I once performed a Google search to determine the core premises of Modern Portfolio Theory. The answer that came back is that there are two things that need to be so for Modern Portfolio Theory to work: (1) investors must be rational; and (2) investors must have easy access to the information needed to make sound decisions.
We Do Not Have Access To The Information Needed To Make Decisions
I certainly don’t believe that investors are entirely rational. Humans are not entirely rational in any other field of endeavor. I don’t see why stock investing would be the one exception.
It took decades for Warren Buffett to build Berkshire Hathaway into the conglomerate it is today. Along the way, the Oracle of Omaha and his business partners have acquired a range of different companies and extracted cash from failing businesses to reinvest back into growth stocks. Q2 2021 hedge fund letters, conferences and more The Read More
I also don’t think that we have access to the information that we need to make sound decisions. I say that because I have seen how people who have doubts about the Buy-and-Hold strategy are silenced on internet discussion boards. If Buy-and-Hold were a real thing, Buy-and-Holders would welcome questioning of their strategy. Questioning would help them sharpen their understanding. Rarely have I seen Buy-and-Holders react warmly to questioning of their strategy. I have seen a few exceptions to the general rule. But the typical Buy-and-Holder would prefer that the strategy not be questioned.
There was a poster at the Early Retirement Forum who believed strongly that investors should be taking valuations into consideration when making investment decisions. In ordinary circumstances, we would have been fast friends. But I noticed that, while he was sometimes complimentary of my posts, he also often kept me at arm’s length. The owner of that site had created a calculator that told people when it was safe to retire. It was based on the “4 percent rule,” which argues that a retirement plan that calls for an annual withdrawal of 4 percent of the portfolio amount is very safe. I say that it depends on the valuation level that applies on the day the retirement begins. When valuations are where they were in 1982, a 9 percent withdrawal is safe. When valuations are where they were in 2000, there is some risk attached to any withdrawal rate greater than 1.6 percent. I believe that his poster did not want to antagonize the owner of the site by saying that his retirement calculator was in error. I did that. So this poster did not want to get too close to me.
He made good points in his posts. And he was never banned from the site for holding unpopular views, as I was. So I suppose that an argument can be made that he did the right thing. His diplomatic approach caused more Buy-and-Holders to become aware of the dangers of their strategy than did my approach of insisting that my right to post my honest views be respected.
Buy-and-Holders Turn Against One Another
I have never seen a Buy-and-Holder turn against another Buy-and-Holder because the two did not agree on all points. It is the normal thing in life for people who hold the same views on most questions to get along despite any differences they might have on other matters. The Buy-and-Holders at that board often tried to isolate me, to suggest that my views were extreme and crazy. I see that as an unfair way to make a case. If it is true that valuations affect long-term returns, it is a logical impossibility that the safe withdrawal rate is the same number at all valuation levels. So I think that the case is clear that the retirement calculator was steering people wrong and that my valuation-minded friend should have been brave enough to state in clear terms that he thought that I was right on that question and should not have worried about being attacked for it.
It of course doesn’t matter all that much in the grand scheme of things how I was treated at that discussion board. But the full reality is that I experienced similar behavior at many other places. Most people want to believe that Buy-and-Hold is a sound strategy; they want to believe that the numbers on their portfolio statement are an accurate reflection of their accumulated wealth. I say different. I say that more than half of the wealth in today’s stock market is the product of irrational exuberance and has no lasting value.
It is the purpose of a market to put a price on the things being offered for sale in the market. If the stock market sets the price of stocks at x value, that is their value, yes? Not really. The market can only perform the function of setting prices properly if there is a free flow of information to the investors who are causing the market to move in one direction or the other. For so long as people do not feel free to state their views clearly (including the view that the retirement calculator of the owner of the site gets the numbers wrong), the market cannot do its job. I do not believe that our stock market is doing its job today.
I certainly do not think it would be a good thing if only people who agreed with me could post at internet discussion boards. My views are outlier views. We need to hear all kinds of views. We need to hear from Buy-and-Holders and we need to hear from Valuation-Informed Indexers and we need to hear from people who hold middle-of-the-road positions. My concern is that Buy-and-Holders feel far more free to advance their views than do Valuation-Informed Indexers. So the information needed for the market to set prices properly is not available to it.
Markets are information-processing machines. Once people develop a bias for high stock prices (most stock investors greatly prefer high prices), it becomes hard for the market to obtain the mix of information bits that it requires to get prices right. We all should be careful to encourage a diversity of viewpoints to be expressed in discussions of stock investing. The market is a public good. We all have an interest in seeing that it obtains what it needs to remain in working order at all times.
Rob’s bio is here