"Money" Breaks Ranks

Research on Safe Withdrawal Rates

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JWR1945
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Post by JWR1945 »

unclemick wrote:One aside - since the markets supposedly adjusts for all elements - has anyone seen anything relating to the effects of inflation adjusted securities on regular fixed and stocks - I've seen no evidence of valuation adjustments to 'compete' with say TIPs - ???
Please clarify.

I have noticed that the interest rates on TIPS go down when stocks start to fade and they go back up when stocks are more popular. I have noticed financial articles suggesting TIPS in the same manner: buy TIPS when the outlook for stocks is poor.

I have seen the long-term TIPS 30-year bond (available on the secondary market) with interest rates varying between 2.0% and 2.5% this year.

You often hear the bulls in the stock market talk about money on the sidelines. Cash has been building up and it has to go somewhere. My guess is that TIPS money on the sidelines will stay away from stocks.

Have fun.

John R.
hocus2004
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Post by hocus2004 »

"The study looked at money moving in and out of 6,900 U.S. stock funds from 1998 through 2001 and found that while the average fund returned an annualized 5.7 percent, the average fund investor earned a measly 1 percent a year by buying and selling at the wrong time."

Many index-fund investors will take these comments as verification of the wisdom of not chasing hot funds. They are right to do so to a point, but only to a point.

There is a sense in which the S&P index is just one very big "hot fund." People rushed into it because the price went up, and people will rush out when the price goes down, just as they do with mutual funds of narrower scope.

The sales pitch for index funds is that they permit you to "buy the market." The unstated premise is that buying the market is a good thing. It generally is a good thing, of course. That's why the premise is generally unstated; people making a pitch for index funds don't feel a need to present evidence for this point because it is "so obviously true."

But it's not ALWAYS true. There comes a point at which the price of buying the market goes so high that doing so no longer offers a good value proposition.

I believe that there was good intent behind the development of the "Stocks for the Long Run" paradigm. The people who came up with it believed that middle-class investors needed a little push to overcome their concerns over risk and invest more in stocks. I believe that this is the primary reason why the paradigm's little logic gaps were tolerated. The feeling was that "anything that we can do to get middle-class investors to purchase stocks on a buy-and-hold basis is a good thing."

Only over time did the little logic gaps become monsters. Now there appears to be no way to reverse the bull psychology but for bear psychology to take over. Once people buy stocks, they become committed to stocks. Once they become committed, they don't want to hear about the down side of owning stocks. The process of making purchases influences the decision-making process. No one needs a push today. But the tempoarary little push has been transformed into a permanent hard shove.

I believe that the idea that the risks of owning stocks can be permanently eliminated by investors taking a vow to buy and hold is fundamentally flawed. The reality is that some vows to follow a buy-and-hold stratagy are realistic and some are not. The investors making the purchases are not the ones who should be making the assessment as to whether their particular vows are realistic ones or not. Investors need outside objective guidance on this question if they are to have reasonable confidence in the long-term success of their buy-and-hold stratagies.

My sense is that buy-and-hold is more realistic for those who have price-informed stock allocations than it is for those who put just about everything in stocks regardless of price. I believe that the historical data can provide us with clues as to what sorts of stocks allocations we can realistically expect to maintain for the long term.

The valuation issues are important. But they are not the only issues that need to be taken into consideration in development of a Data-Based SWR Tool. Since investment decisions are made by human beings, we need to take the psychological realities of human beings into account in developing effective stratagies. We need to consider not only what the data says about what allocations work best from a theoretical standpoint.. We also need to adjust the numbers we come up with as a result of our theoretical investigations to render them practical for use by real-world investors.

That's a project for the down the road. I mention it from time to time just so that people will not forget that, while we have made great progress in 27 months, there is a good bit of unfinished business that is likely to keep us busy for at least 27 more.
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Post by unclemick »

Jwr's post on many different objectives is worth reading several times.

My version is - understand the horse you rode in on - POGO (not Peanuts as JWR reminded me).

I once posted early on - on the other forum - 'the perfect retirement spot' - naively pictured in my mind - all ER's with aloha shirts, parrothead hats, listening to Jimmy Buffett records in the same area. Wrong!

Hence - Hocus (? zero stocks? currently) and I (balanced index plus dividend stocks) can use the same SWR Reasearch data to come to different ways that apply to our individual situation.

Hence - my grumpy's - not enough retaining context, although the article does get better toward the end. The horse is out of the barn, after the fact aspect, of these kinds of articles - playing to the emotional tendency to over react in the opposite direction, rediscovering costs matter, etc.

Having some old scar tissue from my personal - er adventures in the 60's, 70's, and 80's - doesn't help my attitude either.

And yes - I was a subscriber to Money for a number of years. - I did like the individual case studies - even though the premise of always needing a financial planner to figure out the problem - ???? - really???
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Post by hocus2004 »

"Hocus (? zero stocks? currently) and I (balanced index plus dividend stocks) can use the same SWR Reasearch data to come to different ways that apply to our individual situation."

We are in complete agreement on this one, UncleMick. It's an important point that is often misunderstood. The Data-Based SWR Tool provides information bits developed by making reference to historical stock-return data. It is up to the individual investor making use of the tool to determine how to put its insights to use in the crafting of his or her personal investment plan.

I personally have a zero percent allocation to stocks today. That's what my unusual circumstances call for. But by no means do I say that a zero percent allocation is right for the average investor. If I were asked to offer a guess as to the allocation that might be right for the average investor, I would say that 50 percent stocks might make sense when valuations are at moderate levels. I would be inclined to take that down to 30 percent at high valuation levels and up to 70 percent at low valuation levels. Of course, my views on this question may change as we continue our investigations into what the historical data really says.

It's even possible for me to imagine an investor for whom a 74 percent stock allocation might make sense at today's valuation levels. That would be an exceptional case, in my view. But I believe that a zero percent allocation is best only in exceptional cases too.

It's unfortunate that a good number of people react so emotionally to presentations of what the data says. Data is data. It says what it says. I attribute this to insecurity. I believe that some investors have a voice in the back of their head telling them that they are overinvested in stocks, and they are trying to suppress that voice as evidence accumulates supporting its message. It's hard to ignore the power of a data-based presentation. So the stuff we do on this board makes some people angry.

What pains me is that there are also a good number who hear those voices and who want to explore the realities in reasoned discussions. We had over 100 community members over at the Motley Fool board ask that reasoned discussions be permitted. They lost out on the opportunity to do so that the board was created to facilitate because the group that wants to block discussions, while smaller, is far more intense. Those who want to continue to believe in the SWR methodologies of the past are absolutely dogmatic on every possible discussion point. Those who see possible merit in the new tool are unsure at this point of all its ins and outs and thus are reluctant to pursue their desire for reasoned discussions too ardently. The loud minority has generally had its way with the more soft-spoken minority, and that has caused a large number of our most insightful community members to take their leave of us.

Anyway, you are right in your understanding that the tool is a descriptive one and not a prescriptive one. I hope that word gets out to others. We all need to be doing what we can to heal the community's wounds. The discussion-board communications medium is an exciting new medium with the potential to do a lot of good. But minimal rules of civility in discourse need to be enforced for the new communications medium to realize its potential.

This is not a medium in which individuals participate passively. We all play a role in steering things a little bit in a positive direction or a little bit in a negative direction. Each post that each of us puts forward has leveraged impact because each post sends signals to other community members as to what the community as a whole is about, what its goals are, what sorts of things it tolerates, what sorts of things it encourages, and so on. Working together, we can get back to the wonderful place we all enjoyed being in a few years back. It's taken longer for us to find our way back there than I had once hoped, but I still believe that someday someway we will pull it off. When I have doubts, I go back to the Post Archives and recall the way we were. We were special once. We will be again. I've heard it said that it must get really dark before the breaking of a new dawn.
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Post by JWR1945 »

unclemick wrote:Hence - Hocus (? zero stocks? currently) and I (balanced index plus dividend stocks) can use the same SWR Research data to come to different ways that apply to our individual situation.
Thank you kindly for saying this.

I have been frustrated to see others characterize our research as prescribing some narrowly defined formula. Our intent is to open up opportunities.

We look at a variety of alternatives to see what each has to offer. No one should be forced to settle on what is best for someone else.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

hocus2004 wrote:One, even if what we are saying is just common sense, the problem with common sense is that it's not too common anymore. Endless voicing of the "Stocks for the Long Run" paradigm has left lots of investors repeating 12 nonsensical stock dogmas (it's a random walk both in the short term and in the long term, the market is efficient, even long-term timing is impossible, the risk in stocks goes away if you plan to hold them for the long term, price doesn't matter, and so on) before breakfast. Today, stating the obvious is controversial. Today, common sense observations are shocking.
Mark Hulbert has reached the same kind of conclusion regarding investment newsletters.

In the July 2004 issue of the Hulbert Financial Digest, he points out that only three out of the fourteen newsletters that he has been following since he started in mid-1980 have done better than buy-and-hold of the Wilshire 5000 index over those twenty four years. Adjusted for risk, the number of winners increases to four. Adjusting for survivorship bias, the percentage of winners drops in half.

If we stop at that point, the record for newsletters is dismal.

But Hulbert does not stop there. He points out that a strong bull has dominated the market since mid-1980. He states:
The problem comes when trying to ascertain what these dismal long-term results mean for investing from this point going forward. The typical conclusion that many draw from the HFD's performance data is that one should never try to time the market or attempt to pick stocks that will outperform the averages.

But this conclusion follows only if the stock market will provide anything close to the returns over the next decade as it has over the last two.
Mark Hulbert then presents newsletter results for the past five years, during which the Dow Jones/Wilshire 5000 Total Return Index has fallen at an annual rate of -1.1% (annualized). The statistics are tossed upside down, not only for the 24-year survivors, but also for newsletters in general. Out of 101 newsletters that Mark Hulbert has followed on the last five years, 84 have beaten a buy-and-hold strategy.

From this Hulbert suggest that it is fair to predict that newsletters will do great if the market's performance during the next decade is bearish and similar to that of the past five years. If the market is bullish and performs similar to that of the past twenty-four years, newsletters will do poorly.

His personal opinion is that the market is likely to underperform in the next decade because of valuations and demographics.

He points out that it is only necessary for the stock market's downside risk to have increased in order to make newsletters attractive.

Have fun.

John R.
Mike
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Post by Mike »

From this Hulbert suggest that it is fair to predict that newsletters will do great if the market's performance during the next decade is bearish and similar to that of the past five years.
Does this include momentum newsletters such as No Load Fund X and Sound Mind Investing?
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Post by JWR1945 »

The July 2004 results show that No Load Fund X was among the best 5-year and 10-year mutual fund newsletters on both a total return and a risk adjusted return basis.

The July 2004 results show that Sound Mind Investing has done well among asset allocation newsletters throughout the time that it has been tracked by the Hubert Financial Digest. [It is not in a group that is separately rated by its performance.]

From this, my best guess is yes it does in both cases.

Have fun.

John R.
Mike
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Post by Mike »

Thanks John.
hocus2004
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Post by hocus2004 »

Here's a link to a Wall Street Journal article about a seeming (he denies it) loss of confidence being experienced by the lead proponent (Fama) of the Efficient Market Theory.

http://online.wsj.com/article/0,,SB1098 ... 44,00.html?

Juicy Quote #1: "Stock prices, the paper said, could become "somewhat irrational...." For years, efficient market theories were dominant, but here was a suggestion that the behaviorists' ideas had become mainstream."

Juicy Quote #2: "Robert Shiller, a Yale University economist, has long argued that efficient-market theorists made one huge mistake: Just because markets are unpredictable doesn't mean they are efficient. The leap in logic, he wrote in the 1980s, was one of "the most remarkable errors in the history of economic thought." Mr. Fama says behavioral economists made the same mistake in reverse: The fact that some individuals might be irrational doesn't mean the market is inefficient."

Juicy Quote #3: "Defending efficient markets has gotten harder, but it's probably too soon for Mr. Thaler to declare victory. He concedes that most of his retirement assets are held in index funds, the very industry that Mr. Fama's research helped to launch. And despite his research on market inefficiencies, he also concedes that "it is not easy to beat the market, and most people don't." "
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Post by Mike »

The move among academics seems to be from completely efficient to mostly efficient. Even the non efficient guy uses index funds.
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Post by unclemick »

Hence - Dreman's "contrarian", Bernstein's "persistance of the value premium". and Buffett's 'try to buy a good business at a good price". Not to mention Ben Graham, Geraldine Weiss, etc., etc.
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Post by Mike »

A small minority can beat the majority by seeking pockets of inefficiency.
hocus2004
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Post by hocus2004 »

"A small minority can beat the majority by seeking pockets of inefficiency."

I think this understates it, Mike.

I think that Shiller gets to the essence of things in his comment set forth above in Juicy Quote #2. He says that just because markets are unpredictable does not mean that they are efficient. The Efficient Market Theory proponents did something valuable by stressing the unpredictability of the market. But they went too far in concluding that markets are efficient. They are not. Stocks are sometimes absurdly overpriced and at other times absurdly underpriced.

This is why, as unpredictable as stock returns are in the short term (Shiller is obviously referring only to the short term in his comment because he has been willing to "predict" long-term returns in his writings), they are highly predictable in the long term (and intermediate term). The reason why stock returns are highly unpredictable in the short term is not that the markets are efficient. It is that there are so many factors influencing prices in the short term that short-term price changes are essentially random. It is only over the long-term that the critical valuation factor can assert itself and become dominant. If the markets were efficient, it would not be possible to predict short-term OR long-term prices, and we know from our earlier work at this board (as well as from the writings of people like Shiller and Bernstein) that long-term prices are highly predictable (within a reasonable range of accuracy, of course).

The WSJ article suggests that Thaler is showing a lack of confidence in his behavorial school beliefs by investing in index funds. I dispute that suggestion. I think it is fair to say that I am in the behavioral school. I am certainly not in the efficient market school (although I believe that EMT proponents have made important contributions to our understanding of how stocks work). But I am also a big believer in index fund investing. I see no conflict in these two beliefs.

The benefit of index funds is that they remove one of the risks of stock investing--the risk of making a bad choice of companies to invest in. There is sometimes a price paid (in terms of diminished gains) for doing that, but it is a choice that makes good sense in many circumstances (especially for those who don't want to go to the trouble to research companies). If you invest in index funds, you guarantee yourself the overall market return. In general terms, that's a pretty good darn thing to do. So I like having the option of being able to invest in index funds.

What I reject is the idea that you obtain the same value from investing in an index fund at all possible price levels. That's an absurd idea that has become popular largely because of the influence of the EMT school. The EMTs are just flat-out wrong about this. It is a belief in EMT that has caused many investors to discount the effect of changes in valuation levels in the development of their investing strategies. This is a terrible mistake. It is critical to take the effect of valuation changes into account if you hope to make reasonablly sound investment choices.

It does not take any special skill to beat the majority of investors, so long as the majority of investors are failing to take the effects of valuation changes into account when making investment choices. All that you have to do is look at what the historical data says, and you know the intrinsic value of your stock investment, while those not taking valuation into account are left in the dark. That provides the valuation-informed investor an enormous edge. I provided some hints of the dollar value of this edge in the "About This Board" post. Those who take valuation into account start out the Retire Early game with an advantage of hundreds of thousands of dollars over those who do not. They do not need to save as much to achieve their goals because they are investing in a way that is so much more effective that they can reasonably count on seeing their investments produce for them hundreds of thousands more in accumulated capital over time.

Stock returns are highly unpredictable in the short run. EMT proponents did something important by showing us that is so. Stock returns are highly predictable in the long term. EMT proponents did us great harm by suggesting that this is not so. The sensible thing for us to do is to take the good of EMT and leave the bad. If the markets were truly efficient, you would not see the wide variance in long-term returns between those who begin 30-year retirements at times of high valuation and those who begin 30-year retirements at times of low valuation. We should be taking advantage of those inefficiencies. We should be following strategies that allow us to capture the value left on the table by EMT proponents who continue to purchase stock indexes when they are a bad buy (which is when we lower our stock allocations) and who are forced by the consequences of their earlier excessive purchasing of overvalued stocks to sell stock indexes when they are a good buy (which is when we increase our stock allocations).

It is probably true that it is only a small minority following such strategies today. But I see no reason why it should remain a small minority. The strategy is open to anyone aspiring to early retirement and seeking a data-supported short-cut to getting there. If 90 percent of investors were following these strategies, prices would moderate and the strategies would not offer such powerful benefits. But it does not look like there is much risk of that happening anytime real soon. If every aspiring early retiree now alive on Planet Earth used the Data-Based SWR Tool to inform his or her investment strategies, there would still be plenty of money being left on the table by EMT proponents for even more to retire many years sooner than would have been possible had they not had this tool available to them to inform their investing decisions.
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Post by JWR1945 »

Here are two highly relevant quotes from The (mis)Behavior of Markets by Benoit Mandelbrot with the assistance of Richard Hudson.

From page 193:
Some economists, when thinking about long memory, are concerned that it undercuts the Efficient Market Hypothesis that prices fully reflect all relevant information; that the random walk is the best metaphor to describe such markets; and that you cannot beat such an unpredictable market. Well, the Efficient Market Hypothesis is no more than that, a hypothesis. Many a grand theory has died under the onslaught of real data.
From page 229:
No question, such speculation is very tentative, and I prefer to avoid it. To drive a car, you do not need to know how it goes; similarly, to invest in markets, you do not need to know why they behave the way they do. Compared to other disciplines, economics tends to let theory gallop well ahead of its evidence. I prefer to keep theory under control and stick to the data I have and the mathematical tools I have devised. They permit me to describe the market in objective and mathematical terms as turbulent. Until the study of finance advances, for the how and why we well each have to look to our own imaginations.
The evidence does not support the Efficient Market Hypothesis. At best, it is possible to identify some factors the might be consistent with the Efficient Market Hypothesis provided that a new study shows such a connection. That is all that Burton Malkiel was able to do in the 2003 edition of A Random Walk Down Wall Street.

Some will point out that a model does not have to be perfect to be useful. Both Mandelbrot and Dreman point to the fruits of the Efficient Market Hypotheses. It gave us portfolio insurance and the crash of 1987. It gave us Long Term Capital Management and almost brought down the entire international financial establishment. Not only has it failed to be useful, at times it has been outright dangerous.

Some will point to the speed at which the market absorbs new information as evidence of efficiency. This is a quite a leap in logic and it is in the wrong direction. As David Dreman points out, just because the market reacts to new information does not mean that it is correct in its interpretation. Only in the simplest of circumstances is it reasonable to expect market reactions to be correct. Mandelbrot takes this further, pointing out that there are many different players in the market who act in different time frames and who impact the market differently. There are many waves of market adjustments to new information, some almost instantaneous and some taking many months to appear.

Have fun.

John R.
Mike
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Post by Mike »

The strategy is open to anyone aspiring to early retirement and seeking a data-supported short-cut to getting there.
Yes, I agree. Early retirees are a small minority. They will not exert significant influence on the market.
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Post by JWR1945 »

Earlier, I wrote:
From this Hulbert suggests that it is fair to predict that newsletters will do great if the market's performance during the next decade is bearish and similar to that of the past five years. If the market is bullish and performs similar to that of the past twenty-four years, newsletters will do poorly.
Hulbert has continued with his investigation of short-term market timing and newsletters. He has found that the popularity of timing increases when markets are doing badly and it decreases when they are doing well. He has come up with an excellent explanation as to why this happens.

He points out that, when the stock market does poorly, almost any strategy that keeps you out of stocks (or, at least, below 100%) will look good. Timing inherently keeps your stock allocation below 100% some of the time. If the market is doing poorly, this causes your performance to look a lot better than if you had followed a buy-and-hold strategy.

[Theoretically, it is still possible to do worse than buy-and-hold, but you would have to work at it.]

Mark Hulbert has compared the popularity of short-term market timing approaches before and after bear markets. He has found that market timing newsletters have been most popular after a bear market (such as with stocks today) and they have been least popular after a bull market (such as with bonds and gold today).

Have fun.

John R.
hocus2004
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Post by hocus2004 »

Jason Zweig is on a roll. Here is a link to recent interview he did with Peter Bernstein.

http://money.cnn.com/2004/10/11/markets ... /index.htm

An earlier interview with Peter Bernstein, in which he advocated market timing, is set forth at the "My Days at Pizza Hut Univeristy" thread.

http://nofeeboards.com/boards/viewtopic.php?t=1326

Hot Peter Bernstein Quote #1: "Investors do better where risk management is a conscious part of the process. Maximizing return is a strategy that makes sense only in very specific circumstances. In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn. "

Hot Peter Bernstein Quote #2: "I view diversification not only as a survival strategy but as an aggressive strategy, because the next windfall might come from a surprising place. I want to make sure I'm exposed to it. Somebody once said that if you're comfortable with everything you own, you're not diversified. I think you should have a small allocation to gold, to foreign currency, to TIPS [Treasury Inflation-Protected Securities]. "

Hot Peter Bernstein Quote #3: "Your wealth is like your children -- the primary link between your present and the future. You should try to think about it in the same way. You want your children to have freedom but you also want them to be good people who can take care of themselves. You don't want to blow it, because you don't get a second chance. When you invest, it's not your wealth today, but it's your future that you're really managing. "

Hot Peter Bernstein Quote #4: "Pascal's Wager doesn't mean that you have to be convinced beyond doubt that you are right. But you have to think about the consequences of what you're doing and establish that you can survive them if you're wrong. Consequences are more important than probabilities. "
JWR1945
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Post by JWR1945 »

After all of the grief that we have received because of the words market timing, these words stand out. Maybe, it will startle enough people for them to start thinking instead of reacting.
Individuals can't ignore the asset-allocation question. You want to have some structure as to where you want to be. And rebalancing is a wonderful form of market timing for individuals, almost judgment-free.
Then again, maybe not.

Have fun.

John R.
hocus2004
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Post by hocus2004 »

I picked up the link to this paper (the link provides access to both an abstract and a PDF download) from a post by PeteyPerson put to the Market Theory board at the raddr-pages.com site. It's titled "Looking for Rational Investors in a Perfect Storm,"Â￾ and is authored by Louis Lowenstein.

http://papers.ssrn.com/sol3/papers.cfm? ... _id=625123

Lowenstein: "It's a paradox; so much scholarly work premised on the role of rational investors, and yet no one bothers to study them or seek them out....Gosh, perhaps they've been hiding."
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