Set forth below is the text of an e-mail that I sent to Bill Schultheis, author of The New Coffeehouse Portfolio, on May 14, 2009. Please see Tuesday’s blog entry for background.
Bill:
This is Rob Bennett, owner of the www.PassionSaving.com site. You were kind enough to respond to my post at the “Get Rich Slowly” blog and I said in my own response that I would follow up with an e-mail aiming to begin a dialog with you about the need for a national debate on the flaws in the Passive Investing model.
I am a huge fan of John Bogle and of his investing ideas, which are of course to a large extent the investing ideas that you too advocate. I don’t think that it is overstating things to say that these ideas have revolutionized middle-class investing. That’s where I am coming from re all this. My goal is to save the good in the Passive Investing package (which is considerable) by fixing what is bad in it (the idea that investors should remain “passive” re their stock allocations in the face of huge price changes). It is my belief that this one analytical error makes it impossible for Passive Investing to succeed as a long-term strategy. It is my belief that the idea that “timing never works” (interpreted broadly, as it usually is) has caused and is in the process of causing more human misery than any other idea in the history of personal finance.
It is simply not accurate to say that timing never works. I have seen a great deal of evidence showing that short-term timing (changing your stock allocation with the expectation of seeing a benefit within a year or two) never works. I am personally convinced re that one. But I have studied this matter in great depth for seven years and I have yet to hear one rational argument or see one sliver of historical data indicating that long-term timing (changing your stock allocation in response to big price changes with the understanding that you may not see a benefit for doing so for five years or even ten years) might ever not work (it always brings better returns on a risk-adjusted basis). Have you?
If long-term timing works, we need to get the word out. We need a national debate on the errors made in the first-draft formulation of the Passive Investing concept. This will lead to a reform of this investing model, which will permit the model to grow and flourish for many years to come. If the model is not soon reformed, it appears to me that the odds are good that it will continue to cause financial ruin for the investors who follow it and will ultimately be discarded entirely. I would view that as a tragic loss.
I use strong words. That’s because I have seen up close and personal what the idea that “timing never works” does to the investors who try to square it with their common-sense understanding that the price that they pay for stocks MUST affect the long-term value proposition that they obtain from them. Most of my explorations of these topics have been conducted on internet discussion boards. I have interacted with hundreds of investors who love the idea of learning about the realities of timing, what works and what doesn’t and how best to design one’s portfolio to get the probabilities on one’s side. I have also interacted with a good number of investors who are in pain because they understand on some level of consciousness that price MUST affect the long-term value proposition and yet they have elected to follow an investing strategy rooted in the premise that it does not. This core contradiction causes HUGE amounts of cognitive dissonance. It makes it all but impossible for large numbers of otherwise smart people to consider flaws in their ideas or to develop confidence in their strategies.
We went to valuation levels never before seen in history in the 1990s. That’s because the idea that “timing never works” caught on. The only brake on an out-of-control bull market is investor fear that insane price levels cannot be sustained. The claim that “timing never works” is an implicit claim that “valuations don’t matter.” Millions of investors failed to apply the brakes when their common sense told them to because their common sense was overruled by the Passive Investing dogma that “timing never works.” The out-of-control bull inevitably produced a huge price crash and the huge price crash inevitably produced an economic crisis. This madness must stop!
I propose a national debate on these issues. People need to hear both sides of the story. People need to talk things out. People need to ask questions and hear answers developed from a multitude of different perspectives. People need to come to terms with the realities of stock investing as we understand them today and with both the great breakthroughs and the grave flaws of the Passive Investing package of ideas.
The obvious place to have the debate is on the internet. We have available to us a communications medium that facilitates instant global communications including both average investors and any experts who elect to participate. I have engaged in numerous efforts to begin such a debate in numerous places and the reaction has been the same just about everywhere. There is always huge interest. There is a great thirst today among ordinary middle-class investors for sensible and realistic investing advice. There has also always been a small number of people who view
themselves as “expert” in the field (perhaps they have started a web site or a discussion board) and who react with intense hostility to questioning of the “timing never works” dogma. I have seen this happen too many times to believe that it is the result of a quirk of one particular individual or one particular site’s posting administration practices. Defensiveness over questioning of the “timing never works” dogma is endemic to believers in the Passive Investing model and to a large extent to all of today’s investors (and, incredibly enough, to most of today’s investing experts!).
This is what needs to change. For the good ideas in the Passive Investing model (keeping costs low is a good idea, ignoring the short-term noise is a good idea, sticking with a strategy for the long term is a good idea, accepting the need to tap into the higher returns offered by stocks is a good idea) to survive, investors need to be educated as to why it is every bit as important to engage in long-term timing as it is to avoid short-term timing. We need to reformulate the Passive Investing model to retain the good in it while rejecting the flawed element — the idea that valuations do not affect long-term returns and that therefore there is no need to change one’s stock allocation in response to big price changes.
Honest posting on valuation-related topics has been banned at numerous discussion boards at which large numbers of Passive Investing advocates congregate. This shows clearly the extent to which defensiveness has come to dominate “consideration” of the flaws in the model.
I’ll leave you with links to two articles posted at my site that document the problems with how Passive Investing strategies are followed by real live investors in the real live world. The first is entitled “Internet Discussion Boards Ban Honest Posting on Valuations!” and sets forth snippets of 101 comments by discussion-board participants showing how great is the desire for informed exploration of these topics and how great is the pain being experienced by those trying to continue to maintain confidence in the failed dogmas:
http://www.passionsaving.com/investing-discussion-boards.html
The second is entitled “Stock Panic Up Close and Personal.” This article offers observations on ways in which the contradictions of the Passive Investing model have caused large numbers of investors to run around in circles trying to make sense of the nonsense idea that valuations do not affect long-term returns (this idea is of course implicit to any claim that it is not necessary to change one’s stock allocation in response to big price changes):
http://www.passionsaving.com/stock-panic.html
Your voice is of course a greatly respected one in the community of Passive Investing advocates. A few words from you would have a great positive influence. I hope that we can work together to bring an end to the frictions and to bring resolution to the contradictions and misunderstandings.
Thanks much both for the fine work you have done over the years helping middle-class investors come to a better understanding of the realities and for taking the time to listen to my plea for help in taking the Indexing Revolution in a new direction. Please let me know if you have questions about what I have said or if you have thoughts about how best to proceed.
Rob
