Rob Bennett: The Coming Revolution in Investment Advice
Editor’s Note: Here’s a guest contribution from Rob Bennett, who writes the “A Rich Life” blog
This is an exciting time to be writing a personal finance blog. We are today on the threshold of the biggest advance in our understanding of how stock investing works we have ever seen.
When I was on the plane to St. Louis to attend FinCon13, I opened my New York Times to read an article about how University of Chicago Economics Professor Eugene Fama and Yale University Economics Professor Robert Shiller had jointly been awarded the Nobel Prize in Economics. The article noted a great oddity of the joint award. Fama and Shiller have developed models for understanding how stock investing works that are in complete contradiction to each other. Both cannot be right in what they say about stock investing. So the Nobel Committee was choosing to give the highest award in the field to one man who had gotten everything wrong!
Because most do not feel confident today saying who is right. Fama’s ideas are dominant (The Buy-and-Hold Model is rooted in Fama’s research). But there has been more and more research in recent decades showing that Fama was wrong on one important finding and that the piece of the picture added by Shiller added an element of critical importance. The committee wanted to honor Shiller for his contributions but was reluctant to declare Fama wrong because an entire industry has been constructed to promulgate his ideas. So they punted. They gave both men the prize.
The implications of Shiller’s ideas remain generally unexplored. Even Shiller himself never addressed the question of how investors should set their stock allocations in his best-selling book. The ideas are amazingly controversial because, if Shiller is right, we have all for many years been taking on far more risk than necessary while greatly limiting our returns. That’s going to change following the next price crash, which we should be expecting before the end of 2016 if Shiller is right.
We are all soon about to learn that just about everything that we once thought we knew about stock investing has turned out to be wrong. This presents huge opportunities for bloggers. We need to explain how things got on the wrong track. We need to point out the weaknesses in the articles and books published in this field over the past three decades. We need to develop new calculators. We’re going to be very busy!
Shiller’s research shows that long-term returns are highly predictable. There is now 33 years of peer-reviewed research (based on 140 years of historical return data) showing that you can know in advance what your return on the purchase of an index fund will be in ten years. We cannot predict returns precisely. But we can identify a range of possibilities and assign rough probabilities to each point along that range. Once Shiller’s model (Valuation-Informed Indexing) becomes widely known, bloggers like you will be able to tell your readers when they should invest heavily in stocks and when the long-term value proposition just is not there.
Even better, Shiller’s research shows us how to reduce the craziness of stock investing. The trick is to always, always, always consider price when buying stocks. Think what would happen to the used-car market if no one ever consulted Edmunds.com to determine whether the price being asked for a car was a fair one or not. If we did things that way, the used-car market would not work well — a market cannot do its job of setting prices properly if those participating in it do not exercise price discipline. Few of today’s investors change their stock allocations in response to big shifts in valuations. They should be doing that. It will be the most important job of bloggers of the future to explain to investors why and how to make the allocation changes they need to keep their risk profiles roughly constant.
Rob Bennett writes the “A Rich Life” blog. He is the lead advocate of Valuation-Informed Indexing, the investing strategy rooted in the research of Nobel Prize-Winning Economist Robert Shiller. Be sure to attend Rob’s investing blogger meetup at FinCon14.
Image Credit: Bengt Nyman