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When Stock Prices Crash, Where Does the Money Go?

by J. Money on Thursday, March 11, 2010

This is a guest post by Rob Bennett

It’s a question you always hear after a stock crash. It’s usually asked in apologetic tones, as if it were a dumb question. It’s not. It’s a question that most of the big-name experts don’t fully grasp the answer to. Understand this one and you go to the head of class in Investing School.

When stock prices crash, where does the money go? It goes “Poof!”

That’s the truth. People think of stock investing as a serious business played by serious people. So they assume that there must be a complicated answer to this question. There must be some mysterious process by which the trillions of dollars of wealth that are lost in a stock crash disappear.

Nope. We can bid stock prices up to any level we want. We can all vote ourselves raises if we like. The only penalty is that, when we bid them up too high, they must crash back down in the following years. What is made from nothing must eventually return to nothing. It always happens that way. It always will happen that way. Now you know.

The strategy takeaway? Don’t invest too heavily in stocks when prices are high. Someone has to pay the bill for those times when we bid prices up too high. It doesn’t have to be you.

——————–
Rob Bennett is author of the A Rich Life blog and recently wrote a Google Knol entitled “Why Buy-and-Hold Investing Can Never Work.” (J: I don’t necessarily agree or disagree with “buy and hold,” (although I usually hold way more than sell) but I do find this topic interesting.)


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{ 44 comments… read them below or add one }

1 jim March 11, 2010 at 1:59 pm

This oversimplifies things a bit I think for a few reasons. First, how do you know when it's "too high?" Second, if you don't know if it's too high then you never invest and you never grow (unless you're satisfied with savings account interest rates).

Also, it doesn't go poof, it goes into the pockets of whomever was a net seller in the process. If a stock is "really worth" $10 and you pay $12, then the person you buy the stock from walks away with $12. When the price falls, wealth isn't destroyed… only yours. The wealth still exists in the seller's bank account.

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2 Wojciech Kulicki March 11, 2010 at 2:07 pm

"What is made from nothing must eventually return to nothing."

I don't feel that's accurate at all. We grow and create wealth because we are human beings capable of producing things, services, ideas, etc. Through our human capital, we're able to generate things that make us money.

The idea that unfounded gains are foolish to chase is one thing, but I kind of found this post's take a bit depressing, to be honest.

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3 Anonymous March 11, 2010 at 2:20 pm

@Jim

Not quite. If you have $1000 in principle, and the share prices go up to where you have a $100 gain (10% gain), and the share prices then drop, that money goes nowhere. Paper gains are only hypothetical, and depend on a buyer willing to pay that price. Paper gains also create tons of hypothetical wealth. The gains aren't real money until sold, and the losses that result from the crash aren't real lost money until sold either.

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4 Rob Bennett March 11, 2010 at 2:34 pm

First, how do you know when it's "too high?"

This is Rob Bennett, author of the Guest Blog Entry. Thank for your comment, Jim (and thanks to J. for running the Guest Blog Entry!). I'll respond to the best of my ability (and speaking from my perspective only, to be sure!).

There are two answers to your question. One is that I have a calculator at my web site called "The Stock-Return Predictor." The calculator employs a regression analysis of the historical stock-return data to tell investors when prices are too high. In January 2000, prices were high enough to bring the most likely 10-year return for stocks to a negative 1 percent real. That's too high!

The second answer is that we all would know a great deal more about the answer to this question if we talked about it more. I have argued that we need to launch a national debate on the realities of stock investing in which those of us who believe that Buy-and-Hold can never work would challenge those who think it is a good idea and see whether they are able to come up with good responses. I believe that our knowledge of how stock investing works is primitive today. The way to learn is to open our minds to the consideration of all sorts of questions that many thought had been closed during the Buy-and-Hold Era.

Rob

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5 Rob Bennett March 11, 2010 at 2:46 pm

Through our human capital, we're able to generate things that make us money.

Absolutely, Wojciech. I am certainly not saying that all stock market gains are illusory. Going back as far as we have records (1870) the U.S. economy has been sufficiently productive to finance real stock market gains each year of 6.5 percent real. That's the good stuff!

Think of it like the money you earn from your job and the money you "earn" by borrowing on a credit card. The first type of money is real and good, the second type of money is illusory and it hurts you to pretend that it is real. When stocks go up by 6.5 percent real, investors are left richer in an entirely real sense. But when stocks go up by more than 6.5 percent real, they are just borrowing returns from future years and those "gains" need to be paid back.

Think of how messed up our economy would be if we told people that, whenever they wanted something and couldn't afford to pay for it with money they earned at their jobs, they should just borrow on a credit card and through some magical process it would all work out. That's what we've been doing during the Buy-and-Hold Era. We told people during the 1990s that it was okay to bid stock prices up by 20 percent or 30 percent per year and that there was no need to lower their stock allocations even when prices got to such dangerously insane levels. That's why we are in an economic crisis today. $12 trillion of wealth that we were treating as real went "Poof!"

You're not funding your retirement in a serious way by treating cotton-candy gains as real wealth. We all need to learn to distinguish the real stuff (6.5 percent real of gains per year) from the phony credit-card stuff (anything significantly more than that).

Rob

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6 Rob Bennett March 11, 2010 at 2:53 pm

I kind of found this post's take a bit depressing, to be honest.

This comment saddens me, Wojciech. I know you are sincere. I have heard comments along these lines many times when I have shared these ideas with other middle-class investors. I think that the depressing feeling comes because these ideas are so shockingly at odds with the ideas put forward in the Buy-and-Hold Model. When you study this stuff in depth, you learn that these are very encouraging ideas indeed.

What is it that makes stock investing risky? Volatility, no? Well guess what we do away with if we teach people the realities of stock investing? Volatility! Volatility is 100 percent optional. If investors were taught to lower their allocations each time stock prices went to dangerous levels, stock prices would never again go to dangerous levels. Each time prices got too high, there would be sales, and the sales would bring prices back to reasonable levels.

If we all learned the realities, we would continue to earn 6.5 percent real from stocks but by investing in an asset class with little price volatility (and, thus, little risk). That's investor heaven! It's a win/win/win/win/win.

Rob

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7 Rob Bennett March 11, 2010 at 3:03 pm

the losses that result from the crash aren't real lost money until sold either.

I am of course grateful for your comment but I feel that I need to let people listening in that we disagree, Jim.

The entire historical record shows that gains greater than 6.5 percent real always disappear in the following years. John Bogle calls this phenomenon (Reversion to the Mean) an "Iron Law" of investing.

All of the losses suffered in the crash were real because we are still above fair value. That money is never coming back. However, if we were to go below fair value prices, losses suffered at that point would be only temporary in nature.

If we are at fair prices and stocks drop 50 percent, you don't need to worry because that money will be returning to you within a few years. If we are at double fair value (as we were for the entire time-period from 1996 through 2008) and stocks drop 50 percent, you have lost money that you will never see again.

I think that the key to successful long-term investing is learning how to distinguish real gains and losses from temporary gains and losses. You can identify which type of gain or loss it is that you are dealing with by taking note of the valuation level that applies on the day you purchase the shares of the index fund (the concepts that I am talking about here do not generally apply for people purchasing shares of individual companies).

Rob

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8 kt March 11, 2010 at 3:09 pm

it doesnt go poof! it goes into the pockets of those how bought it when the prices were low enough(while knowing their intrinsic values) and short the stock when the media had hyped the prices too high. you dont believe me, ask john paulson, the hedge fund titan where all that cash went(he made tens of billions of dollars when the markets were going to hell)

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9 Rob Bennett March 11, 2010 at 3:10 pm

When the price falls, wealth isn't destroyed… only yours. The wealth still exists in the seller's bank account.

Please take a look at the capitalization of the U.S. market. In inflation-adjusted and economic-growth -adjusted (remember, economic growth justifies a 6.5 percent gain each year) terms, I believe (it's been some time since I checked) that it is today about $8 trillion less than what it was in January 2000. The $8 trillion is not in anyone's pocket — it has gone "Poof!"

That $8 trillion is money that we borrowed from the future in the late 1990s by pumping up stock prices by 20 percent and 30 percent per year even though the productivity of the U.S. economy only supports gains of 6.5 percent real per year.

Rob

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10 Wojciech Kulicki March 11, 2010 at 3:14 pm

Thanks for following up, Rob. Your comments have given me more to think about, for sure.

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11 Rob Bennett March 11, 2010 at 3:27 pm

Your comments have given me more to think about, for sure.

What a nice thing to say! You've made my morning, Wojciech.

Please understand that my investing stuff is "controversial." I say what I sincerely believe and I work it hard to be as sure as I can possibly be that I have gotten it right. But there are lots of good and smart people who think I am out to lunch re this stuff.

Rob

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12 Rob Bennett March 11, 2010 at 3:41 pm

it goes into the pockets of those how bought it when the prices were low enough(while knowing their intrinsic values) and short the stock when the media had hyped the prices too high.

I understand your point, KT. If you knew the right time to short stocks, you would make a bundle, that's for sure. And there are indeed smart people who maintain that they can know the right time.

I personally am not convinced. It's entirely possible that these people are just smarter than me (it's been known!). I certainly don't think that it would be a good idea for me to short the market. And I don't think it would be a good idea for most middle-class investors to do so. Short at the wrong times and you will get yourself killed. Warren Buffett tried shorting the market in his early years and gave it up as something that was beyond his abilities!

I saw that stocks were insanely overvalued in 1996 and went to a zero stock allocation. I put my money in TIPS and IBonds paying 3.5 percent real. I am ahead of the game on that "bet" today and I will go further ahead over the years through the magic of compounding. But, if I had gone short in 1996, I would have had my head handed to me (stock prices zoomed ahead in 1996, 1997, 1998, and 1999).

My take is that in the long-term (10 years out) stock prices are highly predictable. But in the short term they are not predictable at all. That's because it is investor emotions that determine stock prices in the short term but economic realities that determine stock prices in the long term. Emotions are not predictable. Economic realities are.

Rob

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13 Kathy Kristof March 11, 2010 at 4:13 pm

Hi. I wrote a book called Investing 101 and thought I'd weigh in on the "how do you know when a stock is overvalued" question.

You know a stock is over-priced when it's price/earnings ratio is out of normal ranges and exceeds its earnings growth. Normal price-earnings ratios range from about 9 to 20, but companies that are growing really fast can have higher p.e.s because they're supporting the price with growth.

It comes from the notion that when you buy a share of stock, you're buying a piece of a company and you'll ultimately share in the company's good (or bad) fortune.

So how do you know the p/e? Take today's market price and divide by the company's annual earnings per share. So, if the market price is 20 and earnings per share is $2, you say 20/2 = 10.

Value Line can tell you the normal p.e.; or you can check the company's annual report and see how fast earnings are growing by comparing this year's earnings to last years. If the percentage change is greater than the p.e., you're probably okay.

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14 Rob Bennett March 11, 2010 at 4:29 pm

You know a stock is over-priced when it's price/earnings ratio is out of normal ranges and exceeds its earnings growth.

Thanks for helping out, Kathy.

I'd like to add one point that I know from experience often throws people.

People hear about this and it sounds too good to be true. Even my own wife told me that my investing ideas sounded too good to be true to her when I was telling her about them one time while driving in the car!

The question people have is — If all this is so, why the heck doesn't everyone invest this way? How could you keep something like this bottled up?

The answer is that it was the creation of index funds that made these ideas practical for the typical middle-class investor. Benjamin Graham (Warren Buffett's mentor) was saying that investors should change their stock allocations in response to big price shifts all the way back in the 1930s. But in those days investors were investing in individual companies and using valuations to set your allocation is a far less powerful tool when you are investing in individual companies. It is the introduction of index funds that made this strategy what it is today (or what it could be today if people had a way of learning more about it).

The difference is that, with individual shares, the valuation level is one factor among many affecting the long-term result you obtain. With an index fund, every factor other than valuations is priced in to the market price. So all you need to do to be virtually certain of getting that average long-term return of 6.5 percent real is to add a valuations filter.

The mistake that was made in the development of the Buy-and-Hold Model is that they failed to stress the need to consider valuations when setting your stock allocation. There's an historical reason for that. The Buy-and-Hold Model is rooted in academic research and, at the time Bogle founded Vanguard, the academics still believed in the Efficient Market Theory (the EMT has since been discredited by a mountain of more recent research). If the market were efficient, the market would always be getting prices roughly right and extreme overvaluation would be a logical impossibility. So naturally people thought in those days that there was no need to take valuations into consideration when setting one's stock allocation.

Now we know better. Or at least some of us believe that we do.

Rob

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15 Simple in France March 11, 2010 at 5:41 pm

Well–I really enjoyed this–I'm great at saving, but terrible at investing, so I'm in 'learning mode.' I actually think I learned even more from the resulting comments than from the post. Thanks.

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16 Rob Bennett March 11, 2010 at 6:15 pm

I really enjoyed this….I actually think I learned even more from the resulting comments than from the post.

Thanks for those kind words, Simple.

I have been discussing these ideas at various boards and blogs for eight years now. I have obtained two reactions. There is a large number that enjoys the learning experience (without necessarily buying into everything I say, of course). And there is a small but incredibly intense group that often tries to shut down the discussions. My strong sense is that what we are dealing with here is something new that has incredible potential to do a lot of good for everyone but that strikes some as exceedingly strange and even unbelievable. It's usually those who are better informed about investing who have the more negative reaction because they are more wedded to the conventional Buy-and-Hold approach.

I wish that there were a magic wand that I could wave to just make everyone chill out. I don't think that I know everything. I know from experience that I am entirely capable of getting things wrong. But if these ideas stand up to scrutiny (and our experience of the first eight years of the discussions is highly encouraging), they could change the history of investing in a very positive way. So I of course feel bound to do all that I can to get the ideas out to as many people as possible.

I have zero desire to make those who believe in Buy-and-Hold feel bad. In fact, the model that I favor (Rational Investing) has its roots in Buy-and-Hold. All that I have done is take the good work done by the smart people who came up with Buy-and-Hold and change it in one important way to fix one big mistake that I believe these people made. That change makes the whole thing work. And an investing strategy that actually works is so much better than one that does not, you know?

I ask all who are listening in and sympathetic to say a prayer that perhaps some of the Buy-and-Hold Dogmatics will ease up in their criticisms a bit so that we can all (including those who are today Buy-and-Hold dogmatics) enjoy a wonderful learning experience together. If these ideas stand up to scrutiny, that's a huge advance and everyone is better off. If not, then we can have that much more confidence in Buy-and-Hold knowing that it was able to stand up to a challenge. I believe strongly (I am a reporter by trade) that questioning of Buy-and-Hold must be permitted. If we cannot question, we just cannot learn. Never being able to learn anything new about investing would be really depressing, in my view.

It has made me happy to be able to respond to some sincere questions. It's constructive back-and-forth among friends that makes this work worth doing for me. And please understand that I think of all Buy-and-Hold advocates as my friends. I have of course learned many wonderful things from Buy-and-Hold advocates over the years. Do you know who got me started down the road I am on today? It was John Bogle! (his book Common Sense on Mutual Funds taught me that Reversion to the Mean is an "Iron Law" of stock investing).

Rob

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17 Financial Samurai March 11, 2010 at 10:18 pm

*Poof* indeed! Rob, glad you got your guest post up! Simple, yet to the point :) This is why I think including the full value of stocks in your net worth is dangerous.

J, good to speak and hug it out. I've cleared the air in the groups btw in case you were wondering. I'm looking forward to some really good toro sashimi and sake bombs next time you come out!

Best,

Sam

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18 Rob Bennett March 11, 2010 at 10:34 pm

Rob, glad you got your guest post up! Simple, yet to the point :)

Thanks, Sam. It's always nice to hear your warm and animated voice.

This is why I think including the full value of stocks in your net worth is dangerous.

Okay. But just to be clear and complete, I would argue that the opposite is so at times when stocks are greatly undervalued. Say that we go down to a P/E10 value of 7 or 8 sometime over the next five years (as we did in the wake of every other case of insane overvaluation). That would mean that your true portfolio value would be double the nominal value stated at the time.

This is a big deal. A drop to 7 would be a loss of nearly two-thirds of the current value of the market (we are today at 20). After a loss of two-thirds on top of the losses people have already experienced, lots of people would be depressed and tempted to sell. The valuation-informed approach would give them good reason not to because it would tell them that only the losses from 20 to 14 (fair value) would be real and that the further losses from 14 to 7 would be only temporary in nature (the most likely annualized 10-year return starting from 7 is 15 percent real!)

Taking valuations into consideration changes every aspect of the investing strategy story. It's not bad for people to be skeptical of new ideas — that's healthy and prudent. But I think that people should make more of an effort to consider the far-reaching implications of the ideas that are being put forward. We could be generating lots of good discussions at lots of fine blogs if we all got about the business of exploring this stuff in serious (and fun!) ways.

That's my sincere take, in any event.

Don't be bashful about telling your friends to do what's right!

Rob

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19 J. Money March 12, 2010 at 12:46 am

Well, you sure are thorough now aren't you Rob :) Thx for responding to everyone's comments. I knew it was risky throwing up one of your posts but it's always nice hearing a new point of view and different style – so thanks!

@Sam – Thanks for calling me directly, I really appreciated that. Glad we're still anonymous friends here ;) I'll hit you up for sure next time I'm in town, and I'll even show up!

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20 JoeTaxpayer March 12, 2010 at 2:54 am

Indeed, Rob is right on the wealth going away.
Whether we are talking stocks, real estate or commodities, when the price is X% below its previous high, that difference in wealth is simply gone. One day a stock holder is sitting on a million dollar portfolio, feeling like a millionaire, and able to borrow against it. When the market now says his portfolio is worth say $500,000, but there were no transactions, to say that someone else now has that $500K in their pocket implies a zero-sum game where one does not exist.
You can accuse Rob of the generality of "too high," but it's a truism which may only be obvious in hindsight.

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21 Schroeder March 12, 2010 at 3:58 am

There is a large number that enjoys the learning experience (without necessarily buying into everything I say, of course). And there is a small but incredibly intense group that often tries to shut down the discussions.

Like the Monevator, for example?

http://arichlife.passionsaving.com/2010/03/11/monevator-blog-bans-honest-posting-on-flaws-of-buy-and-hold/

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22 JoeTaxpayer March 12, 2010 at 6:14 pm

Indeed, Rob is right on the wealth going away.
Whether we are talking stocks, real estate or commodities, when the price is X% below its previous high, that difference in wealth is simply gone. One day a stock holder is sitting on a million dollar portfolio, feeling like a millionaire, and able to borrow against it. When the market now says his portfolio is worth say $500,000, but there were no transactions, to say that someone else now has that $500K in their pocket implies a zero-sum game where one does not exist.
You can accuse Rob of the generality of "too high," but it's a truism which may only be obvious in hindsight.

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23 Robert March 12, 2010 at 11:09 pm

So basically, stock prices are just imaginary numbers that may or may not refer to actual monetary value?

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24 myfinancialobjectives March 13, 2010 at 1:08 am

Many stocks are still way below their 52 week high. In the long run, I'd say now is still a good time to invest, though I'm thinking we will have a market correction coming here sometime soon..

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25 Banker March 13, 2010 at 2:06 pm

How to know when a Stock (or other asset) is to high, is a very difficult question with no simple answer. If you knew for certain there would be sitting on the beach in the Bahamas with an umbrella in your drink! For years before the Tech crash of 1999-2000 and the Credit Crisis of 2007-2009 I heard about these markets being over bought but it still took years before they crashed! I think the safest way to play markets is to consistently take profits as the market is moving your direction and to cut losses quickly when they reverse course. Sure sounds simple but I know it is difficult. As an example all of my 401k money i put into the market last year has been taken out and placed in cash (because the market rallied). New money will be put in again this year. If the market falls I will have a lower average, if it goes higher i do the same as 2009. I will never be rich doing this but neither will i with buy and hold (10,000 invest in S&P in 2000 was worth 9000 10 years later) Good Luck Banker…

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26 Rob Bennett March 13, 2010 at 4:32 pm

I knew it was risky throwing up one of your posts but it’s always nice hearing a new point of view and different style – so thanks!

Thanks for those kind words, J.

I look forward to the day when it’s not viewed as “risky” anymore to challenge the Buy-and-Hold dogmas. It should just be the ordinary course of business. People have different views on baseball and on fashions and on novels and on politics — and on investing models! That’s a good thing. It’s by hearing our views challenged that we all learn.

Rob

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27 Rob Bennett March 13, 2010 at 4:46 pm

You can accuse Rob of the generality of “too high,”

Thanks for your helpful and balanced comment, Joe.

I believe that what you are saying is that we don’t know for certain how to recognize when prices are “too high.” My view is that there is a sense in which that is true and a sense in which it is not.

It’s true for most of us today for only one reason — valuation-related topics have rarely been discussed in depth during the Buy-and-Hold Era. When you start studying this stuff, you learn the most interesting things. You learn that there are smart people who have done the hard work and who indeed have good tools for knowing what it “too high” and what is not. You can check how reliable these tools have been over the years and you discover that they have been highly reliable.

Not everyone was surprised by the crash. There were some who saw it coming. If we were smart, we would all start paying a bit more attention to those people and a bit less to those who were shocked and amazed and astounded that the market once more did what it has done every time in history when we went to the valuation levels we went to during the crazy years.

I’ll give you one example of what I mean when I say that we could all learn a lot more about what is “too high” by spending a little effort learning about this topic. My web site does not rank first for many search terms. But I do rank first for “P/E10.” That’ insane! “P/E10″ is the most effective valuation metric, the one recommended by Robert Shiller and Benjamin Graham and John Walter Russell. There should be thousands of sites writing about P/E10 today. But there obviously aren’t if my site is sitting at the top of the pile.

I am confident that there are good tools out there for assessing valuation levels. I certainly don’t object if there are some who question whether I am right about that or not — there can be reasonable differences of opinion on this matter. But I have a hard time seeing it as a good thing that valuations are generally discussed in so little depth that many of us don’t even know what the various valuation metrics are and why some work better than others. That should be common knowledge and it would be if the people who believe in Buy-and-Hold were more open to permitting those who do not believe to express their sincere viewpoints openly and as part of civil and reasoned discussions.

We all should favor a move in that direction.

Rob

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28 Rob Bennett March 13, 2010 at 4:53 pm

So basically, stock prices are just imaginary numbers that may or may not refer to actual monetary value?

In the short term that’s essentially right, Robert.

In the long term it is not right at all.

In the short term, it is investor emotion that determines stock prices. In the long term (after the passage of about 10 years of time) it is the economic realities. You determine whether stocks are a good buy or not by comparing the emotional current-day price with the real long-term price (the price that will apply after Reversion to the Mean takes place).

At the prices that applied in 1982, the most likely 10-year annualized return was 15 percent real (because stocks were undervalued and Reversion to the Mean was going to pull prices up) At the prices that applied in 2000, the most likely 10-year annualized return was a negative 1 percent real (because stocks were overvalued and Reversion to the Mean was going to pull prices down. Which stock allocation works in both circumstances?

There is no one stock allocation that works in both circumstances. This is why I am so down on Buy-and-Hold. Buy-and-Hold posits that it is okay (or even a good idea!) for investors to stay at the same stock allocation at all times. Huh? That can’t be if valuations affect long-term returns. If valuations affect long-term returns, you need to adjust your allocation in response to big price changes so that your risk level stays roughly constant.

Rob

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29 Rob Bennett March 13, 2010 at 5:06 pm

Like the Monevator, for example?

Precisely so, Schroeder.

What would we all be saying if we knew of a non-investing blog that appeared,/i> to permit comments but in fact banned comments that were not in accord with the viewpoint held by the author? We would view the entire thing as a fraudulent enterprise, no? Well…

The author of the Monevator blog is a smart guy and a nice guy and he is a fine writer. But he is wrong to ban honest posting on the flaws of the Buy-and-Hold Model. People need to hear both sides.

Say that I am wrong about every single thing that I say. If that’s so, then the Buy-and-Hold advocates obviously will be able to point out my mistakes. right? So having the discussion would leave people more confident in Buy-and-Hold than ever. That’s a good thing if I am wrong. So there’s zero downside in permitting both sides of the story to be told.

Now say that I am right. In that circumstance, the author of the Monevator blog is doing great harm to his readers by banning honest posting. Does he know everything there is to know about investing? Does he really want to take on the responsibility of figuring it out all by himself? I sure do not. I permit honest posting by Buy-and-Hold advocates at my blog, partly because I know that it is possible I am wrong and I want people to challenge me and tell the side of the story that I cannot.

It is madness that the author of the Monevator blog is playing it the other way. It is a sign of a lack, of confidence in his investing ideas. If we were talking about any subject other than investing, everyone would see that in five seconds.

I am trying to help the guy out. I am trying to teach the fellow (while also learning from him in return, to be sure). And he gets hostile about that? If anyone ever had any doubts but that following a Buy-and-Hold strategy causes investors to become intensely emotional, I think it would be fair to say that this incident proves it.

And this is by no means the first time I have been banned for pointing out the flaws in the Buy-and-Hold Model. It’s happened so many times at this point that I’ve lost count. We’re probably up to somewhere around 15 bannings at this point. Yowsa!

Rob

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30 Rob Bennett March 13, 2010 at 5:19 pm

How to know when a Stock (or other asset) is to high, is a very difficult question with no simple answer. If you knew for certain there would be sitting on the beach in the Bahamas with an umbrella in your drink!

Thanks for adding your thoughts to the mix, Banker.

My view is that it is impossible to know how stocks are going to do over the next year or two but not too hard at all to know (to a reasonable degree) how they are going to do 10 years down the road. My guide is the historical stock-return data (we have data on U.S. stocks going back to 1870). There has never in that time been a time when short-term timing worked. There has also never been a time when long-term timing (changing your allocation in response to big price changes with the understanding that you may not see a benefit for doing so for as long as 10 years) did not work.

Long-term timing provides huge benefits. It beats Buy-and-Hold in 90 percent of the return sequences that can come up, sometimes by very large amounts. The typical middle-class investor could retire five years sooner by switching from Buy-and-Hold to Valuation-Informed Indexing.

But this is not a means for getting rich quick! I went to a zero stock allocation in 1996 because prices had reached insanely high levels assuring a price crash sooner or later. I am now a good bit ahead on that “bet” (I put my money in TIPS and IBonds paying 3.5 percent real) and I will be going farther and farther ahead over the years as compounding works its magic. But the dramatic crash did not come until 2008. And I was down in a big way from 1997 through 1999.

Only short-term timing would permit you to make a quick killing. I know that there are some smart people who believe that short-term timing is possible. My personal view is that it is not. I believe as strongly that short-term timing never works as I do that long-term timing always works.

Rob

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31 The Rat March 13, 2010 at 7:35 pm

I think one of the good takeaways from a thread like this is the importance of not placing too much emphasis on equities in one’s portfolio. A portfolio with say, 80-100% exposure to stocks is asking for trouble when there are problems in the markets.

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32 Pop March 16, 2010 at 6:04 pm

If I were to summarize this post and entire thread in one sentence, it would be: “A stock price is what the last person to buy paid, not what the next person to buy will pay.” If the media wanted, it could have written “Lack of interest destroys $100 million in beanie baby wealth” about a decade ago just as easily as it writes the stock market wealth stories now.

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33 J. Money March 17, 2010 at 1:49 pm

OOooh I like that Pop! Going to tweet that later ;)

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34 Roger, the Amateur Financier March 17, 2010 at 10:15 pm

An excellent view of what happens when stock prices drop. It’s always good think to keep in mind that stocks (and anything, really) is only worth what we can sell it for to someone else.

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35 Monevator April 17, 2010 at 6:33 am

Hi Rob,

Thanks for your generous assessment of my writing. As you know, I think you’re a great writer on savings…

I don’t want to follow you around the Internet to discuss this ‘banning’ but as this post has a lot of comments, a bit of balance please.

I asked you not to keep commenting with the same variation about valuation-informed investing that you’d put on well over a dozen posts on Monevator. I felt you’d made your point.

You felt you needed to do so, so I began deleting those comments.

It’s not fair to say you didn’t get to say your piece — there’s dozens of comments from you on Monevator.

Since I stopped allowing your comments, my blood pressure has subsided and I even had some readers thank me. Nobody has asked for them back.

I have no ill-feelings — if you look at my Twitter stream just the other day I suggested someone read your blog for more on valuation informed strategies.

I just didn’t – and don’t! – want it clogging up my blog.

best
M.

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36 Rob Bennett April 17, 2010 at 7:40 am

I have no ill-feelings — if you look at my Twitter stream just the other day I suggested someone read your blog for more on valuation informed strategies.

That’s great to hear, Monevator. I believe that you don’t have hard feelings (I certainly do not either) and I thank you for the kindness.

Since I stopped allowing your comments, my blood pressure has subsided and I even had some readers thank me.

Yes — but why?

I’d be grateful if you and any others listening in here would give some thought to the “why?” question. What is it about hearing that valuations matter that causes people who believe in Buy-and-Hold to get so upset? We have people offer different viewpoints on lots of other question without people getting upset? Why does pointing out the flaws of Buy-and-Hold bother people so much?

My view is that it wouldn’t bother people if they were confident about their strategies. I want you and your readers to be confident about your strategies. So I want to help you challenge them and see if you can maintain confidence in them when they are challenged. If you cannot, I would like to see you change your strategies. If you maintain confidence in the face of challenges, maybe that will cause me to change mine — which of course would be a good thing if I am wrong.

I very much appreciate the tone of your comment here, Monevator. We obviously disagree. But we are talking here as friends, and that is as it should be. Here’s an idea that maybe you could pursue with some of the other bloggers. Would it be possible to have one blog that has some traffic where we could all meet to talk over these questions? It doesn’t do me any good to talk about this stuff only at my own blog if there is a gentleman’s agreement among all the big bloggers that no one will ever link to me and thus my words will never be seen by anyone. You say that you don’t want my comments clogging up your blog. What if we has one blog identified as the place where Buy-and-Holders and anti-Buy-and-Holders meet to discuss these questions. Over time, I think that some of the Buy-and-Holders might be won over enough to permit my comments on their blogs too. But they could dip their toes in the water a bit first at the designated “free posting” blog.

It is not my aim to hurt anyone’s feelings. My aim is to see to it that people somehow get to hear both sides of the story. 90 percent of the world today believes that Buy-and-Hold works. If we always decide things by majority vote, that is never going to change. If we want there to be some way for the new model to win support, we have to have a place that has traffic that people can go to to talk about it.

Any help that you (or anyone else reading these words) can offer to get something like that started up would be greatly appreciated, Monevator.

Rob

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37 Cleaning House April 19, 2010 at 10:55 am

Rob “hocus” Bennett aasked: “I’d be grateful if you and any others listening in here would give some thought to the “why?”

That’s easy, Rob. It is always a relief to rid yourself of an incessant internet troll and idiot posing as something he is not.

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38 Rob Bennett April 19, 2010 at 11:04 am

Here is a link to an article at my site at which 101 members of the Retire Early and Indexing discussion-board communities object to the tactic being employed in the Cleaning House comment just above:

http://www.passionsaving.com/investing-discussion-boards.html

This is why we are experiencing an economic crisis today. We learned what really works in stock investing in academic research that was published 30 years ago. But we cannot talk about it because it hurts the feelings of some of those who have advocated Buy-and-Hold strategies for people to learn the realities. So large numbers continue to advocate what doesn’t work and millions suffer the financial consequences of not being able to learn about the realities (we learn by talking things over in civil and reasoned and friendly and warm discussions).

Heaven help us all!

Rob

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39 Carlyle April 19, 2010 at 3:29 pm

Here’s a link to a lengthy thread which exposes the misrepresentations and mischaracterizations inherent in Rob’s claim that 101 folks actually are supportive of his trolling hobby;

http://www.s152957355.onlinehome.us/cgi-bin/yabb2/YaBB.pl?num=1189390571/4#4

It’s also interesting to note how Mr. Bennett demands that he be given unfettered access to express his views at any blog where he chooses to post but heavily censors opposing viewpoints at his own blog.

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40 Rob Bennett April 19, 2010 at 3:47 pm

Why do I sometimes get the feeling that I struck a nerve when I questioned the legitimacy of the Buy-and-Hold concept?

My belief is that we’ll all be a lot better off when we can talk this stuff over as friends. I think John Bogle is a genius. I can say openly and enthusiastically that I have learned important things from hundreds of people who are big believers in Buy-and-Hold. How many Buy-and-Holders can say the same thing going the other way? Why not? Is it really possible that the people who came up with Buy-and-Hold discovered every last thing that we will ever know about investing?

I think not. Buy-and-Hold was a huge advance. I am grateful to all the people who taught us so much. But it is my sincere take that Bogle and all the others are flawed humans, like all the rest of us. They got a lot of stuff right, they got some important things very, very wrong. And we all should be trying to help them come to grips with this reality and to move forward to an appreciation of some better ideas.

That’s my sincere belief, in any event. Given that its my sincere belief, I believe that I am required in conscience to put it forward in all my writings and podcasts dealing with investing topics. I’ll continue to do so regardless of whatever intimidation tactics Carlyle and his Goon friends direct at me. And I will continue to urge Bogle and Monevator and all other responsible Buy-and-Hold advocates to disassociate themselves from the Goon element that purports to speak on “the same side.” These sorts of tactics make Buy-and-Hold look like something a lot worse than just a discredited investing approach.

Holy moly!

Rob

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41 Carlyle April 19, 2010 at 4:20 pm

Mr. Bennett, I hardly thinking pointing out the obvious, i.e., you are a troll, qualifies as an attempt to intimidate you. You’re free to post at any blog willing to endure the customary wall-of-words routine you employ to drown out opposing viewpoints. And you’re free to post whatever drivel you choose to post on your own blog. Since your own site receives little traffic, it’s natural you should seek out other more poplular blogs such as Budgets are $exy as they offer you more opportunity to become the center of attention than does your own lightly travelled blog. But you shouldn’t get so hysterical when it is pointed out that you have a long and storied trolling career. There are still some folks unfamiliar with you and your history. Rather than itimidation, it’s merely a public service to enable them to quickly get up to speed on you and your posting history at personal finance discussion boards and blogs.

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42 J. Money April 19, 2010 at 4:37 pm

Woah…. okay, no more posting Mr. Rob – and others who like to poke Mr. Rob ;)
Let’s retire this bad boy before it gets crazier.

Thanks guys,
-J$

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43 Carlyle November 28, 2010 at 6:09 pm

I am sorry if I came off as a jerk on this thread.

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44 Rob Bennett November 28, 2010 at 7:28 pm

Thanks for saying that, Carlyle

Rob

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