Dreman's Blockbuster

Research on Safe Withdrawal Rates

Moderator: hocus2004

JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Dreman's Blockbuster

Post by JWR1945 »

I am reading David Dreman's 1998 book Contrarian Investment Strategies: The Next Generation. I am only half way through. Without doubt, it is a blockbuster.

Throw away William Bernstein's writings and everything that rests on the Efficient Market Hypothesis, Modern Portfolio Theory, the Capital Asset Pricing Model and Slice and Dice methods. Dreman had proved repeatedly and convincingly that those theories are false.

For example, you may have read that the return that you can get from an investment increases with risk, generally described in terms of volatility. That is false, demonstrably so. Dreman shows that the opposite is true. Contrarian strategies (low P/E, low P/B, low P/Cash Flow and high dividend yield) consistently outperform alternatives at a greatly reduced risk.

The key is how humans react to information: the psychology of markets.

Keep three books. Get a foundation by starting with John Bogle's Common Sense on Mutual Funds. Start investing with Lowell Miller's The Single Best Investment. Follow up and improve performance further by reading David Dreman's Contrarian Investment Strategies: The Next Generation. Supplement this with such things as a recent issue of Mergent's Dividend Achievers.

Dreman is very good about the practical aspects of investing, such as how long to hold a stock and keeping costs low.

What I like best, however, is his dedication.
For Holly, Ditto and Meredith, without whose love, support--and pleasant diversions--this book might have been completed many months earlier.
Have fun.

John R.
hocus2004
Moderator
Posts: 752
Joined: Thu Jun 10, 2004 7:33 am

Post by hocus2004 »

"Throw away William Bernstein's writings"

Now you've gone too far!!!

"The key is how humans react to information: the psychology of markets. "

Here's a post that I saw this morning at the Berkshire-Hathaway board:

http://boards.fool.com/Message.asp?mid=21330973

RalphCramden: "My financial adviser JoeJoeBubbaJr gave me a different view into that phenomenon. He perceives his clients as disliking being told to buy more foreign stocks. His own "dynamic asset allocation" scheme was telling him something over 50% weighting in foreign assets for the last year or two. He wailed and gnashed his teeth over how most of his clients would react to this.

"I don't think there are too many of us who will pay to receive advice we don't like. "


He is saying that people who know better are telling middle-class investors what they want to hear rather than what is. They are pandering. The are not shooting straight.

I hate that stuff. It causes people to lose large amounts of their accumulated capital. It delays the time at which middle-class workers win their financial freedom by years or even decades.

The problem that I have to deal with, as someone who writes about personal finance stuff for a living, is--how do you get around the marketing reality? The marketing reality is what Ralph Cramden says above, people generally will not pay you for telling them what they do not want to hear.

The best solution that I have come up with is to tell it straight but to do everything possible to avoid the emotional hot buttons. That's why I make it a point to stress the "data-based" aspect of the data-based SWR tool and to avoid to the extent possible translating that into investment advice. You don't often hear me saying" "Oh, you should be 50 percent invested in stocks," or 10 percent, or 90 percent, or whatever. I try to the extent possible to stick to revealing what the historical data says.

There's a point at which this cannot be done. People ask me to reveal my personal allocation, and at some point I feel that I need to say that I have a zero percent allocation to stocks at this time. And I think that when you are posting at boards at which there are others claiming that the historical data reveals a 4 percent withdrawal from a high-stock portfolio to be "100 percent safe," that you have to let people know the take-out number that really is "100 percent safe" at the current valuation levels (it's something near 2.5 percent), and the act of revealing that reality contains an inherent recommendation that some people lighten up on stocks a bit. So my stratagy is not a perfect solution to the marketing problem.

My view is that it is the best that can be done under the circumstances. I refuse to be something less than a straight shooter. The entire point of my saving project was to get myself into a position where I could shoot straight with people, to not have to engage in all the phony baloney stuff that most journalists must engage in to hold onto their jobs. So I cannot go along with the "tell them what they want to hear" concept. But I don't like the idea of alienating my readers one tiny bit. I want to spread these ideas as far as I possibly can. I don't want this to be a little niche movement. I want all middle-class workers with an interest in financial freedom to at least have access to the insights developed at the various boards.

The place where I draw the line is "Is it data-based or is it really opinion?" When I say that I have a zero stock allocation, I am stating a fact, but I am NOT making a recommendation. There really are particular circumstances that apply only in regard to me that make that allocation appropriate. I really bellieve that most investors should keep some skin in the stock gain even at valuations like those we have experienced in recent years. My way of dealing with the marketing problem is to play that reality up, to try to present our findings in the least threatening way possible.

My approach is to say "here is what the data says, but please understand that there are all sorts of non-data-based considerations that you need to take account of in determining your stock allocation." That way those who do not feel comfortable acting on what the data says have an out. They can act on what their emotions say and not feel that they need to "disprove" that data-based analysis.

My goal is to reach the group (a group which I believe is large) that is not so data-focused that it is going to act solely on what the data says but that is enough interested in what the data says that it wants to at least be informed as to the realities. This is the group that I am in! I am not the type to make decisions solely based on what the historical data says. In ordinary circumstances, SWR analysis is not something that I would be spending time on. But I am not the sort of person who rejects data-based analyses either. I see value in them. I like to have my decisions informed by what the data says.

What I am really aiming to do is to help people use their common sense in making their investment decisions. In ordinary circumstances, that should be an easy goal to achieve. People have a natural inclination to act on the basis of what their common sense tells them.

With stocks, however, there are all sorts of impediments to the use of common sense. Lots of people suspect just from the use of their common sense that the conventional methodology claims cannot possibly be true. Can it really be that a 74 percent stock allocation is ALWAYS optimal, REGARDLESS of the valuation levels that apply? It can't be, and most reasonable people know this.

Most reasonable people do not like to take action solely based on common sense, however. Most people want to find some support for their common-sense views in the literature dealing with a subject matter. It is damn hard to find much support for common-sense insights in the lnvesting literature of the past 20 years! The literature is polluted with junk science. People craft all these fancy spreadsheets and calculators and things that look real pretty but are rooted in nonsense assumptions. People see that "everybody" is saying the same thing, and they assume that their common sense must be faulty in this case.

The average investor's common sense is not faulty. It is the studies being put forward by the "experts" that are wrong. The experts are not even trying to get it right. They are trying to be popular. When stocks go down, the same experts who today are saying that stocks are always the best investment choice for the long run will be saying instead that no middle-class investor should be invested in stocks at all. The wheel just goes around and around on all this nonsense gibberish.

I don't like being thought of as a "bear." I do not view myself as a "bear." I am a Retire Early guy, a FIRE guy, a Passion Saving guy. I did not get into SWR analysis because I care about numbers of spredsheets. I got into it because I care about achieving financial freedom early in life. Once I started down the path of making that happen, I saw no choice but to take a look at the historical stock-return data and see what it said. Once I looked at it, I saw no sensible reason to ignore the message of the data for the sake of appeasing the "experts" who were pandering and telling people a very different story.

Pandering can do great harm to people. I don't see it as a joke. I understand the pressure that a lot of the investment analysts feel to play up stocks in the middle of the hottest bull market ever experienced in history. I get that, and I don't really fault them up to a point. But when people start saying that the historical data backs up these pandering claims, I see an important line being crossed. When you cite historical data as your support, you incur an obligation to report it straight. When you cite data, you are leading people to believe that there is some sort of science involved. When there is science involved, you should aim for objectivity. No exceptions.

The clash that we experience in the Great Debate is the clash between the standards that apply in most fields other than investment analysis (reports on data should aim for objectivity) and the standards that apply in investment analysis (pandering is commonplace, stocks are talked up to the moon during bull markets and rejected out of hand during bear markets). I am trying to find a way to step around the emotional minefields, to create a tool that does not threaten people (because it does not tell them how they must invest) but which does inform them as to the realities (because it does accurately report what the historical data says). I am trying to create a space in the marketplace of ideas for an honest and informed data-based investment analysis tool.

I like Dreman. I find some appeal in the idea of contrarian investing stratagies. But I don't like the idea that only the small portion of the population that is contrarian by nature knows about these stratagies. I don't expect to be able to turn everyone into a contrarian (that goal would be an absurdity, would it not?). I am seeking to allow some contrarian insights to make their way out of the contrarian ghetto and into the mainstream. People can reject Dreman's insights as "contrarian," put them in the category of oddball stuff that they can safely ignore. Can people put the entire historical record in the category of oddball stuff? I think it is hard to argue with a straight face that the entirre historical record is an anomoly. There must be some reason why the historical data keeps repeating the same message over and over again--valuation matters, valuation matters, valuation matters.

Valuation matters. That's really all that I am trying to say. There are some who will say "Oh, we accept that valuation matters, it's no big deal that you have found historical data supporting that claim." Well, if valuation matters, then stocks cannot possibly always be the best investment class for the long run. If valuation matters, then there has to be some point at which a 4 percent withdrawal from a 74 percent S&P portfolio is no longer "100 percent safe." I'm not a Numbers Guy, so it is not for me to identify that point for people. But William Bernstein is a Numbers Guy and he identified it. And JWR1945 is a Numbers Guy and he identified it. The points identified by these two Numbers Guys are not anywhere remotely in the same neighborhood as the point identified as "100 percent safe" in the REHP study. I wonder why.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

hocus2004 wrote:"Throw away William Bernstein's writings"

Now you've gone too far!!!
OK. Don't throw them away. Just be very cautious.

One of the things that a numbers guy looks for is where someone else's numbers come from and whether they are consistent with those from other sources.

You may recall that I have a problem with William Bernstein in this regard. I know where numbers similar to his come from, but not his precise numbers. That is, he presents much evidence to support plausibility, but not his actual numbers.

In contrast, I have noticed that David Dreman's findings are consistent with those of James O'Shaughnessy in What Works on Wall Street. This supports David Dreman's claim [hidden among the footnotes] that his calculations using 60 years of data are consistent with the shorter period that he presents. Similarly, James O'Shaughnessy' findings about price to earnings, price to book value, price to dividends and dividend yields all support David Dreman's claims that, when he presents one or another of these in a Figure or Table, it really is similar using the other measures of value (unfavored stocks). While James O'Shaughnessy's work has hidden flaws, David Dreman's thoroughness stands out in contrast.

In short, you can trust David Dreman's numbers. You can take them at face value.

That having been said, David Dreman is among those who recommends all stocks all of the time (with rare exceptions). That can cause difficulties in times of high valuations. He recognizes that his approaches provide better relative performance, but not necessarily positive absolute performance. In addition, I do not think that he has incorporated TIPS into his approach.

David Dreman mentions the psychological advantages of dividend bases strategies for those in retirement and for others when it is likely that prices will fall in the near future (e.g., unknown date but within a decade). If you depend on an income stream, a big fall in prices won't cause you to sell in a panic. You only need for the income stream to continue and grow gradually to get you through the rough spot.

I will add that I consider this to be only part of the story. At least a portion of one's portfolio should retain its buying power to cover unanticipated cash needs and for redeploying one's holdings.

Have fun.

John R.
User avatar
Alec
Admin Board Member
Posts: 31
Joined: Wed Sep 10, 2003 4:00 am
Location: Crofton, MD

why stop?

Post by Alec »

Ken French has a publicly available data library with return info going back to the 1920's, for all kinds of portfolios : P/B, Cash/P, D/P, E/P, industries, etc. There is some int'l return data from 1975 as well.

Value and Growth Investing: A Review and Updata, by Louis Chan and Josef Lakonishok (one of the founder's of LSV Asset Management). It was recently published in the Financial Analysts Journal. These two, others, and some people at the University of Chicago (Fama's stomping grounds) have been arguing against the higher risk/value story for years.

Sounds like an interesting book. I'll put it on my x-mas list. Cool

- Alec
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

hocus2004 wrote:My approach is to say "here is what the data says, but please understand that there are all sorts of non-data-based considerations that you need to take account of in determining your stock allocation." That way those who do not feel comfortable acting on what the data says have an out. They can act on what their emotions say and not feel that they need to "disprove" that data-based analysis.
Somewhere, David Dreman says something like this. (I haven't located the reference yet. He has written lots of juicy quotes.)
Now for the rude question. Does it work? [Or what do the data say?]
Understand that when you show someone "what the data say," you are being rude. It should not be so, but it is.

Have fun.

John R.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

Alec wrote:Value and Growth Investing: A Review and Update, by Louis Chan and Josef Lakonishok (one of the founder's of LSV Asset Management). It was recently published in the Financial Analysts Journal. These two, others, and some people at the University of Chicago (Fama's stomping grounds) have been arguing against the higher risk/value story for years.
Put Dreman's book at the top of your list. Definitely.

David Dreman's story is much different and I believe his version. The academics fought him tooth and nail, repeatedly using his writings as examples for students of how not to do research. He showed over and over again that their assumptions were false. They repeatedly ignored the data. They repeatedly worked from false premises. They did not look at data to learn reality. Those academic breakthroughs of the 1990s simply tell us when the academics finally accepted his observations of the 1970s.

However, they made sure never to give David Dreman any of the credit that he was due.

David Dreman has an exciting, compelling, human interest story. His experiences were similar to hocus2004's with Safe Withdrawal Rates, but many times worse.

OTOH, Dreman has earned much more money than any Nobel Laurette and deservingly so. There is justice after all.

Have fun.

John R.
unclemick
*** Veteran
Posts: 231
Joined: Sat Jun 12, 2004 4:00 am
Location: LA till Katrina, now MO

Post by unclemick »

I'm a David Dreman fan - even though I never read his book - his Forbes articles were the first thing I read back when I subscribed.

P.S. Reading between the lines - Bernstein is still not entirely happy with the the explanations for the persistance of 'the value premium' over time.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

For unclemick:

David Dreman provides strong evidence that supports what I say about your hobby stocks. They should be primary. Your Vanguard holdings should be secondary.

Your choice of ATT has about a 50% chance of being a spectacular success. It can take 5 to 8 years or even a decade. But if it is a success, it will be a spectacular success and its outstanding performance will persist for another decade.

My selection of Merck is more likely to show an early success, but it would not be as spectacular.

William Bernstein is consistently careless about the relationship between risk and return. He frequently suggests that higher risk guarantees a better return. That is false, obviously so. What he should say is that you should never accept a higher risk without a reasonable expectation of higher returns.

There are lots of ways to increase risk without increasing return.

The value premium increases return while decreasing volatility. The evidence is overwhelming. Interestingly, the persistence of the value premium appears to have increased in recent years. Too many people use terms such as value and contrarian loosely. The net effect is that many people who think that they are value investors and contrarians are wrong.

Notice the psychological nature of this finding. It is perceptions that drive the value premium, not rationale actions.

Have fun.

John R.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

Familiarity can cause us to underestimate the significance of another's work. I have followed David Dreman's columns in Forbes magazine for a long time and I thought that I knew what he had to say. Boy was I wrong.

But that is why it took so long for me to get around to reading his book.

Have fun.

John R.
hocus2004
Moderator
Posts: 752
Joined: Thu Jun 10, 2004 7:33 am

Post by hocus2004 »

"These two, others, and some people at the University of Chicago (Fama's stomping grounds) have been arguing against the higher risk/value story for years. "

Thanks very much for coming forward with that link, Alec. It's most helpful.
hocus2004
Moderator
Posts: 752
Joined: Thu Jun 10, 2004 7:33 am

Post by hocus2004 »

"David Dreman has an exciting, compelling, human interest story. His experiences were similar to hocus2004's with Safe Withdrawal Rates, but many times worse. "

Yikes! I had better send the guy a Get Well Soon card!

"OTOH, Dreman has earned much more money than any Nobel Laurette and deservingly so."

...Or maybe not.
hocus2004
Moderator
Posts: 752
Joined: Thu Jun 10, 2004 7:33 am

Post by hocus2004 »

"You may recall that I have a problem with William Bernstein in this regard. I know where numbers similar to his come from, but not his precise numbers. That is, he presents much evidence to support plausibility, but not his actual numbers. "

I know where you are coming from re Bernstein. I'm torn re this question.

I believe that different investment advisors are coming from different places. The majority (let's call this Class C) genuinely believes that the Stocks for the Long Run paradigm is valid. The people in this group have never independently explored the data in depth. They have heard others say something to the effect of "timing is impossible," and they bought into it without reservation. I believe that it will take a serious bear market to get advisors in this group to reassess.

Then there is Class A. This is a group of people who know what's what and who dare to tell the whole truth about what's what. I put Andrew Smithers and Rob Arnott and Robert Shiller and John Templeton and Peter Bernstein in this group. These names have great influence, and each of these people have said things that, were they taken seriously by other investment advisors, would cause the Stocks for the Long Run paradigm to topple. The problem is that there are so few in this group that it has been possible so far for Class C and Class B to ignore the strong statements coming from Class A. Publications of the recent article in Money magazine (see the "Money Breaks Ranks" thread) suggests that it is getting harder to ignore the realities all the time and we may be getting closer to the time when Class A statements will receive the serious discussion (not just at our boards, but everywhere) that they merit.

I think that we may need to create a Class B for people like William Bernstein, John Bogle, Scott Burns, Warren Buffett and some others. This is a group that clearly understands things better than Class C, yet appears to be highly reluctant to state things as clearly as do those in Class A. If you read William Bernstein's work carefully, it is clear that he does not believe that stocks are always the best investment class for the long run. But if you are doomed and determined to believe that they are, you can find statements he has made that lend support to your doomed and determined position. So we see his writings being cited both for the good and for the ill. He has put forward statements into the public arena that conflict with each other. The same is true of Scott Burns. I have gained a great number of insights from all of the people I include in Class B. But I also think that they all have a tendency to pull too many punches. It's not yet clear to me whether John Mauldin fits better in Class A or Class B; the column of his that I posted a few days ago is a Class A statement. (I reserve the right to changes any of these classifications as events reveal themselves).

Why is it that the obviously smart and hard-working and well-intentioned people in Class B do not do what the people in Class A do, state things clearly enough so that investors could act to protect themeselves from the toppling of the Stocks for the Long Run paradigm before it topples? Here is where I circle back to the words above that I quoted from your post.

I believe that Bernstein views himself primarily as a popularizer of investment insights, not as a researcher (I do not mean to say here that he does not do his own research, just that he does not see this as his primary role). I think (this is a guess) that he is worried that, if he reports things absolutely straight, his readers will respond in inappropriate ways to what he reports.

Dreman's audience is pretty darn sophisticated. My sense is that the readers of Forbes are even more sophisticated than the readers of the Wall Street Journal, which in my view is Bernstein's audience. If Dreman recommends that his readers buy high-dividend stocks at times of extreme high valuation, I think that he has a reasonable amount of confidence that they can pull it off. My sense is that Bernstein does not possess this confidence in his readers. I think that he worries that, if he reports clearly what he knows about the flaws of the Stocks for the Long Run paradigm, that at least some of his readers will start trying to engage in short-term timing and that it will ruin them.

I think Bernstein (and the other Class B's) is wrong on this. I think he is making a mistake. My view is, you tell people what the data says, and you leave it to them to decide what to do with the information, you can't try to control things. But I think that Bernstein and Bogle and people like that are still fighting the last war--they see the buy-and-hold revolution as a breakthrough victory for informed investing and they worry that anything that undermines confidence in buy-and-hold is going to do more damage than it is worth. Telling people to make the sorts of strategic shifts that Dreman is recommending undermines the buy-and-hold dogma that has become solidified in the past two decades.

The Class B''s have created a monster, in my view. The buy-and-hold revolution really was a good thing; I think they are right about that. But confidence in buy-and-hold grew so large that we reached valuation levels where the reasons why buy-and-hold was pushed in the first place no longer apply. The idea behind buy-and-hold was to hold stocks long enough so that you could get through the rough patches and realize the long-term gains generally associated with stock investing. Valuations have gone so high that everything has been turned on its head. Now stocks are a short-term bet; anything can happen in the short-term, so an all-stock portfolio could do well for 12 months or 24 months or 36 momths. But stocks are now not the best bet for all investors for the long term. Buy-and-hold investors are now committing themselves to an investment class that has less than exciting long-term prospects. Buy-and-hold has become not a means of enhancing long-term returns but a means of diminishing them.

The important question is--What happens After the Fall? My hope is to use the Data-Based SWR Tool to restore confidence in buy-and-hold after it has been greatly damaged. I am not trying to bury buy-and-hold, but to save it. Is the use of long-term timing anti-buy-and-hold? I say no. My guess is that I will be holding my stock investments for a lot longer than the people following the conventional methodology end up holding theirs. The investing approach being developed and refined in this board community is an Informed Buy-and-Hold approach. Our approach is an approach to buy-and-hold that stands a realistic chance of working in the real world. We are the true buy-and-hold investors because we are engaging in buy-and-hold not because it has become a dogma but because we possess a clear understanding of what makes buy-and-hold work. What makes it work is that it puts the probabilities on your side. We are spending our efforts learning about stock invrestment probabilities. Any true buy-and-hold investor should want to do that because it is knowledge of the probabilities that supplies the investor the confidence he needs to hold through troubled patches.

The bottom line here is that I think that Bernstein underestimates his readership. He would get heat directed at him if he told all he knew. So what? He would also get a lot of positive reactions; we had a lot of positive reactions in the early days of Great Debate, did we not? Taking the heat is part of the job. It's not fun. But the way that I look at it is, when you are getting a lot of heat directed at you, you know that you are saying something important. Otherwise, why would people be so worried about word getting out?

Class B's are going to cause more damage to the buy-and-hold concept by keeping their mouths shut than they would have by telling it 100 percent straight. It's going to get told straight one way or the other, in any event; publication of the Money article shows that. So it would be better for the Class B's to just go ahead and put all of their cards on the table now. I'm not saying that is going to happen, I am just saying that I think it would be a good thing if it did. I am very much open to any ideas that community members have for us helping to make it happen a little sooner than it otherwise would.
hocus2004
Moderator
Posts: 752
Joined: Thu Jun 10, 2004 7:33 am

Post by hocus2004 »

"William Bernstein is consistently careless about the relationship between risk and return. He frequently suggests that higher risk guarantees a better return. That is false, obviously so. What he should say is that you should never accept a higher risk without a reasonable expectation of higher returns. There are lots of ways to increase risk without increasing return. "

You are right about all of this, in my view. It appears to me that Bernstein's thinking here has been polluted by his belief in the Efficient Market Theory.

If the market is truly efficient, it is not possible for anyone to ever made a bad investment choice. The theory argues that no amount of effort will yield any investment edge. If that is so, then the reverse must also be so--no lack of knowledge can do you any harm. According to Efficient Market Theory, some guy who sees stocks as a get-rich-quick scheme if only you know to buy the companies with a really good story for how they are going to take over the world is equally capable as Warren Buffett of picking the right stock.

It's nonsense. But it is nonsense that has had a great influence. It is dangerous nonsense.

That's not to say that the Efficient Market Theory has not generated its share of powerful investing insights. EMT did a lot of good in the days before it began doing a lot of bad. A lot of the most dangerous theories in the world are theories that at one time did some good. It is the good that these theories do that persuades people to buy into them. It is because people buy into them that the theories become able to do so much harm.

There are many cases in which theories are not all good or all bad. There are many that possess a mix of valuable insight and dangerous misperception. Efficient Market Theory had its day in the sun. My view is that it is now leading a lot of middle-class investors over a cliff. A lot of people are going to get hurt in their discovery of why some guy who thinks that buying story stocks is the fast track to the easy life is not in reality quite as likely to pick stocks successfully as is Warren Buffett.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

hocus2004 wrote:"David Dreman has an exciting, compelling, human interest story. His experiences were similar to hocus2004's with Safe Withdrawal Rates, but many times worse. "

Yikes! I had better send the guy a Get Well Soon card!

"OTOH, Dreman has earned much more money than any Nobel Laurette and deservingly so."

...Or maybe not.
Send him the card anyway. He might become curious as to why you sent it.

Have fun.

John R.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

Here are some interesting quotes from the chapter about What is risk? From pages 298-301:
How did these professors know that investors measured risk strictly by the volatility of the stock? They didn't, nor did they do any research to find out, other than the original studies of the correlation of risk and return, with results that were mixed at best. The academics simply declared it as fact.
..
In the first place it has been known for decades that there is no correlation between risk, as the academics define it, and return. Higher volatility does not give better results, nor lower volatility worse.
..
Buried with this canon of modern finance is modern portfolio theory, as well as a good part of EMH [Efficient Market Hypothesis]. Fama's new findings rejected much of the academic work of the past, including his own. He said at beta's graveside, "We always knew the world was more complicated. He may have known it, however he did not state it for more than two decades.
..
I wrote almost two decades ago that betas, built as they were on spurious correlations with past inputs, were unlikely to work in the future. This is precisely what has happened.
Annual volatility is important during the accumulation stage when you are using dollar cost averaging. More volatility means that you are likely to buy shares of stock at a greater discount to their average price. Volatility is good before retirement.

Annual volatility is important during the distribution stage when you are withdrawing funds. Although some purchases can be delayed, a lot of them cannot. More volatility during retirement means that you are more likely to have to sell shares when prices are low. Volatility is bad during retirement.

But even then, volatility does not tell the whole story. Prices matter. This can push retirees to select dividend based strategies instead of alternative value strategies. Avoiding the need to sell shares is important if prices are likely to fall. In contrast, some of the alternatives may look as good or better when valuations are attractive

Todays prices lead us toward dividend based strategies.

Have fun.

John R.
unclemick
*** Veteran
Posts: 231
Joined: Sat Jun 12, 2004 4:00 am
Location: LA till Katrina, now MO

Post by unclemick »

My left handed, INTJ, possibly wrong understanding of Bernstein boils down to this:

You put together a portfolio of asset classes where the data leads you to an 'expected return' for each asset class over the long term (?30-50 years? or more). ???Valuation doesn't matter - because you are rebalancing to hold your % allocation for that asset class - heh, heh, heh - ie sooner or later (within 50 years) you will get a decent buy. The correlation among the asset classes helps smooth the ride over time - ie all the zigs and zags don't move in unison for each asset class.

A little tongue in cheek - but I'm balanced index with a 10% REIT index counterbalancer so theorywise - sort of in the ballpark. I like computers to do the rebalancing - although the REIT postion may require some manual adjustment if it gets more than 10-15% out of whack.

And then, and then there are my dividend stocks - so I have a toe in the value camp.

Bernstein, Coffeehouse, and that ilk have too many asset classes for me and I don't trust my emotions/discipline to rebalance.

In contrast - I can take wide swings in my individual stocks and buy more on dips - if I perceive the value is there.

Go figure? - but it works for me.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

unclemick wrote:A little tongue in cheek - but I'm balanced index with a 10% REIT index counterbalancer so theorywise - sort of in the ballpark. I like computers to do the rebalancing - although the REIT position may require some manual adjustment if it gets more than 10-15% out of whack.
It might be better for you to increase your REIT allocation!

Looking at calculator results, rebalancing has offered less than 0.1% benefit for increasing Historical Surviving Withdrawal Rates while eliminating almost all of upside. About 30% to 50% of the time, there would have been a tremendous benefit in letting your stock allocations grow.

Studies about rebalancing usually fail to consider transaction fees, taxes and other expenses. They present the ideal, best-case results. The benefit is not very big.

A fixed asset allocation with rebalancing generally produces a compromise return that is just a little bit better than individual components but not nearly as good as the best. This really shows up when commercial paper or some other very low (real) return asset class is considered. If stocks deliver around 7% (real, total return) and commercial paper delivers about 1%, a 50%-50% split returns just a little bit more than 4%. That's quite a penalty for reducing volatility!

There are better measures of risk than volatility alone. Volatility is an important factor, but it is not the only factor.

Have fun.

John R.
hocus2004
Moderator
Posts: 752
Joined: Thu Jun 10, 2004 7:33 am

Post by hocus2004 »

"My left handed, INTJ, possibly wrong understanding of Bernstein boils down to this:

"You put together a portfolio of asset classes where the data leads you to an 'expected return' for each asset class over the long term (?30-50 years? or more). ???Valuation doesn't matter - because you are rebalancing to hold your % allocation for that asset class - heh, heh, heh - ie sooner or later (within 50 years) you will get a decent buy. The correlation among the asset classes helps smooth the ride over time - ie all the zigs and zags don't move in unison for each asset class. "


This statement is a good illustration of the thinking process at the root of the Stocks for the Long Run investing paradigm. The key phrase is "Valuation doesn't matter." That is the key point that is being contested in the Great SWR Debate.

Does valuation matter or doesn't it? Common sense says that valuation matters, and, if you ask a proponent of the Stocks for the Long Run school whether valuation matters, more often than not he will say "yes, valuation matters." But if you take a look at the data that he uses to support his expected return assessments, you find that, when calculating the expected long-term return of stocks, he acts AS IF valuation does not matter.

Why?

The suggestion I put forward earlier in the thread is that the reason why Stocks for the Long Run advocates got in the habit of not accounting for valuation when forming their long-term return expectations is that they believed that this aspect of the question was not that big a deal and including an adjustment for valuation would make things "too complex" for readers of their studies. But the act of not accounting for valuation made stocks appear to be more attractive in the long-term than they really are, and the perception that stocks are ALWAYS the best possible asset class fueled the greatest bull market in history. At the end of that bull market, the valuation effect was no longer a small one, but a huge one. Valuation didn't matter all that much when valuations were at moderate levels. It matters a whole heck of a lot when valuations are at the level they are at today.

Models that do not account for valuation do not work. They appear to work in some circumstances. That doesn't prove anything. There are many analytically invalid tools that work in some circumstances and not others. The unfortunate thing about the Stocks for the Long Run analytical approach (the REHP study is just one product of the Stocks for the Long Run paradigm) is that many will not accept that the approach is invalid until it produces bad results in the real world. At that point the financial ramifications of the tool's analytic invalidity will already have been felt. The analytic invalidity was there from the first day. It is the increase in valuations that caused it to become so serious, and it will likely be a fall in prices that will cause it to be widely appreciated.

"It works for me."

I think it would be better to say that it workED for you, unclemick. You have done well with your investments, and you are far enough ahead of the game at this point that even if stocks perform in the future as they have in the past, you are probably going to come through more than okay. That's no true of aspiring early retirees putting together their plans today. Those investors need to know what the historical data says about how their investments are going to perform starting from the valuation levels that apply today. Those valuation levels are very different from the ones that applied in the early 1980s. It is not reasonable to point to how people made out starting from the early 1980s as an indication of how people starting out today are llkely to make out over the long term.

A crushing loss in the early years is the worst thing that can happen to an early retirement plan. The odds of a crushing loss in the early years is far higher for retirements beginning today than it was for retirements beginning at times when stocks were at more moderate valuation levels. That's not my personal opinion, that's a plain statement of what the historical data reveals to any analyst who takes an informed look at it.

Early retirees need to know that. If early retirees are going to take the sort of chances that are involved in planning for a 4 percent take-out from a high-stock portfolio at these sorts of valuation levels, responsible people at the various boards should be putting them on notice as to the extent of the risk that the historical data indicates they take on by doing so. If the various FIRE/Passion Saving/Retire Early boards cannot perform the task of making aspiring early retirees know of the worst risks they take on by proceeding with their plans, what the heck good are we? If we can't manage to work up the courage to do that much, why are we even here?
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

hocus2004 wrote:A crushing loss in the early years is the worst thing that can happen to an early retirement plan. The odds of a crushing loss in the early years is far higher for retirements beginning today than it was for retirements beginning at times when stocks were at more moderate valuation levels. That's not my personal opinion, that's a plain statement of what the historical data reveals to any analyst who takes an informed look at it.
Let's take this sentence by sentence.
A crushing loss in the early years is the worst thing that can happen to an early retirement plan.
This can be seen directly in the Gummy's Safe Withdrawal Rate Equation. That is, this is a mathematical fact if one excludes extremely unlikely conditions. The historical record shows us that such extreme conditions do not exist in the real world. [An example of such an extreme condition would be that a loss of 50% would automatically cause a long lasting bull market to appear. Mathematical theorems consider such possibilities, but their applications seldom do.]
The odds of a crushing loss in the early years is far higher for retirements beginning today than it was for retirements beginning at times when stocks were at more moderate valuation levels.
Professor Shiller's work shows this in terms of P/E10. Other indicators support this as well. This includes theoretical arguments as well as Tobin's Q and other metrics. For example, the Gordon Equation shows us that the market cannot maintain its long term return. Dividend yields and their growth rates are too low.
That's not my personal opinion, that's a plain statement of what the historical data reveals to any analyst who takes an informed look at it.
We see this empirically in the calculator results. The worst case Historical Surviving Withdrawal Rates have occurred at times of high valuations (the Great Depression and Stagflation).

Have fun.

John R.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

From pages 351-354 of David Dreman's Contrarian Investment Strategies: The Next Generation.
You Can Never Go Wrong in Real Estate
..
In The Graduate, a guest..takes him aside and whispers one word to him:plastics. That's where fortunes would be made in the 1960s. In the 1980s it was to be commercial real estate. The beginnings, as they often are, were sound enough. The remarkable boom in real estate was triggered by its impeccable performance in the past. Real estate had a solid record of appreciation since the war, and, like stocks, was an excellent shield against inflation. Because it had only gone higher in the past 40 years, it was inevitable, the smart money believed (and all money thinks it is smart), that it would continue to soar.

Big bucks flowed into commercial real estate.
..
When commercial real estate appreciated at a 15% clip through the early eighties, everyone wanted on the bandwagon. Pension consultants urged their major clients to jump in. A large number of the decisions were based on modern portfolio theory. After all, they could make 15% or higher returns. Much more than the stock market. Better yet, it added diversification and lowered beta, which according to their efficient market training, made the returns greater still. Large pension funds placed major money in questionable ventures, many near the top.
..
The people who were buying commercial real estate were not rubes. They were loan officers and other razor-sharp professionals worldwide, many of whom had devoted their entire careers to evaluating properties. These experts made bad loans that nearly wiped out the U.S. Savings and Loan industry, pushed banking and insurance industries to the brink, and launched the worst panic on the stocks of financial companies since the Great Depression. Internationally, the damage was comparable.
The beginnings, as they often are, were sound enough. This sounds like hocus2004.

(and all money thinks it is smart) I just couldn't let this one get away unnoticed.

A large number of the decisions were based on modern portfolio theory and Better yet, it added diversification and lowered beta, which according to their efficient market training, made the returns greater still. This is important. Watch out for sweeping generalizations based on modern portfolio theory and the efficient market hypothesis.

The people who were buying commercial real estate were not rubes. This is important. Highly intelligent people can make stupid decisions. Of course, those decisions seem incredibly stupid only when looking back, not when they were made.

Have fun.

John R.
Post Reply