Valuation-Informed Indexing #142
by Rob Bennett
Most fast-food places are fanatical about keeping their restrooms clean. It’s considered a more important job than providing friendly service or juicy hamburgers. Customers draw conclusions about all sorts of things when they see dirty restrooms. They imagine that a restaurant that doesn’t care about keeping the restrooms clean doesn’t care about lots of other things that the customer cannot check out for himself.
I believe that in days to come people are going to see that the failure of The Stock-Selling Industry to do something about the errors that were discovered in the Old School safe-withdrawal rate studies over 10 years ago was a sign of bigger problems.
The history here is that I put up a post at a Motley Fool discussion board back in May 2002 pointing out that the studies that say that a retiree can count on a retirement plan calling for a 4 percent withdrawal to work fail to adjust for the valuation level that applies on the day the retirement begins and thus are are analytically invalid. It’s obviously not possible to do the calculation properly without adjusting for valuations. So those studies are dangerous. Millions of aspiring retirees obtained a false sense of confidence from reading these studies and will be suffering horrible life setbacks in years to come as a result.
In the early days, most people in the field rejected my claim. Pretty much everyone has come around in recent years. No one denies today that the studies are in error. But none of the studies has been corrected. The common view today is that, while the studies are in error, it’s not a big deal. The world won’t come to an end because millions of middle-class people suffer failed retirements.
I hope that the world doesn’t come to an end. And my guess too is that it will not. However, I believe that we will have to endure a far larger social problem as a result of our delay in correcting the studies than we would have faced had we been up front with people going back to the time when the errors were discovered. I believe that the best thing to do when a mistake is discovered is to correct it and move on. I believe that rule applies with even greater force when the error is one dealing with a money question.
I believe that we are going to conclude that the errors in the Old School safe withdrawal rate studies were indicative of errors in the conventional thinking about how stock investing works that have far broader application. Discovering the errors in the retirement studies was like discovering a dirty restroom in a fast-food joint. The one problem we were seeing with our eyes was telling us that there were likely lots of other problems that had not become plainly visible yet.
The problem with much investment advice is that it cannot be tested effectively. Good investment advice often does not pay off for many years and bad investment advice often does not do harm for many years. By the time the advice has been shown to be good or bad, few remember who it was who gave the good or bad advice. Accountability is lacking in this field.
The safe withdrawal rate studies offered us a unique opportunity to check on how serious the experts in this field are in their claims that they root their advice in academic research. It sure sounds like a good idea. And the experts so often refer to research that most of us assume that they are indeed staying on top of the latest studies and incorporating the latest findings into their advice. The retirement study saga shows that this is not at all the case.
Most of the experts use the claim that their strategies are backed by research as a marketing gimmick. it sounds good to say that advice is rooted in research. It makes investors feel comfortable to hear those kinds of promises. But honoring the promises would tie the hands of the experts. When you take research seriously, there are things you cannot say that from a marketing standpoint you might very much want to say. The 10-year delay in correction of the retirement studies shows us that, when there is a conflict between marketing imperatives and the need to be true to the research, most investing professionals put marketing concerns first, second, third and fourth.
The reality is that today’s experts are not taking valuations into consideration in ANY of their calculations. It’s not just the safe withdrawal rate studies that present a problem. The only reason why the problem became visible in the retirement area is that the retirement studies require identification of a worst-case scenario, a single point on the spectrum of possible return scenarios. When you have one number to look at, it is possible to say whether the number is accurate or not.
Once we saw that the retirement numbers were not accurate, we should have reacted not by minimizing the problem but by wondering whether it might be indicative of a much deeper and broader problem than the one that had became obvious. I suspect that the reason why we have feigned unconcern for some time is that on some level of consciousness we suspect how deep the problem goes and we are worried about what it will mean to come to terms with it.
Rob Bennett has recorded a podcast titled “When Stock Losses Are True Losses and When They Are Not.” His bio is here.