Views on How Stock Investing Works Are Hard to Change Because the Subject Is So Darn Important

Say that you are five minutes into a movie and those five minutes have been a disappointment. It’s not too hard to acknowledge the mistake, push the “stop” button and go back to the home page to select what had been your second choice.

Get The Full Warren Buffett Series in PDF

Get the entire 10-part series on Warren Buffett in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Q3 2020 hedge fund letters, conferences and more

Acknowledging The Second Mistake

Now say that you spent months researching colleges and have now spent three months at the one that you picked and that you are now experiencing doubts as to whether you made the right choice. It’s not so easy acknowledging the mistake in that case.

How Warren Buffett Uses Discount Rates To Value Stocks

Berkshire Hathaway Warren BuffettWarren Buffett has never detailed the process he uses to value the businesses he acquires for Berkshire Hathaway. However, over the years, he has provided some limited insight into his methods. Q3 2020 hedge fund letters, conferences and more Based on these comments, it is widely assumed that Buffett uses a discount cash flow model Read More


It’s far more important that you acknowledge the second mistake. Your entire career is riding on it. But it’s harder to acknowledge the mistake because you have so much more invested in it. Acknowledge the mistake and you may have to take some classes over. You will certainly have lost some money eating and sleeping at the wrong school. And you will experience some embarrassment telling your friends and family that you made a mistake.

It is not only the importance of correcting a mistake that causes us to correct one. It is also the extent of the investment that we have made in the wrong way of doing things. We can stick with decisions with devastating consequences for a long time if we have a lot invested in them.

Views About How Stock Investing Works

Back in the 1960s we developed as a society a very wrong way of thinking about how stock investing works. We came to believe that the market is efficient, that investors make rational choices when setting stock prices. If that were so, market timing would not be required and in fact would be a bad idea. The idea that market timing is not required or does not work became the conventional wisdom.

Then this Robert Shiller fellow came along in 1981 and showed with peer-reviewed research that the market is NOT efficient, that in fact valuations affect long-term returns and that risk is thus not stable but variable and market timing is absolutely required for any investors who wish to keep their risk profile constant over time.

The Buy-and-Hold opposition to market timing was a mistake. Those who follow the peer-reviewed research in this field have known this for 39 years now. Yet the mistake has not been corrected. Why not?

It is a matter of critical importance that the mistake be corrected. People rely on investment advice to finance their retirements. If it turns out that Shiller’s Nobel-prize-winning research is legitimate research (I believe that it is), then we have been doing it wrong all these years. When stock prices got out of hand, we all should have been practicing market timing and thereby pulling them back down to reasonable levels. Now it’s hard to know what to do. If a good number of us do lower our stock allocation, that could bring on the long-deferred price crash that could bring our entire economic system down. Most of us don’t even want to contemplate such possibilities.

They need to admit the mistake is huge. But the emotional investment in the mistaken way of doing things is even bigger. So we put off the day of reckoning. We cross our fingers and hope that things will kinda sorta work out -- somehow.

The Requirement Of Market Timing

If we were to acknowledge that market timing is required, we would need to rewrite all the textbooks. We would need to recalculate our life savings. If Shiller is right that half of the value of today’s stock market is irrational exuberance, we are all far behind where we have been led to believe we are in our retirement planning efforts. If irrational exuberance is a real thing, lots of businesses will be failing when it disappears. And lots of workers will be thrown out of their jobs.

I like to think that this is the last time that we are going to go through something like this. Prior to 1981, we did not have Shiller’s research to guide us. So we just did not know how stock investing works. It was just one of those things. Now we know but we cannot bear to acknowledge that we know because we have caused such problems in the years in which we couldn’t acknowledge that we know. I believe that the next price crash will bring that to an end (panic brings people together) and then we will be free.

There’s no telling how much we will be able to learn about this fascinating subject once we all feel free to start over at the beginning. Stock investing is an important subject. It’s too important for us to keep ourselves in the dark forever. Even if moving into the light is going to cause us to feel some regret over the many years in which we held back from doing that.

Rob’s bio is here.