors’ ability to follow reasonable strategies. What sort of investing advice becomes popular at such times? Unreasonable investing advice. The kind that flatters investors into thinking that their experience with overvaluation might prove to be the exception that proves the rule. The kind that dominates most newspapers and television programs and web sites today.
To some extent, we get the investing advice we deserve. When we are responsive to good investing advice, we get more of it. When we insist on investing advice that allows us to remain in the fantasy worlds we have created for ourselves, we get more of that sort of thing.
The poor investing advice of today is to a large extent just a product of the runaway Bull Market (the Bull may be on his way to leaving the scene of the crime, but he does not appear to be in too great of a hurry to do so). My guess is that we will see a marked improvement in the quality of much of the investing advice available to us when prices enter an extended downturn.
Explanation #2 for why today’s stock investing advice is so poor is that most of the popular strategies were not developed with the needs of the middle-class worker primarily in mind.
It’s a rare middle-class worker who can afford to ignore investing issues for his or her entire life. For most of us, corporate pensions and Social Security are not going to provide what we need for retirement. So we all need to save and we all need to invest. There’s a pressing need for good investing advice today.
My guess is that good investing advice will in time be put forward to meet that need. The reality that we need to keep in mind when trying to understand the poor quality of much of today’s investing advice is that the need for all middle-class investors to learn about investing is a reality that came into play only in recent decades.
For most of humankind’s history, the majority of workers had to work until they were too weak or sick not to do so. Retirement has been a viable option for the majority for only 60 to 70 years.
For part of that time, corporate pensions provided much of the funding needed for those employees in circumstances fortunate enough to permit retirement. Social Security was in better shape in earlier years too. It is only in recent decades that the pressure has been put on the middle-class worker to invest his or her money effectively to finance his or her retirement.
Good investment advice will come along to meet that pressing need. It should not surprise us too much if it takes a little bit of time for this to happen, however.
I don’t believe that most of today’s investing advice was developed with the needs of the middle-class worker primarily in mind. Many of the ideas that drive today’s advice are holdovers from an era where the needs of higher-income workers were paramount.
The good news is that there are already signs that things are beginning to change for the better.
Explanation #3 for why today’s stock investing advice is so poor is that reporters need sources.
I used to work as a reporter under daily deadline pressure. Do you know what your primary concern is on waking up each morning when you know that you need to produce at least one news article by the end of the day? It’s getting your calls returned. A lot of the words that you use to fill up your articles are brought in through the telephone line. If your calls are not returned quickly, your editor is required by law to take out a gun and shoot you (that’s why it’s called a “deadline,” you know).
There are lots of people who make a living selling stocks. Those people know that helping out reporters on deadline pressure helps sell stocks. These people are motivated to paint stocks in a positive way and so naturally they do so. Those with different perspectives on how to invest generally are not able to devote as much time and energy to getting their message heard.
Explanation #4 for why today’s stock investing advice is so poor is that many of the sources of investing insights are compromised by their connections to the stock-selling industry.
Even people who are not directly involved in the business of selling stocks often do better for themselves by saying things that slant things in favor of stocks.
I have a lot of my money in IBonds paying 3.5 percent real. I bless the day that I made that investment.
It wasn’t the easiest investment in the world to acquire. When I went to a bank to purchase the IBonds, there were no pretty brochures on the table pointing out the benefits of IBonds. When I said that I had come to buy IBonds, no one rushed forward to shake my hand like they were my long-lost cousin. It was a different experience than the experience you are likely to have if you show up somewhere where stocks are sold and say that you want to buy stocks.
I don’t know any of the details, but my guess is that there is not much of a commission earned by the people who sell IBonds. IBonds are bought, not sold.
That affects people’s thinking on them. Advertising works. The good points of stocks are repeated to the point at which we are exhausted from hearing the message and are inclined to buy some stocks just to make the broken record stop repeating itself. You only hear about the good points of IBonds from developing a desire to learn about the good points of IBonds. IBonds are the naturally shy investment class.
When I use the word “compromised” above, I don’t mean that the people providing today’s investing advice are unethical. I mean that, like most humans, they generally do what it is easiest to do. It takes a lot more effort to buy IBonds than it does to buy stocks, and it takes a lot more effort to sell IBonds than it does to sell stocks. People tend to put forward advice on things they are comfortable talking about, and most people are more comfortable talking about stocks than they are talking about IBonds.
It’s in that sense that much of the investing advice you hear today is slanted in favor of stocks. There’s a huge industry set up to make the selling of stocks proceed smoothly. There is no such industry in place for the selling of IBonds or TIPS (Treasury Inflation-Protected Securities). It’s harder to sell or to buy these alternative asset classes. What is hard to do is not done so often as what is easy to do.
Explanation #5 for why today’s stock investing advice is so poor is that the investing field is perfectly designed for the proliferation of spin.
A “spin” statement is a statement that lives halfway between the world of the truth and the world of the lie. Spin is not false. Spin is usually plausible and in many cases even partly true. Spin is not the complete truth.
Spin thrives in discussions of investing. There are two reasons: (1) investing discussions usually involve lots of numbers; and (2) few possess a strong understanding of where the numbers are coming from. Numbers are often included in investing advice to make the advice sound more convincing than it would sound if the focus were on the logic of the statement being made. The reality is that our understanding of the numbers relating to investing is generally so weak that the numbers can be used to “prove” just about any point imaginable.
What 10-year annualized return are you likely to obtain on your purchase of shares of the S&P index? A numbers-oriented case can be made for just about any number you care to pull out of the air.
A case can be made for 12 percent. That’s the real return stock investors received during the recent bull market. Those returns are freshest in people’s minds. To many, those are the returns that count most.
A case can be made for 10 percent. That’s the nominal return that applies over the history of the U.S. stock market.
A case can be made for 7 percent. That’s the real return that applies over the history of the U.S. stock market.
A case can be made for 4 percent. That’s the real-return number you get if you adjust for valuations to determine the number that applies on a going-forward basis (long-term returns always drop dramatically in the wake of a wild bull market) and assume that valuations will remain at today’s levels indefinitely.
A case can be made for 1 percent. That’s the real-return number you get if you adjust for valuations and assume that valuations will drop in the manner in which they have dropped in the wake of prior big bull markets.
A case can be made for a negative 5 percent. That’s the number you get if you assume a worst-case scenario (it’s the 10-year annualized real return for the S&P that has only a 5 percent chance of turning up but which cannot be entirely ruled out).
Tell me what return you want to believe you will see from making a stock investment, and I can make a spin-driven case for the number you want to hear. Not all of these numbers are equally likely. But most of us don’t know what we need to know to predict long-term stock returns effectively. Until we get up to speed, spin will continue to dominate the investing advice we hear.
Explanation #6 for why today’s stock investing advice is so poor is that 80 percent of the advice is aimed at serving 20 percent of the need.
Much investing advice is provided free, but with the hope that some sort of transaction will take place that will generate a financial benefit for someone. That’s one of the reasons why much more effort is put into developing advice on advanced investing questions than is put into developing advice on the fundamentals.
What most of us need is a sure understanding of the basics. There aren’t too many people who profit from developing clear and effective advice on the basics. Much of the advice you hear on the basics of investing is stuff that the people offering the advice just pulled from some other source without giving much thought to it.
Explanation #7 for why today’s stock investing advice is so poor is that many investing experts don’t relate well to their readership.
Here are some words from the preface to The Four Pillars of Investing, by William Bernstein, in a description of the flaws of his first book, The Intelligent Asset Allocator: “My aim had been to explain Modern Portfolio Theory, a powerful way of understanding investing, to the general public. What I instead produced was a work comprehensible only to those with a considerable level of mathematical training and skill.”
Bill is one of the good guys. The words above show that he is trying. The reality, though, is that most of us don’t need another explanation of Modern Portfolio Theory. I don’t say that there is no place for that sort of thing. There is. But there is too much of that stuff being put forward today. What those of us in the investing-advice field need to do is to avoid the temptation to offer yet still more descriptions of Modern Portfolio Theory.
I’ve reached a point in my own understanding of these issues at which it irritates me just to write or speak the phrase “Modern Portfolio Theory.” I don’t applaud it as “a powerful way to see investing” (there are ways in which Bernstein’s claim is correct, to be sure). I see it as a dead end. I see it as something worse than that. I see Modern Portfolio Theory as something that has caused middle-class investors to become alienated from their own common-sense understanding of how stock investing works.
This isn’t the place to go into the theoretical failings of Modern Portfolio Theory. The point for purposes of this article is that using Modern Portfolio Theory as the root theory in the development of investing advice turns people off.
If people get turned off by your investing advice, they don’t listen to it. They often do something even worse. They ignore the boring reasoning process and take away just the bottom-line recommendations. That means that people end up doing things without understanding why they are doing them. Not good.
Bernstein is bummed because his readers don’t want to look at his fancy equations. Maybe it’s his readers who have more sense. Maybe his readers get it that learning how to invest shouldn’t be so darn complicated. Maybe his readers think that that sort of thing is okay for people in the business but that the ordinary middle-class investor shouldn’t have to be struggling to come to terms with too many equations to figure out how to finance his or her retirement. I mean, for heaven’s sake!
There’s a place for equations. I call the www.Early-Retirement-Planning-Insights.com site the most valuable site on Planet Internet, and that place has equations that walk up to you when you enter the room and ask you if they can have the next dance. The point is — there comes a time when you need to formulate the investing advice that follows from use of the equations into something that the average middle-class investor can understand. John Walter Russell does that at a number of articles at his site.
William Bernstein does it too at times. I’m not saying different. I see a difference between Russell’s work and Bernstein’s work, though. Russell’s work is rooted in common sense; the equations are used to identify the specifics that cannot be grasped through the use of common sense alone. Much of Bernstein’s work starts from the equations. Much of it is equation-centric.
That’s why he struggles to communicate his stock investing advice in a way that the average middle-class investor can understand. When you are dealing with Modern Portfolio Theory Brand investing advice, this cannot be done. With Modern Portfolio Theory, equations are often employed as a means to hide from reality, not as a means to learn about reality. Much of today’s investing advice has its roots in an artificial and excessively academic theoretical construct, and it shows when those trying to use it to supply investing advice aim to communicate their message to real live humans.
Since I’m banging on Bill Bernstein a wee bit here, I think it’s only fair that I send you over to his site (after you finish the article here, if you please!) for a little of that Modern Portfolio Theory Brand of stock investing advice.
Explanation #8 for why today’s stock investing advice is so poor is that there is a pronounced unwillingness in this field to integrate new information into the dominant theoretical framework.
It’s not just that the Modern Portfolio Theory jizz-jazz is in many ways wrong-headed. It’s also that the Modern Portfolio Theory is a jealous mistress. So long as this flawed theory remains the dominant theory, alternate theories that better explain how investing works in the real world are not able to gain a footing.
Robert Shiller wrote an important book a few years back. It’s entitled Irrational Exuberance. The book put forward startling claims. It advanced a fresh and more realistic way of looking at the question of how to invest successfully for the long run. The book obtained good reviews. Lots of them. It was a best-seller. All of this is good. The thing that is most striking about the reception given that book, though, is the thing that didn’t happen as a consequence of its publication.
Very few investing advisors changed their investing advice as a result of what Shiller said in his book.
Shiller showed that the now-dominant paradigm (I call it “The Stocks-for-the-Long-Run Investing Paradigm”) is dangerously flawed. He made a compelling case. He provided footnotes and all that sort of thing. He gave speeches where he responded effectively to questioning. He showed that the likely effect of failure to heed his message is going to be a crushing wipeout of middle-class wealth in days to come.
And pretty much everybody in the investing-advice field carried on with business as usual. Outside of a few berzerkos like yours truly, it was as if Shiller had never bothered to make his case.
That’s a bad sign.
A healthy investing paradigm deals with a challenge like the one put forward by Shiller by integrating the new information into a revised version of the core theory. That’s how theories grow and develop and come to bear new fruit. The Modern Portfolio Theory monster deals with challenges by looking the other way. It ignores challenges.
That’s not a sign of a strong paradigm. That’s a sign of a paradigm about to be sent to The Great Beyond. A paradigm that has lost its ability to adapt to the ever-changing world is a paradigm that is about to go the way of the dinosaur.
We are living in the twilight years of the Modern Portfolio Theory, in this boy’s opinion. Good riddance too, by the way. I’m sick of all those equations that circle around and around and around and never get anyplace truly interesting. I’d like to see people like William Bernstein applying their intelligence and energies to the explication of paradigms with greater long-term potential to inform and reward us.
Explanation #9 for why today’s stock investing advice is so poor is that humans have a natural inclination to focus on the short-term.
God created us in such a way that we focus on the short-term when making money decisions. The big problem with the conventional saving model is that it ignores this reality; telling a 25-year-old to save to prepare for his age-65 retirement is a cruel joke. The same problem applies in the investing context. We hear all this stuff about buy-and-hold and the reality is that most investors who purport to be buy-and-hold investors are focused on what has happened in the past five years and what they believe is going to happen in the next five.
I see this on discussion boards all the time. Someone will point to the historical stock-return data to argue that going with a high stock allocation when valuations are where they are today is risky business and the answer will come back: “I had a return of 9 percent over the past four years, buddy, how have you been doing lately with all of those sissy non-stock investment classes you like to tout here?”
People are focused on the short-term. It’s a reality that investing advisors ignore at the peril of those who place confidence in their advice. The buy-and-hold advice you hear so often is good advice in a general sense. It is also extremely unrealistic as a result of its failure to address implementation questions in an effective way. There is little effort made by today’s investing advisors to prepare middle-class investors for what they are going to need to be able to live through if they maintain high stock allocations at times of extremely high valuations. Many of today’s investors don’t even appreciate that today’s valuations are extremely high!
Buy-and-hold will survive, I believe. But to survive it must change. I am looking for a Realistic Buy-and-Hold Investing Paradigm to replace the now-discredited Stocks-for-the-Long-Run Investing Paradigm. The new paradigm will focus on providing investing advice that permits middle-class investors to carry out buy-and-hold strategies in the real world. Tomorrow’s investors will aim not only to talk the buy-and-hold talk, but also to walk the buy-and-hold walk.
Explanation #10 for why today’s stock investing advice is so poor is that humans are inclined to place more confidence in success stories than in analyses of the historical stock-return data.
People are drawn to success stories. They eat them up.
That’s probably a good thing in many circumstances. There’s a lot to be learned from hearing success stories.
Success stories carry dangerous messages to those seeking to learn how to invest successfully, however.
Who is the most successful in a wild bull market? The least prudent of all investors, the investor who throws caution to the winds.
Who is going to get burned the worst in the wild bear market that follows the wild bull market? The guy at the center of the success story of the earlier day.
One of the reasons why today’s investing advice is so poor is that we are drawn to believe in strategies that work for a time for all the wrong reasons. We are served poor investing advice for the same reason we are served fattening foods in fast-food restaurants. Offered a choice, that’s the stuff we grab for first.
Explanation #11 for why today’s stock investing advice is so poor is that those using common sense are often intimidated by those who have a wrong-headed understanding of what the numbers say.
I was at a party and I got to talking about a woman there about investing. I told her about what the historical stock-return data says about going with a high stock allocation at times like this and her mouth was hanging open. It was clear to me when we parted that she planned to have a talk with her husband about their investing plan.
Later, I saw the husband. He made a joke. He was perfectly nice. My sense, though, is that he was a bit annoyed about the thoughts that I had put into his wife’s head. My guess is that he defended their current strategy to her by pointing to the sorts of numbers arguments you see in the book Stocks for the Long Run. Those arguments often come across as strong ones to those who have not examined the numbers in an in-depth way.
I see this phenomenon play out over and over again on discussion boards. There are many people who have doubts about today’s investing advice. When I bring up the flaws, these people express interest and ask questions. But once some big shot know-it-all put up a series of abusive posts insulting anyone who asks questions about the conventional bull-market wisdom, the ones with an interest in exploring new ideas get quiet.
There are many middle-class investors out there today who sense that there is a lot wrong with today’s investing advice but who don’t understand the flaws well enough to challenge loudmouths who are highly defensive about the strategies they follow. The 10 percent or 20 percent who are loudmouth know-it-alls are able to intimidate into silence the 80 percent or 90 percent who possess a sincere desire to learn about investing. I think that phenomenon plays out outside of Discussion-Board World all the time.
We don’t get the stock investing advice we should because we don’t insist on it. We are sufficiently intimidated by the short-term successes of the conventional strategies to feel uncomfortable asking hard questions about them, especially if others react defensively when questions are put forward (and they often do, both in Discussion-Board World and in that giant-sized discussion board community we call “The Real World” too).
Explanation #12 for why today’s stock investing advice is so poor is that humans find comfort in going with the crowd.
We all possess a strong need to be liked and to be popular.
That hurts us when it comes to investing. When stocks are unpopular, they are an amazing buy. When stocks are extremely popular, they are a dubious buy.
When stocks are a dubious buy, most people own more stocks than they should and are defensive about it. Point out the flaws in their strategies and you are likely not going to rise to first place on their Christmas card lists.
I have come to believe that one of the most important qualifications for an investing advisor is a good sense of humor. Why? Because an investing advisor who aspires to tell it straight has to often tell us things we don’t want to hear. The best way that humans have come up with for doing that effectively is through humor.
Most of today’s investing advisors aren’t up for a guest appearance on Seinfeld. That’s another reason why today’s investing advice is so poor.
Explanation #13 for why today’s stock investing advice is so poor is that we put too much trust in experts.
One of the most illuminating discussion-board posts that I have ever read was written by a woman named “Janey” and posted to the Vanguard Diehards board. Janey said that she thought that the things I was saying sounded reasonable enough. She also said that she didn’t have available to her the time it would take to check out my ideas. So she felt obligated to go with the ideas of the experts she trusted the most, experts who put forward viewpoints very different than mine.
That’s the real story. That’s the way humans really make decisions.
People generally do not analyze the arguments put forward by experts. What they do is look for signs as to whether they can trust the expert or not. If he says three things that strike them as being particularly sensible, they come to trust him. Then they go by his say-so on all sorts of issues.
It’s generally a reasonable way to proceed. We don’t understand what the electrician is doing when he fixes the wires in our house. We check to make sure he is competent and we check to make sure that he is ethical, and then we leave the rest to him. That’s what most people do when listening to investing advice too.
It’s not a procedure that works well in the investing context. When stock prices fall, you will experience the panic that follows in a personal way. The only way that you can come to possess the level of confidence you need to have to maintain a buy-and-hold strategy in such circumstances is to understand the whys of each of your investing strategies.
If we demanded that our stock investing advisors explain their recommendations until we fully understood them, we would get better investing advice. We often don’t for reasons that make sense in other areas of life endeavor but not in the investing context.
Explanation #14 for why today’s stock investing advice is so poor is that dumbing it down is often seen to be the only alternative to the Bernstein approach of putting forward too many boring equations.
“Investing for Dummies” is all the rage.
It’s a reaction to the sort of investing advice that is offered by someone like William Bernstein, investing advice with lots of equations weighing it down.
The problem with most dumbing-it-down approaches is that they take the juice out of the topic. It is good for investing advice to be simple and clear and understandable and rooted in common sense. It is not good for investing advice to be simplistic. Some complexities are necessary to tell the story true. Some complexities are what give the story its color and depth and mystery and drama.
Our beef with complex investing advice is that it is boring. Simple investing advice can be boring too. We should seek exciting investing advice. Investing advice should challenge us enough to hold our interest. What is boring about the Modern Portfolio Theory Brand of investing advice is that it is artificially complex. Complications that are rooted in something real pull us in rather than repel us.
Explanation #15 for why today’s stock investing advice is so poor is that bottom-line thinking has become too popular.
The most frequent complaint that I get about my posts and articles is that they are too long. I don’t make a special effort to make them long. I do try to explain things in a step-by-step fashion. That sometimes causes my explanations to be longer than explanations that skip steps.
Many middle-class investors of today just want to hear bottom-line recommendations. They don’t want to know how the investing advisor reached his conclusions, just what conclusions he reached.
The problem with this is that each investing circumstance is so different that there is a danger in putting bottom-line statements of strategic advice to work in circumstances in which they don’t make sense. It is only by understanding the rationale behind a strategy that you can know whether there is a need to modify it in a particular circumstance.
There is no one who knows everything about how to invest. Those who try to make it appear that they do are dangerous people. I believe that the best way to learn about investing is to engage in back-and-forth discussions about it. Investing is more an art than a science. You don’t want to learn what is written on the answer page. You want to develop a feel for how to deal with situations that were not fully anticipated at the time the advice was put forward.
My hope is that this site will serve as a Learning Together resource rather than as a place for Rob to stand up on a box and shout his opinions at unfortunate passers-by. I hope to in time be able to incorporate features that permit more back and forth. Even today, many of the ideas discussed in articles at this site are the product of discussion-board interaction. You get my take on things at this site. But my take is a take informed by a good bit of interaction with a good number of other aspiring early retirees.
From time to time I will write articles summing up our bottom-line findings. But I view it as important that our community members understand the process by which we reached those findings as well as the findings themselves. Those seeking early financial freedom need to be willing to work it a bit harder than those content with financing an age-65 retirement.
Explanation #16 for why today’s stock investing advice is so poor is that we really don’t know all that much about the subject.
People have been investing for a long time. You would think we would know all about the subject. The reality is that it is shocking how little we know.
Behavioral finance is a growing field. Those studying behavioral finance aim to discover how humans interact with their investments to yield either good or bad results. That’s important and elementary stuff. You would think that people would have been studying it all along. The reality is that many ignore the behavioral aspects of the investing project even to this day.
I like indexing. i like it because it’s simple. I don’t take the purist stand that some indexers take, that indexing is superior to all other approaches. I think that it is dumb to become so dogmatic about an investing approach.
What kills me is that people can be dogmatic about an investing approach that has only been around for about 30 years. Indexing has never even been tested in a secular bear market! People make claims for indexing that are absurd given how new an investing approach it is.
What’s true of indexing is true of all sorts of approaches. We know some things for sure. We think we know some other things. And then there are a whole big bunch of things for which all that we have are clues pointing in one direction or another.
Today’s stock investing advice is not so hot because the state of humankind’s knowledge re the subject is just not yet all that well-developed. The dogmatics (I often call them “True Believers”) need to take a pill.
Explanation #17 for why today’s stock investing advice is so poor is that people lack a sure understanding of the fundamentals.
This is the most important thing of all. If you possess a clear understanding of the fundamentals, you will end up okay even if there are holes in your understanding of a lot of the detailed stuff. It doesn’t work the other way around.
If you understand the fundamentals, you will be able to quickly see the errors in most of today’s investing advice when they are pointed out to you. If you don’t, you can be taken in by dangerous claims that may sound good for a time but that will not stand the test of time.
About 20 percent of today’s investing advice focuses on the fundamentals and about 80 percent focuses on the more advanced coursework. I look forward to the day when it is the other way around.
Review the fundamentals and then review the fundamentals some more and then review the fundamentals some more and then review the fundamentals some more. That’s how you become a successful long-term investor. That’s how you attain financial freedom early in life. That’s how you break free of the need for a paycheck to cover your costs of living and become able to spend the hours of your remaining days engaged in work you truly love.
Whew! I did it again. I started out with good intentions. I said to myself: “I’m going to keep this one short, no matter what.” It never turns out that way, does it?
I’m bad right down to the bone. That’s the thing.