A New Approach to “Staying the Course”
By Rob Bennett
Rob Bennett is the author of “Passion Saving: The Path to Plentiful Free Time and Soul-Satisfying Work,” and writes the Financial Freedom Blog. He writes extensively on Valuation-Informed Indexing at his www.PassionSaving.com web site, which features The Stock-Return Predictor calculator, a calculator that reveals the value proposition associated with purchases of the S&P500 Index made at various valuation levels (based on a regression analysis of the historical stock-return data).
Stay the Course!
How many times have you heard that bit of advice? Probably hundreds. It is John Bogle’s favorite admonition to investors.
Have you ever stopped to think what it means?
The idea of Staying the Course sounds great. No investing strategy is going to pay off unless you possess the courage to stick with it through challenges. Investors who Stay the Course are stable, consistent, unshakable.
Right?
Not necessarily.
More than one way to stay the course
Most indexers interpret the phrase as an argument for sticking to a single stock allocation. We determine our stock allocations by performing an analysis of risk and return. Stocks are a high-risk/high-return asset class. An investor chooses a 60 percent stock allocation as the result of a determination that a 70 percent stock allocation would be a bit too risky and a 50 percent stock allocation would provide a bit too low of a long-run return. We all aim to be like Goldilocks and identify the stock allocation that is not too hot and not too cold but “just right.”
The trouble is — the stock allocation that is “just right” today may not be “just right” tomorrow.
Do you believe in the Efficient Market Theory? If you do, you may want to turn to another article for your investing advice at this point. I do not believe in the Efficient Market Theory. I do not believe that stock prices are in some mystical sense always efficient or correct or good or right. I believe that stock prices are sometimes far too low, sometimes far too high, and usually somewhere in the middle of the two extremes.
If you, like me, believe that it is possible for prices to be too high, then you should not be sticking with the same stock allocation in your effort to Stay the Course. For investors like us, changes in prices are causing the course to always be in motion. Risks are greater at times of high prices and long-term returns are lower.
If a 60-percent stock allocation was just right when you elected it during a time of moderate prices, it cannot possibly be just right today, a time of super-high prices (my valuation tool is P/E10, the price of an index over the average of the past 10 years of earnings). For an investor like you to Stay the Course, you need to lower your allocation when prices get to where they stand today, perhaps to 30 percent. Only when prices return again to moderate levels will a 60 percent allocation again be just right for you.
I call this approach to investing Valuation-Informed Indexing. I believe in indexing because I see it as a great way to lock in the overall market return without having to spend lots of time researching individual stocks. Given the long-term returns that have historically been provided by investing in a broad U.S. index, the return obtained by locking in the market return seems plenty appealing enough to me. I don’t believe for 10 seconds that it would be realistic for me to expect to see those sorts of returns for an investment made at today’s prices (we are now at a P/E10 level of 25), however. I have learned from life experience that when it sounds too good to be true, it’s usually because its too good to be true. I don’t believe in banishing that rule from mind when it comes time to make investing decisions.
What sort of long-term return do I expect the S&P index to provide starting from today’s prices? That’s a good question better explored in a separate article. I’ll say this much here, though. There have been three times in the history of the U.S. market when the P/E10 number reached today’s levels. The average drop in the value of the index on those three occasions was 67 percent (that’s from Robert Shiller’s “Irrational Exuberance” book). That’s too risky for a guy like me, a guy who at times of moderate prices might want to go with a stock allocation of about 60 percent.
How about zero stocks then? Is that the answer?
I don’t think so, at least not for the typical investor. I don’t believe that anyone knows how stocks are going to perform in the next year or two or three or four. If stock prices zoom in the short term and you have nothing invested in them, my guess is that you may come to feel regret in your decision to go with so extreme an allocation. Another way of saying it is that, while the risk/return ratio is not nearly as good as it would be if stocks were at moderate prices, it is not so bad as to justify a zero stock allocation.
The goal of a Staying the Course investor is to maintain roughly the same risk profile in your personal portfolio while Mr. Market sends the risk profile for the S&P as a whole through dramatic up and down swings. For today, that means not sticking with your 60 percent allocation and not dropping to a 0 percent allocation, but going with something in the middle of those two extremes, perhaps 30 percent.
Do I believe in Staying the Course? Conceptually, I do. Stability should indeed be the goal of the long-term investor. But I don’t believe in this bit of advice in the way in which it is usually advanced by Bogle. It’s not stability of the stock allocation that should be the aim. It’s stability of the risk/reward profile that you seek. Staying the Course in a meaningful way requires changing your stock allocation to reflect changes in the risk/reward ratio accomplished through changes in the price level of the index in which you are invested.
Stay the Course — Yes!
Stick with the same stock allocation at alll price levels — No!
The Stock-Return Predictor:http://www.passionsaving.com/stock-valuation.html
Financial Freedom Blog: http://www.passionsaving.com/the-financial-freedom-blog.html
Try one of these related posts too!:
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- Book Review: Millionaire by Thirty
- Credit Cards as a Debt Reduction Tool
- Best Finance Articles from Carnival of Personal Finance #122
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Great post - staying the course doesn’t mean freezing your investments forever.
One think I’d like to add is that I’ve made changes to my allocation because of new information/books/strategies that I’ve come across. Obviously you don’t want to be doing this too often but if you learn something new and realize you have too much of “xyz” or not enough “abc” then you should do something about it.
If you make changes for good and logical reasons (and not panic) then I think that is fine.
Mike
I think you ought to have learned a bit about Rob before inviting him to “guest blog.”
He ain’t quite right:
http://www.s152957355.onlinehome.us/cgi-bin/yabb2/YaBB.pl?board=HOCO
Holy moly!
Rob
@some guy, you may be right, and Rob may be right. I opened the ability for other writers to have a voice through my site and to open up discussion. I just read through a few of the postings on the forum you linked to, and it sounds like you guys are pretty inconsiderate in that you’re bashing Rob personally over there. Let’s try to keep this professional please.
It’s intellectually dishonest to propose a market timing system based on P/E10 valuations and then call it something (Stay-the-Course) which means just the opposite. If Rob feels that his P/E10 system is superior, then let it stand on its own. No need to sling mud onto John Bogle and investors who follow Bogle’s Stay-the-Course approach to investing.
Perhaps if Rob could provide evidence that timing using P/E10 valuation is superior to traditional Buy-and-Hold a 60/40 stock/bond portfolio AFTER TRADING COSTS AND TAXES, he might be more persuasive.
Schroeder
“And it certainly is not “slinging mud” at those who practice the conventional approach to Staying the Course to try to steer them in a different direction.”
John Bogle says market timing doesn’t work. Tons of research says market timing doesn’t work. If you want to steer people away from Bogle’s Stay-the-Course approach, you will need to come up with evidence.
I would like you to come back with the results of your research comparing timing using P/E10 valuation to traditional Buy-and-Hold a 60/40 stock/bond portfolio AFTER TRADING COSTS AND TAXES.
Schroeder
You’re wrong to say that Bogle says that all forms of timing do not work and you are wrong to say that there is research showing that long-term timing does not work, Schroeder.
There is lots of research showing that short-term timing (changing your allocation with the thought of obtaining a benefit in one or two or three years) does not work. And Bogle certainly says that. But then so do I. There are few people who have written in opposition to short-term timing more often than I have.
Has Bogle ever said specifically that long-term timing does not work? I have never seen such a statement, and I have been involved in these discussions for six years now. Surely if he had made such a statement there would be someone who would have heard of it and would have pointed us to it. The reaity is that Bogle has spoken in support of long-term timing.
Here are his words:
“”This analysis takes into account my conviction both that the performance of individual securities is unpredictable, and that the performance of portfolios of securities is unpredictable on any short-term basis. While the long-term performance of portfolios is also unpredictable, a careful examination of the past returns can establish some probabilities about the prospective parameters of return, offering intelligent investors a basis for rational expectations about future returns.” — Page 33 of Common Sense on Mutual Funds
If you have a basis for rational expectations about future returns, you obviously want to invest more heavily in stockws when the long-term return is likely to be strong than you do when the long-term return is likely to be weak. That’s nothing more than common sense.
Here’s the address of a page at my site that lists nine statements in favor of long-term timing put forward by big-name experts. There are many more where those came from.
http://www.passionsaving.com/long-term-returns.html
The reason why well-informed experts say that short-term timing does not work is that the historical stock-return data shows this to be so. The same historical stock-return data shows that long-term timing always has worked. Is there some reason why you think we should believe what the data says re the one question and not what it says re the other?
Rob
Rob,
I know that every person’s situation is different, but for you, personally, what fraction of your portfolio is presently invested in stocks?
I guess I agree with the gist of Schroeder’s comments. First, Rob’s approach clearly is market timing but he confusingly refers to it using the same terminology as Bogle (”Stay the course).
Second, Schroeder is quite reasonable in asking for a quantified, after tax and costs, comparison of the results of Bogle’s approach (of which Bogle has published detailed analyses) with Rob’s market timing using PE10. Given the very harsh (indeed, insulting) verbiage that Rob directs toward people like Bogle on his website, I think this is absolutely necessary.
My stock allocation is 0 percent. Most of my money is in TIPS and IBonds paying 3.5 percent real. I will be moving into stocks when prices return to more reasonable levels and when the long-term value proposition for stocks improves to the point where stocks are competitive with the super-safe asset classes.
Rob
I have great respect for John Bogle. I list him as my fifth favorite investing advisor. I think of Bogle as the grandfather of my investing approach (I call it Valuation-Informed Indexing) because it was from Bogle’s book that I first learned where stock returns come from and of the critical effect of valuations on long-term returns. It is Bogle who got me started down the path I travel today.
I do strongly believe that he is wrong in his endorsement of the idea that it is acceptable or even a good thing for investors to stick with a single stock allocation while prices go through dramatic changes. I think that advice is going to end up causing millions of middle-class investors huge financial pain.
Rob
You own NO stocks whatsoever? Wow. You must have bought your TIPS and I-bonds many years ago, because 3.5% real has not been available for quite a while. When did you get out of the market?
Any advice for someone actually investing today?
TIPS are paying .75 to 2%. Anyone who thinks he has TIPS paying 3.5% has failed to mark them to market. A huge mistake for anyone pretending to be a finance advisor.
“One think I’d like to add is that I’ve made changes to my allocation because of new information/books/strategies that I’ve come across. ”
This is a great comment, Mike.
We obviously cannot know all there is to know about investing when we start out. So we need to be open to making changes when we learn new things.
I have seen some people argue that making changes in one’s investing plan contradicts the buy-and-hold concept. I don’t agree.
We need to think through the purpose behind the strategy to know when changes are appropriate and when they are not. Changes made because a strategy just has not paid off for a year or two or three are not a good idea because it often takes longer than that for strategies to pay off. Changes made because you learn something new are obviously a good idea.
Buiy-and-hold should not become a straightjacket.
Rob
“No need to sling mud onto John Bogle and investors who follow Bogle’s Stay-the-Course approach to investing.”
I certainly do not see it as “mud-slinging” to point out when someone gets something wrong. I am grateful when someone points out something that I have gotten wrong. My guess is that Bogle feels the same way.
Rob
Thanks for allowing the link and the commentary, Clever Dude.
It is faar more gracious that what Rob is doing every day at ‘Passion Saving” blog where he censors every post that is even slightly critical of his approach, or asks a legitimate question. I think there should be “Free and Open Posting” on Planet Internet.
Apparently, Rob does not agree with that approach at all, based on his clear, continued, consistent actions as a former board moderator, and now as a blogger.
Thanks, Best wishes.
Rob,
You say that Bogle is wrong to advise investors to Stay-the-Course. It would help if you can provide evidence to support your claim. I have twice asked you to provide evidence and twice you have not done so. I will let readers of this blog to weigh your non-responses to assess whether your claim is valid.
Since you brought up my “mud slinging” comment again, I dug up an example of what you wrote on your blog.
“If there were a good number of true investing experts on the scene today, they wouldn’t have allowed us to get into this mess in the first place. True experts would have spoken up when stock prices first began getting seriously out of hand.
“Bogle didn’t do it. Lindauer didn’t do it. Greaney didn’t do it. They’re not experts. They’re schoolboys. They’re learning.”
You wrote that on June 15, 2007.
http://www.passionsaving.com/200706.html#e453
Schroeder
By the way, I don’t agree with Bogle on everything, either. Does that mean that Bogle is wrong and I am right? That’s probably too strong. But I do respect Bogle for the knowledge and wisdom he has put forward in his speeches and books.
One of the things that I disagree wit Bogle and you, Rob, is that investors don’t have to rely on the S&P 500 as their only equity asset class. Investors can own a variety of stock asset classes and still get good results despite what P/E10 valuations are at any moment in time. For example, investors can own Value stocks, Small stocks, International Stocks and Real Estate Investment Trusts (REITs). What do you think, Rob?
http://www.coffeehouseinvestor.com/Returns.htm
Schroeder
clever Dude:
This will be my last post on the thread, but I just thought that since Rob is touting his site, you and your readers might be also interested in seeing what a different take than Rob’s looks like. See link. If I were a reader, I’d go to some of the links in the thread, look at the style of the posters, soak in the atmosphere, and then compare all of that information to Rob’s single minded self-invented and caustic to outsiders approach as presented on his blog. I suppose Rob could be right, as you said, but you know, I’m not sure I WANT to be right, if that is what it looks and feels like — life is too short, and too precious to squander it.
http://www.diehards.org/forum/viewtopic.php?t=17823&highlight=
Guess I’m done here also. Rob won’t or cannot answer my questions, such as how he’s getting TIPS at several times the market return or where he’d suggest that actual investors put their money.
I went, by the way, to Rob’s site and poked around. I would not advise anyone else to do so. It’s a bizarre mixture of anger, toilet humor, and clearly bogus self-aggrandizement.
@Schroeder and Robb, and anyone else, I did check out some of the forum posts where you guys seem to assume I invited Rob directly to guest post. Rather, I placed an open call for guest articles, which is what you’ll be seeing from a diversity of writers over the next week or two.
The benefit I see of post right AND wrong articles is the discussion they provoke. I won’t promote something that is obviously wrong or that I think is dangerous to my readers, but that doesn’t mean I’m only going to promote things that I think are right.
Based on that, I’d like to invite any and all of you to submit guest posts as well (go to my Contact page) to counter Rob’s article or to write about any other topic you like. However, I just ask that you keep the technical discussion to a minimum because I don’t think my target audience is very experienced investors.
“They’re not experts. They’re schoolboys. They’re learning.”
I think that that’s a good way of saying it, Schroeder. Bogle knows some things. He doesn’t know some other things. That’s the way it is for most of us. It’s by Learning Together that we advance in our knowledge. When people become so certain that they’ve got it all figured out that they close themselves to hearing new ideas, they’re in trouble.
The state of knowledge today of how stock investing works is primitive. Think about what it is we are discussing in this thread. We are talking over whether valuations affect long-term returns or not. That’s a pretty darn basic question. That one should have been settled a long time ago. For many it is settled. But the problem is that some are absolutely certain that valuations do affect long-term returns and some are absolutely certain that they do not. Both things can hardly be so.
So how much do we really know about how stock investing works at this time?
We’re schoolboys. We’re learning. That goes for you. That goes for me. That goes for Bogle. That goes for all of us. We all become better investors when we become able to acknowledge this reality.
Rob
“I’d like to invite any and all of you to submit guest posts as well (go to my Contact page) to counter Rob’s article or to write about any other topic you like.”
Bravo, Clever Dude! That’s how we all learn, by having conversations with each other.
I extend the same offer re space at my blog. I would love to see people contributing guest blogs that offer ideas counter to my investing views. I of course have strongly held views and I of course am obligated to state my sincere views. So I see the biggest weakness of the Financial Freedom Blog being the lack of balance in perspectives being shared. I get some comments putting forward other points of view, but not enough of them. So if Schroeder or others would like to make some points in a guest blog, I very much encourage them to send me some words.
Rob
“True experts would have spoken up when stock prices first began getting seriously out of hand.”
This is key. If the state of investing knowledge were what it should be, today’s prices would be an impossibility. As the long-term value proposition of stocks dropped very low, true experts would have warned people to lower their allocations and that would have brought prices back to reasonable levels. That’s part of the job.
So some of us must be getting some things terribly wrong. Bogle is one of the some responsible for where stock prices stand today. He’s done some wonderful things. His promotion of indexing constitutes nothing less than a revolution in middle-class investing, in my view. But he was in a position of influence when prices rose to where they are today. Either he didn’t try to do enough to bring things under control or whatever he tried was not effective. That’s the plain reality (presuming you accept the danger of today’s price level).
Rob
Investors can own a variety of stock asset classes and still get good results despite what P/E10 valuations are at any moment in time. For example, investors can own Value stocks, Small stocks, International Stocks and Real Estate Investment Trusts (REITs). What do you think, Rob?
It depends on how knowledgeable you are, Schroeder. People can also pick individual stocks that are positioned to do well and beat the overvaluation problem that way. Many middle-class investors do not possess the skills needed to know in advance which asset classes are positioned to do well. That’s the whole point of the Indexing Revolution. If you invest in a broad index, you don’t need to do the research needed to make those sorts of choices effectively.
There will almost always be one or two asset classes doing well. But can you really say with certainty that you know which ones they will be? Is it going to be REITS this time? Is it going to be small cap? Is it going to be international? If you really know your stuff, I think that can work fine. I view it as one of Bogle’s major accomplishments that he has been able to convince a lot of people that it’s better for them not to try to pick the winners. Some can do this effectively, most cannot.
If you try picking all of the slices, then you are pretty much back to where you would be if you just invested in a broad index in the first place. Invest in a broad index and your fortunes are tied to the fortunes of the index. You have locked in the market return as your return. You don’t want to lock in the market return as your return when the broad indexes are at the price levels they are at today. Or at the very least you shouldn’t be doing so without becoming informed in advance of the great risk you are taking on.
Rob
Here’s a link to an article that I discovered just this morning that provides some outstanding background to the questions being discussed here. The academic literature shows one thing but the “experts” have been highly reluctant to share what we have learned in recent years with investors who are not too crazy about the idea of hearing it for so long as prices remain high.
http://www.capitalspectator.com/WM/2008/05/back_to_the_futureagain_1.html
Rob
Rob wrote: “If you try picking all of the slices, then you are pretty much back to where you would be if you just invested in a broad index in the first place.”
Perhaps you can provide evidence to support your claim, Rob. By saying “a broad index”, are you referring to the S&P 500? Some say that the S&P 500 is just one of several slices that investors can own. The S&P 500 represents the US Large Blend slice.
The idea of owning different slices is so the portfolio becomes more diversified. The advantage of a more diversified portfolio is to smooth out the up and down extremes that are present in any single slice. The overall results are demonstrated in the link I provided above.
Schroeder
Bennett is just looking for attention. Whenever he posts his twaddle and people correct him, they’re giving him exactly what he wants. This may generate some traffic for Clever Dude, but if you want to learn about investing, this is not the page for you.
“The overall results are demonstrated in the link I provided above.”
Ignoring prices works well during a secular bull market. We recently experienced the longest and strongest secular bull in the history of the United States.
Ignoring prices works horribly during a secular bear market. The depth of bear markets generally match the height of bear markets. So the bear market that follows the longest and strongest bull in history is likely to be a doozy.
The idea that it is reasonable for stock investors to ignore valuations became popular during a huge bull. It has not yet been tested in the real world. We are now only in the early stages of that first real-world test. The numbers that matter are the numbers that will apply when the test is complete, not the numbers that apply in the early years of the test.
The only way that I know of to gain a sense of the bigger picture realities is to examine the numbers that have applied historically, numbers that are not so influenced by the outlier valuation levels that apply today. Those numbers show that there has never yet been a time when those who ignored valuations during a huge bull ended up experiencing anything less than bone-crushing losses in the years that followed. If we see something different this time, it will be a first.
Rob
Rob,
I’d take you up on your offer, except that you have a clear history of deleting any contribution with which you do not agree. I couldn’t trust any statements to the contrary, as your history as a liar is obvious from even briefly scanning the post archives of any of the 16 websites from which you have been banned.
Rob, the reason why the other areas of the market — Value, Small, REITs — have performed relatively better than the S&P 500 in recent years is because they were not trading at the very high valuations exhibited by the S&P 500 of the late 1990’s. As an example, compare the returns of the S&P 500 with the Value Index in the 1998-2002 period.
S&P 500
http://finance.yahoo.com/q/pm?s=vfinx
Value Index
http://finance.yahoo.com/q/pm?s=VIVAX
Or you can compare the two funds side by side. You will see that the Value index didn’t rise and fall as much as the S&P 500 much during the 1998-2002 period.
http://quicktake.morningstar.com/fundnet/TotalReturns.aspx?Country=USA&Symbol=VIVAX
I agree that investors who own only one slice are more prone to the extremes of bull and bear markets. So you are right to caution readers of this risk. However, as I hope I have demonstrated, this risk has been mitigated by owning a portfolio that diversifies by including different slices.
Schroeder
Rob:
So…where are these key numbers? Hopefully after many years of unemployement and the walkout of your wife and kids - you should have had enough free time to actually compute them.
All of the numbers I have calculated do not support your conclusions…