≡ Menu

7 ways to profit from other people’s folly

Behavioural finance insights

This is a guest post from Tim, author of the Psy-Fi blog, an excellent take on psychology and finance.

Behavioural finance – the study of where psychology meets finance and a car crash ensues – is now accepted as revealing how people mismanage their investments.

The behavioural finance approach offers a very different view of the world to old-fashioned efficient market theories, which reckoned that all stock prices were correct and based on rational thinking by rational investors in a rational world.

No one who’s experienced the last decade of turmoil can really believe that markets are efficient!

On the other hand, efficient market theories have the great benefit that they can be used to create so-called quantitative models. These models work for most of the time while people behave roughly rationally, and so enable investment firms to make decent amounts of money.

Unfortunately they’re also completely useless when everything goes wrong.

Quantitative models are also one of the main reasons for the huge black hole in global finance that our taxes are being used to fill up.

So, what has behavioural finance ever done for us?

If efficient market theories are flawed, we might well ask whether behavioural finance offers a practical alternative for hard-pressed private investors.

Behavioural finance relies on the wetware between our ears, and there’ll be no real model based on it until we can effectively simulate brain chemistry and connectivity.

But while this is no good to the investment industry – which wants ways of removing people from the tricky business of making investment decisions in order to generate fat bonuses as fast as possible (preferably before the next crash) – it can help the rest of us avoid the more dangerous bear traps that investing throws at us.

Here are seven behavioural finance insights to help you to make more money:

1. There’s always a crisis around the corner

History tells us that there is a crash in some market, somewhere in the world, every decade.

To profit: We should always proceed on the basis that we may (temporarily) lose half the value of our investments tomorrow and make decisions accordingly.

2. Everyone is at it

Investment advisors, expert commentators, mutual fund operators and that well-informed bloke we met on the Internet are all affected by behavioural factors. In fact experts if anything get worse results than a monkey throwing darts at a copy of the Financial Times.

To profit: Be very careful whose advice you take because your losses are always your own.

3. Stocks tend to under-react both to good news and bad news

This is because people like to sell at a profit, so they sell stocks on good news when they should keep them, and not at a loss, so they keep stocks reporting bad news when they should sell them.

To profit: If you have to invest actively, then these trends are worth exploiting.

4. People are horribly loss adverse

Even Tiger Woods is more likely to make a par putt than a birdie — avoiding selling stocks at a loss because we want to avoid the psychological pain of losing money is a dangerous policy. We also sell stocks in profit regardless of their future prospects in order to achieve the pleasure of a locked in gain.

To profit: Remember that selling winners and cutting losers for psychological reasons is profoundly irrational and usually damaging to investment returns.

5. Don’t underestimate the gullibility of investors

Companies changing their name to something Internet-related during the dotcom boom saw their share prices soar, even when their business was unrelated to technology. When the market was imploding, the reverse was true.

To profit: Don’t rely on markets for rational pricing.

6. Stay honest

We can improve our investment decisions, but only if we make sure we get good and effective feedback. Most of us don’t like facing the consequence of our decisions and avoid analysing our mistakes. This is the biggest mistake of all.

To profit: Keep an investment diary and schedule a regular review – you’ll be surprised how this changes your decision making mentality. Or try justifying your investment decisions to your partner every six months or so.

7. Don’t confuse anecdotes with evidence

We rely on stories to find our way through our lives, and a good narrative has much more neural impact than a bunch of dry numbers.

To profit: Never forget that in investment it’s the numbers that matter.

Behave yourself

Most successful investment, as Charlie Munger says, is not about being successful but about avoiding mistakes.

Unfortunately human nature means that avoiding share investing mistakes is not commonsense.

Nothing in our evolutionary history prepares us for the need to embrace the markets when blood is running in the streets and to run away when everyone else is dancing in the disco.

Yet unless we’re able to overcome our instinctive reactions, we’re simply apes hoping to follow everyone else to the next banana tree. It’s better to find our own tree and keep quiet about it.

You can read more about behavioural finance on the Psy-Fi blog.

Receive my articles for free in your inbox. Type your email and press submit:

{ 17 comments… add one }
  • 1 FB @ FabulouslyBroke.com September 21, 2009, 12:34 pm

    Fantastic post. You hit on all the points I learned very quickly with my $5000 in individual stocks (just as play money), and pointed out a couple more tips I could use in the future, such as the investment diary.

    Thanks. Also tweeted this.

  • 2 Rob Bennett September 21, 2009, 7:46 pm

    there’ll be no real model based on it until we can effectively simulate brain chemistry and connectivity.

    I agree that this is an important article. I believe that Passive Investing (the model rooted in the Efficient Market Theory) is the past of stock investing analysis and that Behavioral Finance is the future of stock investing analysis.

    I think you’re being excessively pessimistic in the comment quoted above, Tim. We don’t need to simulate brain chemistry to build a Behavorial Finance model. The human emotions evidence themselves in a quantifiable way in both over-valuation and under-valuation. All that we need to do to correct the calculations done under the Passive model for the effect of the human emotions ignored in that model is to factor in the effect of valuations.

    For example, studies done under the Passive model say that a 4 percent withdrawal rate is always safe for retirees. I have constructed (with much help from John Walter Russell, owner of the http://www.Early-Retirement-Planning-Insights.com site) a New School safe-withdrawal-rate (SWR) calculator (“The Retirement Risk Evaluator”) that finds that the SWR at some times drops to as low as 2 percent and at other times rises to as high as 9 percent.

    The only difference between the Old School and the New School SWR studies is that the New School studies factor in the effect of valuations. But, since all overvaluation and undervaluation is the result of investor emotion (if investors were rational, stocks would always be fairly valued), the New School numbers are really showing the effect of changes in investor emotion. Millions of middle-class investors will be suffering busted retirements in days to come as a result of the demonstrably (from the standpoint of those who understand that emotions affect stock investing decisions) false claims made in the Old School retirement studies.

    We don’t need to study the investor brain directly. Investor emotion evidences itself in P/E10 levels. The tricky part is remaining rational enough when most other investors are losing their heads to know to make the valuation adjustment!

    Rob

  • 3 Adam September 21, 2009, 8:13 pm

    I wonder about a possible contradiction. You say that “experts if anything get worse results than a monkey throwing darts at a copy of the Financial Times.” and also that “No one who’s experienced the last decade of turmoil can really believe that markets are efficient!”

    But a big part of the efficient markets hypothesis is just that belief: almost nobody invests better than random–and that includes you. The EMH doesn’t say that markets will be stable.

    So far, I’ve yet to see a behaviourist post that says much more than “EMH is wrong so behaviourism is right.” Yours is the most honest though; you do say that behaviourism isn’t a model at all. But if it’s not, what do we do with it?

  • 4 timarr September 21, 2009, 10:04 pm

    Yes, it is a bit pessimistic. We can clearly say that the EMH is often not true and I’m of (the untestable and therefore unscientific) opinion that it survives because it’s easy to model and therefore provides (false) confidence. Behavioural factors do clearly influence markets at extremes and must, therefore, do so at all other times: random and undirected behaviour creating the effect of an efficient market.

    On the other hand behavioural finance doesn’t offer the comfort of anything that can really be modelled – there are too many different biases, many of which compete, for a start. On the slightly more encouraging side we’re seeing some psychologists start to use behavioural factors to make people behave “correctly” – e.g. to save more for retirement. The danger is that like weapons of mass destruction in the wrong hands such manipulative techniques are highly dangerous. Although finance companies have been using them for years.

    In respect of Rob’s comments I’ll need to dig a bit deeper because some of that is new to me but as I’ve said elsewhere I’m nervous about putting too much confidence in any one factor, even one as historically solid as PE/10. Up until now virtually every back-tested, successful method has failed as soon as it became popular: I’m not sure that valuation norms remain constant over different eras and in an age where it’s information rather than capital, labour or land that carries most value things may be different. But, to be honest, I doubt it …

  • 5 Rob Bennett September 21, 2009, 11:02 pm

    I’m nervous about putting too much confidence in any one factor, even one as historically solid as PE/10.

    Thanks for your comment, Tim. I am the biggest advocate of P/E10 alive on the planet today. I think that using P/E10 can take the negative emotion out of the stock investing experience. But I greatly respect your viewpoint and it helps me to hear some reasoned skepticism re these points. I am an effusive person by nature, so it helps me for me to be reined in a bit from time to time.

    If you ever want to engage in some e-mail interchanges re these points, please know that I would enjoy that (there’s a “Contact Rob” button at the left-hand side of the home page at my blog). And, if you ever have the time to write a Guest Blog Entry where you critique the ideas that I advance at the site (re P/E10 or The Stock-Return Predictor, a calculator that makes use of P/E10, or anything else), I would love to host one by you (regardless of whether your take on the ideas is positive or negative). I always find it a learning experience reading your stuff.

    Rob

  • 6 The Investor October 1, 2009, 8:54 am

    The problem with systems like P/E10 (which, for the benefit of other readers, is a system for looking at the valuation of the market versus ten year earnings for sell decisions) is it can take you out of stocks midway through a rally.

    Think nobody else is using valuation metrics? Think again – a gazillion computer programs are factoring it into their second-by-second calculations, as well as real fund managers.

    As Timmar implies, these days it’s even harder to make simple rules like this work for that very reason.

    If you’re going to market time it’s perhaps as good a system as any, although personally I’d prefer to take a psychological reading of the market. I accept that’s even less likely to give consistent results.

    In my personal opinion, understanding that the market may be overvalued and rebalancing between equities and bonds on a six-monthly basis (or similar strategy) may be the best way of harvesting the good times without the risk of selling out completely and far too early.

  • 7 Rob Bennett October 1, 2009, 11:58 am

    it can take you out of stocks midway through a rally.

    You’re absolutely right about this, Investor.

    I view it as a feature, not a bug. I don’t want to be invested in stock when they are insanely overvalued, rallies or no rallies. My focus is on the long term and stocks have never yet done well on a long-term basis starting from a time of insanely high overvaluation.

    My stock allocation was zero from 1996 through 2008. I missed scores of big rallies. I’m ahead today. And I’ll be earning compounding returns on that differential for many years to come.

    Rob

  • 8 The Investor October 1, 2009, 3:54 pm

    @Rob, I admire your fortitude, even if I wouldn’t apply your methods personally. 🙂

    Out of interest, are you sure you’re still up if you factor in dividend reinvesting throughout? Here in the UK you could have got 2.5% to 5% per year each and every year for those 13 years (higher some years, lower others) and reinvested for further growth.

    Appreciate dividends aren’t such a big component of the US market.

  • 9 Rob Bennett October 1, 2009, 4:42 pm

    @Rob, I admire your fortitude, even if I wouldn’t apply your methods personally.

    Thanks for saying that, Investor. My personal belief is that it takes a certain measure of fortitude to play it either way (putting one’s money at risk is by nature a scary thing to do!). But I understand that you mean these words kindly and I am grateful to you for putting them forward.

    Out of interest, are you sure you’re still up if you factor in dividend reinvesting throughout?

    I know that I am up. But there are complicated reasons for that that don’t apply in most other cases. I had only a tiny bit to invest in 1996 (when I took my money out of stocks). But I was saving large amounts in the later 1990s ($88,000 in the best year). So for me the more important thing is how stocks did from 1999 forward and from 1998 forward rather than from 1996 forward. The record from 1998 and 1999 forward is obviously not as good as from 1996 forward.

    There is no question but that dividends need to be counted. An analysis that does not factor in dividends is invalid.

    I know that most others who got out of stocks in 1996 were up as of earlier this year. We have had a bull run since then, so I don’t know for a fact that that remains so. If it doesn’t, it’s a close enough call that I would say that it was not worth taking on the additional risk involved in investing in stocks to get that tiny differential. Also, it is my belief that we are likely to see another stock crash within the next few years. So any small differential in favor of owning stocks in that time that exists today may evaporate within the next few years.

    I believe that the difference in our viewpoint stems from a belief on your part that all timing approaches are “systems” (this is the word you use above) of one sort or another. I think it is fair to apply the term “system” to efforts to engage in short-term timing (and I do not favor any short-term timing approach for this reason). I do not view long-term timing as a “system.” I view it as a common-sense recognition of the need to take price into account when making a buying decision.

    If someone were to suggest to you that it is a good idea to do research on the fair value of a car before accepting a deal, would you say that they were putting forward a “sytem” to win at the car-buying game? I wouldn’t. I would say that taking price into account can never be a bad idea. That’s how I feel about stock investing. I am not able to imagine any circumstance in which taking price (valuations) into account when setting one’s stock allocation can be a bad thing (on a risk-adjusted basis).

    Timing can certainly fail to provide good results in the short-term. But long-term timing has never failed in 139 years of stock market history. I don’t think that’s an accident and I don’t think that this finding is the result of data-mining. My view is that it is literally impossible that taking price into account could ever provide worse risk-adjusted returns in the long run.

    The reason why is that, when valuations go up, the investor is taking on more risk if he sticks with the same stock allocation. If the investor sets his stock allocation properly, he should be lowering his allocation when valuations rise to keep his risk profile steady. For the investor to permit his risk level to go higher than what he earlier determined was appropriate just does not make sense (in my view!).

    I am grateful for the interest you have shown in the ideas by commenting on them (and I of course see your skepticism as entirely appropriate given how “out there” these ideas are in today’s world). If you ever have an interest in running a guest blog in which I would comment on some aspect of the Valuation-Informed Indexing strategy, please let me know and I would be happy to put something together.

    Rob

  • 10 The Investor October 2, 2009, 5:46 pm

    Hi Rob,

    Apologies in advance for this speedy reply — too much work, alas! — and thanks for your detailed explanation of your thinking.

    I don’t really accept your car analogy is the same as buying shares, I’m afraid. Car sales are relatively illiquid and even today (with Internet dealerships etc) they’re not perfectly efficient. In other words, a car might sell for X in one town, but 20% more than X in another town, or if it’s sold by a charismatic car vendor.

    In contrast, shares sell for the same price everywhere at the same point in time. This undermines the notion of whether the price you’re being offered is “good value”. It’s the price.

    Obviously I understand entirely what you’re saying — that the price relative to its historical valuation or its earnings growth or its peers or its dividend stream might suggest the share (and by extension the market) is over- or under-valued. I agree. But I don’t personally think this is covered by your car dealing analogy.

    As for whether PE10 is a ‘system’, perhaps we’re talking about semantics but I would describe it as that, yes.

    Shares cost what they cost today – pure and simple. If you are a seller (or you’re not a buyer) even though you’d like exposure to equities (not you specifically! I mean “if one is not”…) then in essence you’re saying you know something the market doesn’t know – that prices will be lower in the future.

    I think this ‘mechanical clairvoyance’ attributed to PE10 or other market timing strategies (you call it a valuation strategy, but I’d submit that if the consequence is the user either buys or sells, then it’s a timing strategy) might as well be called a system as anything else. 🙂

    Thanks for clarifying re: dividends. If I recall correctly, UK investors who reinvested dividends from the dotcom peak in 2000 were still up earlier in the year at the market lows, but I haven’t done the maths recently and I may be slightly misremembering. I’m sure they’d be up now. As I said, I accept the US situation is different with lower dividend payouts.

    Finally, I’m not against timing etc per se, I just think it’s incredibly difficult to do and the average investor (or indeed the super-sophisticated or dumb schmuck investor, too! 😉 ) is more likely to miss out than benefit from such attempts, as discussed in realms of academic research.

    But I’m not like Mike over at Oblivious Investor, say. I do dabble around with trading, and I also increase and decrease my index tracking portions (using ETFs) according to valuation, gut feel and in the case of overseas holdings what I perceive to be currency affects. As this sentence implies, it’s much woollier than a simple market valuation measure like Schiller’s, which if it works is likely to have been incorporated into quant strategies etc long ago.

    Have I benefited from such meddling? I strongly suspect so but it’s not clear cut, and I wouldn’t recommend it over dollar/pound cost averaging for most people. (I really should start keeping decent and foolproof records of performance versus the indices perhaps now I’m broadcasting my opinions, but the workload is off putting!)

    Thanks for the offer of a guest post. I may take that up some day, although I don’t feel I could give a rigorous and analytic answer – you might be better with someone like Timmar from the Psy-Fi blog on that score.

    Finally, I have noted on some blogs a tendency for you to bring most conversations around to passive versus active market participation etc. I’m more than happy to have the conversation here on this thread — I think it’s valuable — but with respect, I wouldn’t like to see such comments on numerous threads if you are a regular reader of Monevator (and if you are I thank you!) as I think it gets tiresome for readers, and I personally wouldn’t have time to keep responding.

    I don’t dispute your passion, but ultimately a man’s blog is his own domain and I’m pretty brutal with the old delete button – I wouldn’t want you to put in time on commenting only to see your comments vanish.

    I hope that doesn’t sound Draconian, just trying to head off the problems I’ve seen elsewhere in advance. As for this thread, if you or anyone else would like to comment on PE10 or any other valuation/timing practice(/system) please do feel free! 🙂

    best regards

  • 11 Rob Bennett October 2, 2009, 8:27 pm

    Thanks for the back and forth, Investor. I know it helps me. I believe that it may help some others listening in to these words.

    As for whether PE10 is a ’system’, perhaps we’re talking about semantics but I would describe it as that, yes.

    Okay. But then Passive Investing is a “system” too. The idea of ignoring price is certainly no more a neutral approach than the idea of paying attention to price. It’s universally understood that price matters in the purchase of everything other than stocks. So any model that teaches us to ignore that common-sense inclination is a “system.” If Rational Investing is a “system” aiming at “beating the market,” then Passive Investing is a “system” aimed at beating common sense. There is no neutral ground here. You either conclude that there are times when the market is so irrational that it must be beaten or you conclude that common sense is so averse to your emotional desire that price not matter that it must be ignored.

    in essence you’re saying you know something the market doesn’t know – that prices will be lower in the future.

    Yes. This is the claim being made. When prices are insanely high, they will inevitably fall. The market couldn’t continue to function unless this happened. Rational Investors assume that market prices will continue to reflect the economic realities (as they always have in the past in the long term) and that thus rises to insane price levels are always temporary.

    it’s a timing strategy

    I don’t have any objection to you calling it “timing.” The only way I know to take prices into account in my buying decisions is to engage in long-term timing. I blame Passive Investing for giving timing a bad name. I think it was a plus to give short-term timing a bad name. I think it was the biggest mistake in the history of personal finance to give long-term timing a bad name.

    I just think it’s incredibly difficult to do

    This is a common misperception. Bogle himself made this mistake in a recent interview he did with IndexUniverse.com. There is nothing more simple than paying attention to price when buying stocks. You buy when the long-term value proposition is good and you refrain from buying when the long-term value proposition is poor. What will they think of next?! Given that we take price into consideration when making every other buying decision we make, the complicated thing is to try to come up with some rationalization for not taking price into consideration when making buying decisions. It’s the attempt to rationalize Passive Investing that is responsible for 90 percent of the emotionalism of the stock investing project, in my assessment. It goes against all we know about how to buy things to think that there could be some asset class for which the most fundamental rule of all (that price matters) might not apply.

    as discussed in realms of academic research.

    I’ve heard this one so many times that I went to the trouble to check it out myself, Investor. There is precisely zero academic research showing that long-term timing doesn’t work. There are scores of studies showing that it does. The continued survival of the Passive model has depended for 28 years on The Stock Selling Industry’s efforts to spread confusion on this point. The “experts” over and over again say that there are studies showing that timing doesn’t work while failing to point out that every one of those studies looks at short-term timing and that every study looking at long-term timing shows that it has worked for the entire 139 years of the historical record. I wonder why.

    which if it works is likely to have been incorporated into quant strategies etc long ago.

    If investing were a 100 percent rational endeavor, this would indeed follow. Of course, if investing were a 100 percent rational endeavor, we would never see overvaluation in the first place. If investing were a 100 percent rational endeavor, the market would be efficient and Passive Investing would work in the real world. If we had wings, we could fly. We don’t and I think it’s best to follow investing strategies that stand a good chance of working in the world as it actually exists and not as some might wish it to exist or imagine it to exist.

    Thanks for the offer of a guest post. I may take that up some day

    That sounds great.

    I have noted on some blogs a tendency for you to bring most conversations around to passive versus active market participation etc.

    It certainly is so that I comment on the failings of the Passive Investing model when I can. We all should be doing what we can to bring this economic crisis to an end, in my view. I am of course not capable of bringing any conversations around to any particular topic on my own; that’s a community effort. I think it would be fair to say that The Great Safe Withdrawal Rate Debate has generated more interest and reaction that any other money-related debate in the history of the internet. These ideas have indeed generated a lot of good conversation (and some not-so-good stuff too, to be sure!). But there have also been cases where my comments have not generated a reaction. There have been more of those of late (I personally view this as a good sign, but this point is debatable).

    I wouldn’t like to see such comments on numerous threads if you are a regular reader of Monevator (and if you are I thank you!) as I think it gets tiresome for readers, and I personally wouldn’t have time to keep responding.

    I don’t see how it would be possible for you to speak on behalf of all of your readers. Rational strategies are always minority strategies when prices are where they are today and where they have been in recent years. So you are probably right that the majority of your readers might find comments coming from the Rational perspective to be “tiresome.” But your job is to serve the entire community. I have found at least a small number of people interested in the Rational perspective in every community in which I have posted, and, if I don’t represent that position, I know that there are not too many others who will (Passive Investing dogmatists are often exceedingly hostile to the expression of a Rational Investing perspective). So I will do what I can to help your entire community out when opportunities present themselves. I only wish that there were more of us taking on this important work. Had people been presenting a balanced perspective all along, I think it is fair to say that Passive would never have caught on and we wouldn’t be suffering from the effects of this economic crisis today. I of course understand if you are not personally able to respond to every post; I don’t do that myself at my own blog (although I respond to comments as often as I am able to).

    ultimately a man’s blog is his own domain

    Yucko! We couldn’t possibly disagree more. You have an obligation to your community to play it straight, Investor. If you are not willing to honor those responsibilities, you should not be writing a blog. That’s my sincere take, like it or not. I hope you will think it over seriously in any event.

    and I’m pretty brutal with the old delete button – I wouldn’t want you to put in time on commenting only to see your comments vanish.

    That’s happened to me before, Investor. The academic research has been showing for 28 years now that the chances of Passive Investing ever working out in the real world are precisely zero. The reckless promotion of this “strategy” has caused the greatest loss of middle-class wealth in the history of the United States. I think it would be fair to say that there are a good number of Passive Investing advocates who think of The Delete Button as their best friend. I am not impressed by that sort of thing. If things reached a point where the only way I could “protect” my readers from hearing viewpoints other than my own was to hit the delete button on posts that violate no reasonable rules, I would hang it up as a blogger. Again, my sincere take.

    I hope that doesn’t sound Draconian, just trying to head off the problems I’ve seen elsewhere in advance.

    That fact that you see it as a “problem” for your readers to be exposed to investing ideas other than your own is telling, Investor. I have found this to be a common take among Passive Investing advocates (there are some wonderful exceptions, to be sure). I take my responsibilities to my readers seriously. I know that, if I get stuff wrong, I can cause them great financial pain. I am grateful that the openness of the internet protects my readers because, if I get something wrong, they can get the other side of the story from people with other viewpoints. Your election to deny your readers that opportunity tells us something about the level of confidence you possess in the strategies you advocate at the site. It does not tell us something good.

    I think it would be fair to say, that if we were discussing any subject other than investing, you yourself would be appalled at what you are saying here. How much respect would you feel for a car salesman who told you that you couldn’t have your mechanic look at the car before signing on the dotted line? That’s what you are doing. You are saying that your readers will have to count on you getting it all right all the time because you will not permit the voicing of other points of view at your blog. Shame on you, Investor! You have failed your readers and you have degraded yourself and your blog with these comments.

    if you or anyone else would like to comment on PE10 or any other valuation/timing practice(/system) please do feel free!

    That sounds good except for the obvious conflict with the words above.

    My belief is that you should be reflecting on the reasons for your lack of confidence in your ideas, Investor. New ideas are not a bad thing. It is through new ideas that we all learn and advance. Passive Investing was itself once a new idea. Please think it over. I hope that you take me up some day on the offer re a Guest Blog Entry., My guess is that we could learn a lot from each other through continued interaction re these points of disagreement.

    best regards

    I also wish you the best, my new friend.

    Rob

  • 12 The Investor October 2, 2009, 9:42 pm

    Hi Rob,

    Just quickly.

    Okay. But then Passive Investing is a “system” too.

    Agreed. I was just commenting on your objection to my use of the word system.

    Passive investing is certainly not in my view “a system aimed at beating common sense”, however.

    It is a system that says operations aimed at doing better than the market overall are for most people doomed to failure, so better to invest throughout thick and thin and benefit from the peaks and the troughs.

    I don’t have any objection to you calling it “timing.”

    Grand. I think this paragraph was very interesting, and as I say, I don’t object per se to timing. I just think it’s massively harder than you do.

    The “experts” over and over again say that there are studies showing that timing doesn’t work while failing to point out that every one of those studies looks at short-term timing and that every study looking at long-term timing shows that it has worked for the entire 139 years of the historical record.

    Well, we’re going to have to disagree on this one, Rob.

    I’m sure there’s lots of historical evidence that if you sold the market high and bought low you’d have made much more money, but I disagree there’s lots of evidence to show it has been and can continue to be done successfully.

    If you’re that confident and you can prove it with conclusive academic research, why not set up a low-cost fund where you bring such methods to the wider mum and pop investing community? I’m serious. You’d make a fortune, and help scores of people become rich.

    Alternatively, set up a hedge fund and do it for 20% of returns above the S&P and become rich yourself. 🙂

    If you are not willing to honor those responsibilities, you should not be writing a blog.

    I’ve been through this before, as many of us have in the past 15 years with this miracle medium of the web, here and elsewhere.

    My obligation is to have fun and believe I am adding value to my life. It happens that I also get a kick out of helping others as best I can (imperfect though my help is, as you’ve pointed out here) so the two are not mutually incompatible.

    But this is not a democracy, it is my little blog on the corner of the Internet. I can run it how I like.

    If visitors don’t like it they are free to leave.

    That fact that you see it as a “problem” for your readers to be exposed to investing ideas other than your own is telling, Investor.

    I don’t, I’m happy to have the question raised here on this thread. Very happy, in fact. I agree it’s useful for readers.

    I’m saying I don’t want them on every post, on my blog, as I’ve seen happen elsewhere when you raise this issue.

    I was trying to be polite and giving fair warning because I do appreciate the time it takes to write comments, however much I agree or disagree with them. A shame you haven’t taken it like that, but c’est la vie.

    Shame on you, Investor! You have failed your readers and you have degraded yourself and your blog with these comments.

    Pretty strong stuff.

    You’re entitled to your opinion. As are my readers, who can read whatever they like, and will of course do exactly that, whatever we have to say about it! 😉

    All the best.

  • 13 Rob Bennett October 2, 2009, 10:39 pm

    It is a system that says operations aimed at doing better than the market overall are for most people doomed to failure, so better to invest throughout thick and thin and benefit from the peaks and the troughs.

    I understand. I think that’s a fair statement of the Passive viewpoint. My way of saying it is of course coming from my viewpoint.

    I just think it’s massively harder than you do.

    I think that’s the big point of contention with just about everyone who objects to my take. I believe that long-term timing is simple and easy. This is very much a minority viewpoint today. There’s no question whatsoever about that.

    I’m sure there’s lots of historical evidence that if you sold the market high and bought low you’d have made much more money

    There’s no need for Valuation-Informed Indexers to pick the high and low to come out ahead, Investor. With short-term timing, you need to pick the high and low for it to work. That’s not so with long-term timing. Anyone who lowered his or her stock allocation at any time from January 1996 through August 2008 would have ended up ahead in the long term. We were at insanely high prices for that entire time-period. But we were not at the highest of high prices for that entire time-period. Just getting it roughly right is plenty good enough with long-term timing strategies. That’s an important distinction.

    why not set up a low-cost fund where you bring such methods to the wider mum and pop investing community? I’m serious. You’d make a fortune, and help scores of people become rich.

    I’m all for helping people achieve financial freedom early in life. That’ the gig. But I am a journalist, not a fund manager. If I make millions, it will be as a journalist (I’d be grateful if you would say a prayer!). I have no objection if others set up funds. There’s no need to do this in a fund, however. It’s simple enough that any investor can handle it on his or her own without having to pay any fee.

    I can run it how I like.

    There are lots of things that we can do that we should not do. I would never dream of doing it the way that you are saying you do it. I care about my readers and I know that I protect them from my mistakes by permitting those with other views to comment at my blog. I am going to continue to play it that way and I am going to continue to be troubled when others do not. I find this attitude from a money blogger shocking. I certainly do not mean to say that you are the only money blogger who plays it this way. I have seen similar things at other blogs that promote Passive Investing. I don’t ever recall seeing it at blogs that do not promote Passive Investing. I don’t believe that’s a coincidence. I think it’s a weak idea that inspires lots of defensiveness.

    I agree it’s useful for readers.

    These words I like. This is how I feel about it. It doesn’t bother me at all that you have different views. I feel that we can be warm and friendly in our comments while disagreeing. But I don’t hear warmth and friendship in threats to delete non-abusive comments. That sort of thing comes across to me as defensiveness and intimidation. When you say that sort of thing, it makes it less likely that other community members are going to speak up in support of the Rational Investing ideas. It hurts us all when community members who would otherwise be willing to help us out are silenced.

    I’m saying I don’t want them on every post, on my blog, as I’ve seen happen elsewhere when you raise this issue.

    I’ve certainly never raised any of these points in any inappropriate way. No one would be more opposed to something like that than I would be. What often happens is that community members ask questions about these ideas because they have not heard them before. Is it the right thing for me to ignore those questions? I sure don’t think so.

    If there was more discussion of the Rational approach in all sorts of places, there would be a general understanding of the ideas and there would not be so many questions being asked. I support anything that can be done to help spread the word. That’s one of the reasons I suggested a Guest Blog Entry. I have done everything I can do in this regard. For so long as there is so much interest and so little good information available to people, I think it’s fair to say that I should do what I can to help people come to a better understanding of the realities. I certainly offer no apologies for doing that.

    I was trying to be polite and giving fair warning because I do appreciate the time it takes to write comments, however much I agree or disagree with them. A shame you haven’t taken it like that, but c’est la vie.

    The very fact that there are Passives who feel a need to give Rationals “warnings” about what they may post highlights the problem we need to overcome. I know of no other topic that is so heavily censored on the internet. Why? What is it about Passive Investing that it needs these special “protections” for its advocates to be able to maintain confidence in it? I invite Passives to come to my blog and tell the other side of the story. I welcome that sort of thing because I think it helps provide a balance that I cannot provide on my own. If we were discussing some topic other than investing, I believe that you would see the sense in that approach.

    Pretty strong stuff.

    Yes, that’s so. And if your take on stock investing turns out to be wrong, your readers are going to suffer busted retirements as a consequence. That’s strong stuff too.

    I don’t think that’s what you want to see happen. I am not saying that. I am saying that you should play it straight and thereby take the burden of getting everything right off your shoulders. If you permit other points of view to be expressed at the blog, then it’s up to your readers to sort through it and come to their own views. If you delete non-abusive comments solely because they express a viewpoint not in accord with your own, you mislead people. Most people don’t know that that sort of thing is going on. Most people see comments appear and presume that comments representing different viewpoints are permitted. Do you say in your rules that you do not permit comments representing viewpoints that differ from you own? If not, why not? It’s because you know how awful it would sound to reduce the policy you say you follow to writing.

    You’re entitled to your opinion. As are my readers, who can read whatever they like, and will of course do exactly that, whatever we have to say about it!

    That’s certainly the way it should be. I question whether that is the way it is when we live in a world in which The Stock Selling Industry has hundred of millions of dollars to direct to the promotion of Passive Investing and those who dare to tell the straight story on blogs are threatened with having their non-abusive posts deleted solely because of the positions advanced in them. The entire Passive model is rooted in a premise that investors pursue their self interests when making investing decisions. How can they when they can only hear one side of the story?

    All the best.

    Again, here’s backatcha, man. And please feel free to post in support of Passive Investing at my blog any time you care to and as often as you care to. If you advocate Passive Investing ideas in every post (which you must if you are to be honest just as I must advocate Rational Investing ideas in every post if I am to be honest), I will applaud you for it. I will present the other side of the story, to be sure. But you will not be in any hot water with me for saying what you believe works. My view is that that helps the entire community and that we need to have all viewpoints represented to be able to learn together. I hope and believe that we soon get to place where those working both sides of this matter see that as the best way to go.

    Rob

  • 14 The Investor October 3, 2009, 1:58 pm

    Rob, I simply don’t have time for these huge debates in Monevator’s comments, which I’d suggest are getting to the stage where they detract from both your point and from the blog post in question from Timmar. That is the reason why I said I will constrain their appearance.

    It is not true that there is a conspiracy being pushed by passive investing advocates, or that it crowds out other forms of investing.

    In fact, active fund management dwarfs the amount of money put into passive investing, even in the US, the home of Vanguard and all.

    It also not true to say there is no debate about whether active strategies are better for investors. I read such viewpoints all the time, both in advertising by the active fund management industry and in articles like this one from the Financial Times published today.

    All media outlets constantly make assumptions and set editorial policy concerning their output and interaction with readers/viewers. Firstly, time and bandwidth/paper isn’t infinite, so it’s a practical consideration. Secondly, that’s how consumers get a choice about what they read/view.

    Accordingly, there’s nothing sinister about me choosing to have my own editorial line here on Monevator, just as you do on your blog, where you are free to write what you like.

    Ironically, as I have written above, I’m not even against timing, valuation or trading strategies, as a dogma, so I don’t agree I can be put into that camp.

    Because I feel you have put me on the defensive, I feel it’s only fair to point out to bemused readers that this kind of discussion with you has flared up on numerous blogs and forums over the years, which is exactly why I tried to respectfully give notice that I would be policing against it here.

    I note you’ve been banned from the following sites:

    1) Motley Fool
    2) Bogleheads.org
    3) IndexUniverse.com
    4) Morningstar.com
    5) Early Retirement Fourm

    Readers who want to know more – and who want to hear more of your side of the story – can check out the email from Mike at Oblivious Investor, where he tries to reign in your commenting approach on his blog, and your defense on your blog.

    Unfortunately, whatever your intention I can see why your comments might come across as ‘spammy’ and ‘obnoxious’. Can you? As Mike says I think it detracts from your potential contribution.

    I work for roughly 20 hours a week on Monevator, for very little financial reward, and I am loathe to let it become a home for ongoing Internet battles such as this one. It’s not my fight.

    I would prefer to end on a positive note, so I’ll finish up by saying I felt this was a great comment from you on your home page:

    To save well, you need to be saving for a goal of intense personal concern, something that excites you as much as the benefits you obtain from spending. You should be saving to pursue one of the New Luxuries–having more time for your friends or your family or to pursue cultural interests or to be able to spend the hours of the day doing the work you truly love.

    I wish you well with your blog and your investing.

  • 15 Rob Bennett October 3, 2009, 3:37 pm

    I simply don’t have time for these huge debates in Monevator’s comments

    There’s no need for you or anyone else to engage in any huge debates, Investor. Think about how the thousands of blogs that do not advocate Passive Investing handle the “problem” of community members who put forward comments not in accord with the viewpoint of the blog owner. They let them appear! They let people hear other viewpoints! They do not freak out! The remain friendly and warm with the people offering the different viewpoints! They accept it as normal that not everyone shares a single viewpoint! There is a reason why this is standard operating procedures in all discussions except those that relate to the flaws in the Passive Investing model. It’s because this is what works when people are trying to learn about a subject of mutual interest.

    You have taken this huge burden upon yourself of feeling that you must offer a rebuttal every time someone questions Passive Investing. I hereby wave my magic wand and remove this burden from you. It doesn’t have to be such a biggie. Yes, there are people out in the world who have different viewpoints on investing. Yes, other people will hear their views if you permit them to appear on your blog. No, there is no problem with that. As you yourself suggested in a post above in this thread, people are perfectly capable of sorting through both viewpoints and deciding for themselves what path to take. There have been millions and millions of words devoted to spreading the Passive Investing gospel over the past 30 years. People are not going to forget all the wonderful slogans (timing doesn’t work, stocks for the long run, etc.) if you don’t jump in and “correct” any comments that happen to be posted that question these “truths.” Just let it go. Just stop worrying about it so much.

    It is not true that there is a conspiracy being pushed by passive investing advocates, or that it crowds out other forms of investing.

    I disagree, Investor. I wouldn’t use the word “conspiracy.” I would use the word “cognitive dissonance.” But I very much believe that Passives feel a desperate need to be the only game in town. They strongly feel that, if their views are questioned, confidence in them will crash. I have seen a mountain of evidence that this is so. Passives do not like to be questioned.

    Stocks were selling at three times fair value at the top of the bubble. That means that for every $1,000 an investor put into an index fund, he received $350 worth of stocks and $650 worth of cotton-candy nothingness. Yet stocks continued to sell at a steady pace all through the years of insane prices. Have you ever stopped to wonder why? It’s because we all have a Get Rich Quick impulse within us and the only possible brake on it is our common-sense understanding that, if we buy stocks without regard to price, we will cause our financial ruin. The entire purpose of Passive Investing is to rationalize away this common-sense understanding. Without the heavy promotion of Passive/Emotional Investing, insane bull markets (and the insane bear markets that inevitably follow) are a logical impossibility.

    The idea that investors do not need to take into consideration the price they pay for stocks is not a new one. It’s been around since the first day the markets opened. And it always causes massive bull markets and then massive price crashes. Rational Investing principles have also been around since the first day. The name we give to the times when Passive becomes dominant and the voicing of Rational investing ideas becomes socially taboo is “Bull Markets.” We are today living in the aftermath of the most out of control bull market in history. That’s why Passive is so popular and that’s why we are living through one of the worst economic crises we have ever seen. These things go together.

    In fact, active fund management dwarfs the amount of money put into passive investing, even in the US, the home of Vanguard and all.

    90 percent of the active funds failed to lower their stock allocations when prices went to insanely dangerous levels. I think you are confusing “Passive Investing” with “Indexing.” There is of course no problem with indexing. Indexing is achieving broad diversification with little cost — that’s wonderful. The problem is Passive Indexing and Passive Stock Picking. All Passive Investing is irrational. Indexing can be wonderful or a horrible mistake, depending on whether it is done passively or not.

    Accordingly, there’s nothing sinister about me choosing to have my own editorial line here on Monevator, just as you do on your blog, where you are free to write what you like.

    It’s not only your right to post your sincere beliefs at your blog. It is your responsibility to do so. If you fail to do that, you are failing your readers. This is beyond any dispute whatsoever.

    The question is — Why do you object to the idea of those who do not share your beliefs about ignoring price when buying stocks sharing their beliefs? Just as it would be wrong for you to endorse Rational, it would be wrong for me to endorse Passive. It is wrong for you to pressure me (and the many others who are developing doubts about whether it is a good idea to ignore price when buying stocks) into not expressing my views. There is room in the world for more than one viewpoint about how to invest in stocks.

    I note you’ve been banned from the following sites

    It’s not me as a person who has been banned at any of those places, Investor. The reality is that I am one of the most popular posters in the entire history of most of the sites you refer to here. Tom Gardner is the co-founder of the Motley Fool site. Tom wrote one of the blurbs that appear on the back of my book Passion Saving. Bill Sholar is the founder of the Early Retirement Forum. He wrote another one of the blurbs. There’s an article at the “Banned at Motley Fool!” section of my site where you can read scores and scores of posts put to the Vanguard Diehards board in which community members said that I was the first person who wrote about investing there that ever made complete sense to them and that they wished that the Passive Investing dogmatics would knock off the funny business and permit all posters to express their sincere views. I have put forward tens of thousands of posts to discussion boards and never yet had one removed.

    Have I been banned at those places? Yes. But in not one case was there any claim that I had ever put forward an abusive post. In several cases I received e-mails from the owners of the site expressing regret over having to ban honest posting.

    So why were there bannings? I am the person who discovered the analytical errors in the Old School Safe Withdrawal Rate (SWR) studies. These are the studies that most financial planners have been using to help us plan our retirements for years now. The studies get the numbers wildly wrong because they ignore the effect of valuations. Even a good number of Passive Investing advocates have acknowledged that I am right about the errors in the studies. Larry Swedroe has described the SWR studies as “Garbage-In, Garbage-Out” research. Bill Bernstein has said that anyone giving thought to using one of the studies to plan a retirement would be well-advised to “FuhGedDaBouDit!”

    There is an individual who published one of the Old School SWR studies at his web site who has spent the last seven years of his life following me from site to site and threatening to burn the site to the ground unless they ban honest posting on the SWR topic. He has followers (because he offers Get Rich Quick investing advice, which obviously has great appeal during an insane bull market). When site owners have refused to adopt bans (most have been highly reluctant to do so), he has resorted to making threats of physical violence to posters who post honestly. The sites have found that they cannot get posters to remain at their boards if they do not give in to this individual’s demands.

    Do you know what I think they should do instead? I think that they should ban the fellow making the death threats and let the rest of us have our constructive discussions in peace. Why don’t they? You asked above if there is a “conspiracy” in favor of Passive Investing and I said that there is not a conspiracy but there is certainly a lot of cognitive dissonance. To those who “believe” in Passive Investing, making death threats is not cause for a ban but correcting errors in retirement studies that get the numbers wrong is. That’s an incredible reality, Investor. But that’s the reality that applies in the wake of the most out-of-control bull in the history of the United States (an out-of-c0ntrol bull that just happened to take place at the same time as the Stock Selling Industry was spending hundreds of millions urging investors not to pay any attention to the price at which stocks were being sold and what that told us about the long-term returns that those buying stocks at those prices would be obtaining).

    I can see why your comments might come across as ’spammy’ and ‘obnoxious’. Can you? As Mike says I think it detracts from your potential contribution.

    I am highly confident that Mike is shooting 100 percent straight when he reports that people at his blog have described my comments as “spammy” and “obnoxious.” Mike’s e-mail was frank and true and helpful. He’s describing a reality. Mike is trying to make things better, in my assessment. I applaud his efforts in this regard.

    I am not saying that all of your readers are going to stand up and applaud if you permit honest posting on the flaws of the Passive Investing model at your site, Investor. I know from experience that a good percentage are going to hate the idea. That’s emotion talking. That’s a certain sign that the investing model these people are following is a bad model. A good model would not cause people to feel such uncertainty and doubt and pain and anger and hate.

    How do we bring an end to this madness without discussing the problems? That’s my question. It was my posting at the Retire Early board that built that board into the #1 most successful board at the Motley Fool site. Do you think I have no responsibility to the people who congregate at the board I built to let them know that a retirement study being promoted there on a daily basis gets all the numbers wrong? When I post with people for years at boards and blogs, I come to think of them as friends. A busted retirement is a serious life setback. I don’t like to see my friends suffer serious life setbacks. So I post honestly on the flaws of the Passive Investing model (the errors in the Old School SWR studies were caused by a belief by the authors of those studies that valuations don’t matter).

    People are angry because it hurts to learn that you have been taken. I’m trying to change that. I’m trying to take things in a positive direction. The first step to doing that is explaining to people why the idea that timing doesn’t work is not only incorrect but is actually a logical impossibility. If valuations affect long-term returns, then long-term timing obviously works. The academic research has been showing since 1981 that valuations affect long-term returns. Passive Investing is a mistake.

    I am not trying to hang the people who made the mistake. I understand that we are all human and we all make mistakes. I am trying to get the mistake acknowledged and corrected. When the mistake is acknowledged and corrected, we are not going to see people getting angry to learn what the safe withdrawal rate is when it is calculated properly. Rational Investing is a win/win/win/win/win. There is not one person on Planet Earth who does not benefit from learning how to invest effectively. The hurdle is that some people who made some mistakes will need to learn how to say the three hardest words to pronounce in the English language — “I” and “Was” and “Wrong.” That’s it. That’s the only price we need to pay to move on to The Golden Age of Middle-Class Investing (the post-Passive age).

    You noted in an earlier post that one of the reasons you write your blog is to have fun. It’s the same with me and with most other bloggers. Have you ever considered how much fun it would be to just drop the nasty stuff and move on to some exciting learning experiences? Read that article at the “Banned at Motley Fool!” section of my site (it’s called “Investing Discussion Boards Ban Honest Posting on Valuations!) and you’ll hear scores of people talking about how much fun we all could be having if the Passive dogmatics could pull it in a bit and acknowledge that, yes, they are just like all the rest of us capable of making mistakes from time to time., It really does happen. John Bogle is capable of making mistakes. Eugene Fama is capable of making mistakes. Burton Malkiel is capable of making mistakes. All of them.

    It’s not my fight.

    It is if you care about your readers. The reckless promotion of Passive Investing for 28 years since the academic research showed that the chances of it working in the real world are precisely zero has already caused the greatest loss of middle-class wealth in the history of the United States. And the losses are going to grow much larger in days to come in the event that stocks perform in the future anything at all as they always have in the past. When you elected to blog on investing, this became your fight. You have an obligation to at least make an attempt to get it right (or at the bare minimum to permit posting by those who have made an effort to get it right).

    I’ll finish up by saying I felt this was a great comment from you on your home page:

    Thanks for that kindness, Investor. I was the most popular poster on the Motley Fool site in the days when I posted only on saving. I became the most hated poster on the entire internet as a result of my decision to point out the errors made in the Old School retirement studies. It’s the same guy posting on both subjects. I of course prefer it when people love me. But I am not able to live with the idea of posting dishonestly on a topic that could cause my friends to suffer busted retirements. My hope is that I will possess the strength to continue to post honestly regardless of how many people come to hate me for doing so or how many sites ban me for doing so.

    It shouldn’t be this way. We will all become more effective investors when we live in a world in which there are no penalties for pointing out the flaws in popular investing strategies. The very fact that this is so “controversial” highlights the problems with the Passive model, in my assessment.

    I too would like to end on a positive note. I can say that I believe that your intent is good. I think you write your blog both to have fun and to help people. I think you put forward smart and good stuff. I think your readers enjoy coming here and take away something valuable from doing so. I certainly have no intent to cause you any trouble or anguish. My aim is to help. I wish that I could find the words to help people understand that. I of course understand that your aim is to help as well, but that you are seeing things from a different perspective.

    I wish you well with your blog and your investing.

    It’s a classy thing that you end on a note like that. It certainly earns you points in my book. I understand that I have put forward some words that are hard to take. It obviously speaks well of you that you could hear those words and yet still reach down deep and come forward with a classy and kind sign-off for your post. We are not enemies, Investor. We are at heart both pursuing the same goal.

    Rob

  • 16 Lemondy January 5, 2010, 6:17 pm

    My 0.02 GBP since this was raised on another post;

    1) any passive investor who has a single lump sum to invest and ignores market valuation/timing in asset allocation will have be either lucky or patient to get annualized returns which reward equity risk. I don’t think that’s a controversial statement.

    2) any passive investor who is drip-feeding into the market over a long period (i.e. most people saving for retirement) should simply allocate new capital to attempt to maintain their weighting targets and ignore market valuations/timing otherwise. If my 60/40 equities/bonds has gone to 90/10 during a equities bubble I should be drip-feeding into bonds, and vice versa during an equities crash.

  • 17 The Investor January 6, 2010, 10:47 am

    Thanks for weighing in Lemondy! 🙂

    I’m not sure I 100% agree with your first statement. Certainly they’ll have to be lucky as opposed to unlucky, and we can dance on a pinhead defining equity risk. But (from memory!) over even rolling ten-year periods the statistics for equities on average outperforming cash were compelling (over 90% IIRC). They may have been skewed downwards a little by 2008, granted.

    Point 2 sounds an excellent strategy to me, depending on the ratio of your new money versus your existing money. If you’ve a huge portfolio and modest new contributions, more active rebalancing may be advisable.

    Rebalancing asset allocation to ‘lock-in’ some of the growth in equities (or bonds or what have you) is, of course, a core tenet of managing a portfolio.

Leave a Comment