Most investors agree. The premise of the Buy-and-Hold strategy is that valuations do not matter, that the market is efficient. But in conversations with many thousands of middle-class investors over the past 17 years, I have never gotten the sense that more than a small minority believe that the market is efficient or even care enough about the matter to give it much thought. Most investors value common sense over theoretical purity and most view a belief that valuations matter as common sense.
Is It A Good Time to Be a Stock Picker? Interview With Worm Capital
ValueWalk's Raul Panganiban interviews Eric Markowitz, Director of Research, and Dan Crowley, Director of Portfolio Management, at Worm Capital. In today’s episode they discuss their approach at Worm Capital and where they find opportunities. Q4 2020 hedge fund letters, conferences and more Interview with Worm Capital's Eric Markowitz and Dan Crowley
But how much do valuations matter?
That’s the rub.
I put up a post to a Motley Fool discussion board on May 13, 2002, asking whether valuations should be considered in the calculation of the safe withdrawal rate. Scores of community members found the question compelling. More than a few commented that I had initiated the most interesting debate ever held at that forum by asking that question.
There were also a good number of community members who responded to the question with hostility. This group quickly took to asking me what I thought the safe withdrawal rate was at that time. I had no idea. So I was reluctant to give an answer. But I did believe that the question was a reasonable one. So, after a good bit of prodding, I broke down and offered a guess, that it might be something in the neighborhood of 3 percent (rather than 4 percent, the number that Buy-and-Holders cite as the always-applicable safe withdrawal rate).
I learned later that, at the top of the bubble, the safe withdrawal rate dropped all the way down to 1.6 percent. I wonder now if those defenders of the studies arguing in favor of the 4 percent rule knew what they were doing when they asked that question.
The 1.6 number is shocking. In a surface sense, the fact that that was the number at the top of the bubble is an argument for always including as adjustment for valuations in calculation of the safe withdrawal rate. The adjustment makes such a big difference that it is highly misleading to leave it out.
The full reality, however, is that the fact that valuations matter so much causes most investors not to demand that valuations always be considered but to prefer that they not be considered at all. Huh? That makes no sense. How could that be?
Failing to take a big factor into consideration makes no intellectual sense. That much is certainly so. But failing to take a big factor into consideration makes all the emotional sense in the world. Investors have no problem conceding that valuations matter. After all, we all take price into consideration when deciding on purchases of every good or service that we purchase with the exception of stocks. It would be hard to make a case that stocks should be an exception.
But once we look at the numbers and see how much valuations matter, an exception becomes very much required. At the top of the bubble, the odds that a retirement using a 4 percent withdrawal would survive 30 years was only 30 percent. If those numbers are accurate, our failure as a society to insist that retirement studies report numbers properly will have caused millions of failed retirements once stock prices return to fair-value levels or lower in the wake of the next price crash. If we were to acknowledge that, we would have to make changes to how we design retirement planning studies.
And we don’t want to!
Not for any intellectual reason. For the purely emotional reason that, for so long as prices remain high, our portfolio statements show that we are all closer to retirement than we really are for so long as we can maintain the illusion that valuations do not matter. The day that we accept that Shiller’s research is legitimate is the day that we are required to acknowledge that we all are a lot farther behind in our efforts to finance our retirements than we want to believe we are. Fudging the numbers is the only alternative to acknowledging the realities. So we insist that just about everyone who works in this field fudge the numbers.
Rob Arnott once said: ““Returns are for the most part a matter of simple arithmetic…. Much of our industry seems fearful of basic arithmetic of this sort.” I once thought of math as the one area where objective truth prevails. Humans lie to themselves about the lessons of history and about the realities of human behavior all the time. We all learn that unhappy truth as we acquire knowledge of how the world about us actually works. But we like to think that there are certain facts that are so simple and obvious that we have no choice but to acknowledge them. The safe withdrawal rate should be one of those non-refutable, non-controversial matters.
I am here to report the painful reality that it just is not so.
We want the safe withdrawal rate to be bigger than it really is at times of high stock valuations. And of course the same is true of all other calculations relating to stock investing. We want to believe that we are in better financial shape than we are and so we insist that those who advise us about stock investing always tell us that we are. We don’t tolerate much non-conforming behavior re that one.
We get it that valuations matter. Of course. Obviously. How could they not?
But don’t dare tell us how much they matter. Knowing how much valuations matter would leave us with no choice but to rethink our confidence in the Buy-and-Hold strategy. That would be a painful experience. We are better off not knowing.
Rob’s bio is here.