You get fired.
You’re feeling very, very, very down. And scared about the future.
What do your friends tell you?
They tell you that someday you will look back at the firing as having been a good thing.
It doesn’t seem possible at the time that that could turn out to be true. It’s just nice people saying a nice thing. But you know what? I have heard lots of real-life stories in which it did indeed turn out to be true. I have had this happen in my own life.
People who get fired are usually not dumb people or lazy people or bad people. But there’s usually a reason why they got fired. There was a mismatch between what they were good at and what their employer needed from them. For any of dozens of possible reasons, both the employer and the employee put off dealing with the problem until the effects of the mismatch became so painful that a firing was the only way to force a change.
That’s what is going on with this economic crisis. It is a terribly painful thing for just about all of us. But I believe that there is going to come a day when we are all going to look back at it as the best thing that ever happened to us. I believe that there is today a mismatch between how we think stocks work and how stocks really do work that must be addressed and that the mismatch has been ignored for so long that a point was reached at which an economic crisis was the only way to force a change.
I am the world’s leading critic of Buy-and-Hold Investing. Buy-and-Hold teaches investors that it is okay (or even a good idea!) not to change their stock allocations when stock prices rise to insanely dangerous levels (as they did in the late 1990s). I want to see Buy-and-Hold supplanted by Valuation-Informed Indexing, a strategy that posits that investors must change their stock allocations if they are to have any hope whatsoever of keeping their risk profiles roughly constant.
Bret (the owner of this blog) was kind enough to link to an article of mine not too long ago. Along with his link he quite properly put forward words expressing his skepticism as to whether most investors would be able to follow a strategy in which they must lower their stock allocation when prices are moving quickly up and increase their stock allocation when prices are going quickly down. Bret observed: ”It’s easier to pry a pit bull off your ankle than it is to get someone to sell a stock after it has gone up 80 percent.”
He’s right. Our natural inclination is to buy stocks when prices are going up and to sell stocks when prices are going down. So how do I expect to get this Valuation-Informed Indexing thing off the ground?
Our natural inclination is wrong. It is rooted in emotion, not reason. It’s a mathematical reality that stocks are more risky when prices are high than they are when prices are moderate or low; there has never once been a long-lasting stock crash that started from a time when prices were reasonable and there has never once been a time when prices were at the levels we saw from 1996 through 2008 when prices did not crash hard. So we know intellectually how to avoid most of the risk of stock investing — pay attention to valuations when setting our stock allocation. We just don’t do it. Because our emotions pull us in the other direction.
It is the job of our investing strategies to protect us from self-destructive emotional inclinations. An investing expert that teaches that it is “okay” to stay at the same stock allocation after valuations rise dramatically is to my mind akin to a doctor that tells his patients that it is okay to eat six pieces of chocolate cake each night because he knows that doing that will make him popular. It is sometimes the job of an expert to tell his clients and listeners and readers things they very much do not want to hear but very much need to hear.
It’s never been done that way. I hear that comeback all the time.
My response is to point out that things change. There has never before been millions of middle-class people invested in stocks to finance their retirements. What worked in earlier days does not work in a day in which a stock crash causes millions to become afraid to spend money and thereby craters the entire economy. The stock market and the economy are now connected. We are going to have to start giving better investing advice if we are to realistically expect our economy someday to become a fully functioning one once again.
We can prevent stock crashes. If we impress on investors that stocks offer a poor long-term value proposition when they are overpriced, people will learn to sell at the first sign of significant overvaluation. Which will bring prices down. Which will cure the overvaluation problem. Market prices are self-correcting once investors understand that the first rule of long-term investing is to never, never, never give thought to staying at the same stock allocation at all times,.
We’ve “known” all this for a long time. The academic research showing that valuations affect long-term returns was published in 1981. For 30 years, we have been pretending that we didn’t know what anyone following the literature did know. Because we are humans. Because we let our emotions overrule our intellect. Because we don’t like change.
We all messed up. We have all been fired.
Lucky us! We are through this painful experience now being presented with an opportunity to move on to something a lot better!