Newbies question - Gordon equation & William Bernstein remark

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omers66
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Newbies question - Gordon equation & William Bernstein remark

Post by omers66 » Sun Jun 28, 2020 12:01 pm

Hi, I'm 29 years old and making my first steps as an investor.

I have recently read Dr William Bernstein book "The Investor's Manifesto" and I have been reading in this forum latley and seem to grasp most of the
important stuff. (allocation, diversifisication, buy & hold etc).

There is only one thing that bothers me and that is how should I react to high valuations.
Dr Bernstein suggest calculating expected returns easily with Gordon equation.
Now, what would someone had to do with this information right before the dot-com bubble in 2000 for example?

Dr Bernstein writes about 2000 bubble:
"...investors paid to much attention to historical returns and not enough to the Gordon Equation, which at that time suggested just a 2.4% real return...They also failed to match the risk with the return: The 2.4% expected real return calculated from Gordon equation in 2000 was nowhere near enough to compensate for the ulcers and nightmares that stocks are capable of generating. Something had to give, that something being a fall in equity prices large enough to restore dividend yields to a level high enough to compensate rational investors for bearing the very real risks of owning stocls."

But it's still not clear to me what should investor do in those cases?
Simply keep investing by rebalancing?
Does valuations play any rule for you? or is it simply a tool to know what to expect?
Do you make small/large/ changes to your portfolio as a results of valuations?
For example, I have planed on puting the free available cash from my monthly salary in the stock market? should I stop doing that when valuation are high?

Any thoughts would be highly appreciated.
Thanks

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David Jay
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by David Jay » Sun Jun 28, 2020 12:38 pm

Welcome to the Forum!

Bernstein has an attachment to the Gordon equation, I find that it is of little value to an index fund investor. In his book, "A Random Walk Down Wall Street", Malkiel shows that neither fundamental analysis (i.e. the Gordon equation, etc.) nor trend analysis reliably indicates a proper source of action.

I would take no action based on the expected real return of the market - folks who do that were "getting out of stocks" every year since about 2012. Instead select an asset allocation (stock-to-bond ratio) that you can hold regardless of market movements and just keep throwing money in to your portfolio for the next 30 years.

[edit] Bernstein, in his booklet "Deep Risk", strongly recommends against market timing. His quote: “mistiming the market is probably the most frequent and severe form of permanent capital loss.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: Newbies question - Gordon equation & William Bernstein remark

Post by alex_686 » Sun Jun 28, 2020 12:53 pm

I will point out that the Gordon equations or any P/E ratios will not tell you if the market is high. i.e. If the Gordon equation is telling you that the expected market return is 2.4% real, that is what it is telling you. Not that it is high and will mean revert.

You need something like the Fed model to tell you if the market is high or not. Then things will get tricky.

I do find it information for my AA. I can figure out my expected market returns and risk, and construct a portfolio to fit.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.

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Re: Newbies question - Gordon equation & William Bernstein remark

Post by Horton » Sun Jun 28, 2020 1:03 pm

Expectations of future returns, using the Gordon equation or other models, are useful to build a savings and investment plan to meet your goals. Expected returns are lower than historical returns, so you will need to save more or work longer. If returns end up being better than expected, then you might be able to retire earlier or save less in the future (vice versa if returns are lower than expected). Monitoring your plan regularly with updated expected returns will allow you to make adjustments along the way to achieving your goals.

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Re: Newbies question - Gordon equation & William Bernstein remark

Post by garlandwhizzer » Sun Jun 28, 2020 1:12 pm

David Jay wrote:

I would take no action based on the expected real return of the market - folks who do that were "getting out of stocks" every year since about 2012. Instead select an asset allocation (stock-to-bond ratio) that you can hold regardless of market movements and just keep throwing money in to your portfolio for the next 30 years.
1+

I think this sums it well. Executing a consistent and sound strategy regardless of current market noise is IMO the best long term approach. Keep in mind that most predictions of future market returns are noise. You may choose to make minor adjustments to your portfolio on occasion but hopefully those occasions are infrequent and the changes are minor.

Garland Whizzer

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Taylor Larimore
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by Taylor Larimore » Sun Jun 28, 2020 1:40 pm

omers66:

Welcome to the Bogleheads Forum!

You wrote: "But it's still not clear to me what should investor do in those cases?
Simply keep investing by rebalancing?"


My answer is an unqualified "yes." These experts agree:
"The stock market will fluctuate, but you can't pinpoint when it will tumble or shoot up. If you have allocated your assets properly and have sufficient emergency money, you shouldn't need to worry." (AAII Guide to Mutual Funds)

"Endless tinkering is unlikely to improve performance, and chasing last period's stellar achiever is a losing strategy." (Frank Armstrong, author and adviser)

"It must be apparent to intelligent investors--if anyone possessed the ability to do so (market time) he would become a billionaire--quickly--." (David Babson, author, adviser)

"What it really takes to improve your returns and diminish your risks is a willingness to stop focusing exclusively on the movement of the markets." (Baer & Ginsler, The Great Mutual Fund Trap)

"If we haven't said it enough, we'll say it again: Market timing is dangerous." (Barron's Guide to Making Investment Decisions.)

"Only liars manage to always be "out" during bad times and "in' during good times. (Bernard Baruch, famed investor)

"Market timing recommendations have an impressive track record of being harmful to an investor's financial health." (Peter Bernstein, author, researcher)

"Buy-and-hold will still be justified by low costs, diversification, and mean reversion." (David Blitzer, named 1998 Top Economist)

"There are two kinds of investors, be thay large or small: Those who don't know where the market is headed, and those who don't know that they don't know." (Wm Bernstein, author and adviser)

The Boglehead (forecasting) Contest began in 2001. Of 99 Diehard guesses that year, only 11 even guessed the direction of the stock market. In January 2008, only 2 Bogleheads guessed how low the S&P would go. Of 11 professional forecasters, every one thought the S&P would gain (it declined -38%)

"If you're determined to succeed at investing, make it your first priority to become a buy-and-hold investor." (Jack Brennan, Vanguard Chairman of the Board)

"For the 12 years ending 1997, while the S&P rose 734% on a total return basis, the average return for 186 tactical asset-allocation mutual funds was a mere 384%. (Buckingham Financial Services)

"I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two." (Warren Buffet)

"Market timing is an ineffective strategy for mutual fund investors." (CDA/Wiesenberger)

"Any investment method that relies on predicting the future is doomed to fail." (Chandan & Sengupta, financial authors)

"A successful investor has a good knowledge base, a well-defined investment plan, and nerves of steel to stick with it." (Andrew Clarke, financial author)

"Most investors are unable to profitably time the market and are left with equity fund returns lower than inflation." (2003 Dalber Study)

"Take my word on it. Buy-and-hold is still your best long-run strategy." (Jonathan Clements, author & journalist)

"The buy and hold (S&P 500) equity investor would have earned a return of 8.35% for the 20 years ending 12/08, while the market-timer would have earned just 1.87%." (Dalbar research)

"Market-timing is bunk." (Pat Dorsey, M* Director of Fund Analysis."

"The performance of 185 tactical asset allocation mutual funds was compared with buy-and-hold strategies and equity mutual funds over the years 1985-97. Over this period the S&P 500 Index increased 734%, average equity funds increased 598%, and tactical asset allocation funds increased 384%." (David Dreman, author)

"Market timing is a wicked idea. Don't try it-ever." (Charles Ellis author of The Loser's Game)

"Do nothing. I think all of this market timing is statistically unfounded. I don't trust it. You may avoid a downturn, but you may also miss the rise. Choose the risk tolerance you're OK with and hold tight." (Professor Eugene Fama)

"Forget market timing in any form." (Paul Farrell, (CBS Marketwatch.com)

"The best practice for investors is to design a long-term globally diversified asset allocation based on present and future financial needs. Then follow that plan religiously, through all markets good and bad." (Rick Ferri, author and adviser)

"Benjamin Graham spent much of his career trying to devise a goodformula for when to get into--and out of--the stock market. All formulas, he concluded, failed." (Forbes, 12-27-99)

"Buy and hold. Diversify. Put your money in index funds. Pay attention to the one thing you can control--costs." (Fortune Investor's Guide 2003)

"Don't sell out of fear or buy out of greed. Just keep making investments, and let the market take its course over the long-term." (Norman Fosback, author, researcher)

"The only function of economic forecastng is to make astrology look respectful." (John Kenneth Galbraith, Economist)

"I've learned that market timing can ruin you." (Elaine Garzarelli, former Wall Street Guru)

"Staying on course may be just as difficult in bull markets as in bear markets." (Good & Hermansen, Index Your Way to Investment Success)

"For most investors the odds favor a buy-and-hold strategy." (Carol Gould, author & financial columnist)

"If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting that's going to happen to the stock market." (Benjamin Graham)

"From June 1980 through December 1992, 94.5% of 237 market timing investment newsletters had gone of business." (Graham/Campbell Study)

"Your very refusal to be active, and your renunciation of any pretended ability to predict the future, can become your most powerful weapon." (Graham & Zweig, The Intelligent Investor)

"Those of us that live by looking in a crystal ball learn to eat a lot of broken glass." (Peter Grandich, Wall Street Whiz Kid)

"The best advice: Buy and hold." (John Haslem, author and researcher)

"From 1981 through 2006 the average top performing newsletter had a loss of -27.9% the following year." (Hulbert Financial Digest)

"Once anomalies are discovered, the act of exploiting them will cause them to disappear." (Indexuniverse.com)

"After receiving the Nobel Prize, Daniel Kahneman, was asked by a CNBC anchorman what investment tips he had for viewers. His answer: "Buy and hold."

"Timing the market is for losers. Time IN the market will get you to the winner's circle, and you'll sleep better at night." (Michael Leboeuf, author)

"No one is smart enough to time the market's ups and downs." (Arthur Levitt, former SEC chairman)

"It never was my thinking that made the big money for me. It always was my sitting." (Jesse Livermore, author & famed investor)

"Nobody can predict interest rates, the future direction of the economy or the stock market." (Peter Lynch)

"Buying-and-holding a broad-based market index fund is still the only game in town." (Burton Malkiel, Random Walk Down Wall Street)

"Trying to anticipate any market's ups and downs can be a costly, and futile, exercise. (Wm McNabb, Vanguard Chairman)

"At the peak of the bull market in March of 2000 only 0.7% of all recommendations on stocks issued by Wall Street brokerages and investment banks were to "Sell." (Miami Herald, 1-26-03)

"If you can't handle the short term, if the uncertainty is stressful and the headlines are unbearable, then the markets are too hot for you: get out of the kitchen." (Moshe Milevsky, author & researcher)

"We're not keen on market-timing. It just doesn't work." (Morningstar Course 106)

"We've yet to find anyone who can accurately and consistently predict the market's short-term moves." (Motley Fools)

"An October 2009 study found that of more than 5,000 strategies that employ technical analysis, none produced returns in the 49 countries beyond what you'd expect by chance." (New Zealand Massey University)

"Odean and Barber tested over 66,400 investors between 1991 and 1997. Their findings: "The most active traders earned 7% less annually than buy-and-hold investors."

"Forget trying to time the market and do something productive instead." (Gerald Perritt, financial author)

"We have found that the fund managers who tend to perform the best over time are the ones who spend the least amount of time debating which way the market is heading" (Don Phillips, Morningstar's Managing Director)

"The market timer's Hall of Fame is an empty room." (Jane Bryant Quinn, author, columnist)

"Countless studies have proved that no one is able to time the market effectively." (Mary Roland, author & journalist)

"Trading is based on the rather arrogant belief that the trader knows more than the buyers and sellers with whom he is trading." (Ron Ross, The Unbeatable Market)

"In the long run it doesn't matter much whether your timing is great or lousy. What matters is that you stay invested." (Louis Rukeyser, TV host)

"Investors desperately want to believe they can time the markets, but the statistics tell a different story." (Liz Ann Saunders, Schwab Chief Investment Strategist)

"Predicting which way the markets will head next is really a fool's errand." (Gus Sauter, Vanguard Chief Investment Officer)

"For the 10 years that ended 12-31-2000, only one newsletter out of the 112 that Timers Digest follows managed to beat the S&P 500 Benchmark." (Jim Schmidt, editor)

"What do I really think is going to happen? -- I have absolutely no idea. (John Schoen, senior producer msnbc.com)

"I have learned the hard way that market timing and trying to pick a fund that will out-perform the market are both losing strategies." (Larry Schultheis, author and advisor)

"I'm a strong advocate of buying and holding." (Charles Schwab)

"It turns out that I should have just bought them (securities), and thereafter I should have just sat on them like a fat, stupid peasant. A peasant however, who is rich beyond his limited dreams of avarice." (Fred Schwed Jr., 'Where are the Customers' Yachts?)

"If you are not going to stick to your chosen investment method through thick and thin, there is almost no chance of your succeeding as an investor. (Chandan Sengupta, financial author)

"The forecasting skill of economists is about as good as guessing." (Wm Sheridan, financial author)

"Investors should look with a jaundiced eye at any market timing system being peddled by its guru-creator." (W. Scott Simon, financial author)

"People want to know what lies ahead. I cannot tell them because I do not know." (George Soros, global financier)

"Buying and holding a few broad market index funds is perhaps the most important move ordinary investors can make to supercharge their portfolios." (Stein & DeMuth, (authors & advisor)

"Humans can't consistently pick the right stocks or call markets." (Ben Stein, economist and author)

"It's my belief that it's a waste of time to try to time any market decline, or try to pinpoint a market bottom." (James Stewart, Smart Money columnist)

"It's a staple of personal finance advice: Buy-and-hold, because trading the stock market is a sucker's bet." Larry Swedroe, author and adviser.

"People should stop chasing performance and just put together a sensible portfolio regardless of the ups and downs of the market." (David Swensen, Yale Investments)

"Trust in time and forget market timing. Allow time to work its compounding magic for you. Let market timing inflict its miseries on someone else." (Tweddell & Pierce, financial authors)

"Stay invested. Not only does buy-and-hold investing offer better returns, but it's also less work." (Eric Tyson, author, Mutual Funds for Dummies."

"Few if any investors manage to be consistently successful in timing markets." (Wall Street Journal Lifetime Guide to Money)

"If you're considering doing your own market timing, the best advice is this: Don't." (John Waggoner, USA Today financial columnist)

"If you buy, and then hold a total-stock-market index fund, it is mathematically certain that you will outperform the vast majority of all other investors in the long run." (Jason Zweig, author)
Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "I do not know of anybody who had done market timing successfully. I don't even know anybody who knows anybody who has done it successfully and consistently."
"Simplicity is the master key to financial success." -- Jack Bogle

Topic Author
omers66
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by omers66 » Sun Jun 28, 2020 3:33 pm

Thank you all.
Got it :sharebeer

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Steve Reading
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by Steve Reading » Sun Jun 28, 2020 4:11 pm

omers66 wrote:
Sun Jun 28, 2020 12:01 pm
But it's still not clear to me what should investor do in those cases?
Simply keep investing by rebalancing?
Does valuations play any rule for you? or is it simply a tool to know what to expect?
Do you make small/large/ changes to your portfolio as a results of valuations?
For example, I have planed on puting the free available cash from my monthly salary in the stock market? should I stop doing that when valuation are high?

Any thoughts would be highly appreciated.
Thanks
I will only speculate on what Bernstein hints at here. But I believe his point is that you should look at the expected return of stocks, then of bonds, and decide for yourself the allocation to stocks that you believe is worth based on that. That chapter was him essentially saying "Idk why investors are buying equities when the gordon eqn is saying their forward returns are similar to bonds. That doesn't seem to compensate me enough, so I'll allocate a bit less to equities right now". It is NOT that Bernstein believes equities will drop or mean revert. It's that if equities return that base-case 2.4% real, that would not have been enough to compensate him for the stomach acids.

The implication, of course, is to change your allocation to stocks and bonds based on these valuations. Some call this market timing. I guess it is but the big difference is that Bernstein isn't doing it because he believes either asset will drop or go up. Simply because their base-case, average, expected forward returns do or do not compensate him personally for the risks.

You see this in Bernstein's writing, like when he recommends you "overbalance" by rebalancing to the opposite extreme of your allocation to be opportunistic about valuations. Again, not because valuations will mean-revert and prices shoot up. But because if he was willing to allocate 50/50 when stocks had 7% forward expected and bonds had 3% expected, then he's willing to go, say, 60/40 if stocks have 14% expected and bonds still have 3% expected (say, after a market drop of 50%).

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Svensk Anga
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by Svensk Anga » Sun Jun 28, 2020 7:23 pm

Around the time of the tech bubble TIPS and even I bonds were yielding 3%+ real. If you look at that low risk option versus stocks at 2.4% per the Gordon equation, you might really question whether it is worth buying equities. Jack Bogle did and shifted to a more conservative allocation. Apparently, his move was due more to personal circumstances (heart failure), than market timing.

I think the late 90’s TIPS yield was an anomaly because they were still quite new and the market hadn’t fully figured what they should yield. I would be very surprised if we see 3% real TIPS again. Maybe we will see real bond yields similar to Gordon equation returns, but it will be because both are miserably low. Stocks would seem to have more potential then.

I was 90 - 95% equities through the tech bubble and buying every paycheck and it still turned out alright. This was mid-career.'

Bernstein has written elsewhere that the markets occasionally go stark raving mad. It’s hard to exploit though because you are likely caught up in the madness yourself. FOMO. There’s no telling how far it will go before it reverts.

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firebirdparts
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by firebirdparts » Sun Jun 28, 2020 7:59 pm

It’s a very good question. If you have asset allocation (I did not) then rebalancing gives you some relief mentally and financially. The other two basic possibilities are to be 100% equities and hang on for the ride, or market time. At your age I was a “hang on for the ride” guy. You can’t really market time. When the market is overvalued it often gets more overvalued.
A fool and your money are soon partners

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omers66
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by omers66 » Mon Jun 29, 2020 1:49 am

firebirdparts wrote:
Sun Jun 28, 2020 7:59 pm
It’s a very good question. If you have asset allocation (I did not) then rebalancing gives you some relief mentally and financially. The other two basic possibilities are to be 100% equities and hang on for the ride, or market time. At your age I was a “hang on for the ride” guy. You can’t really market time. When the market is overvalued it often gets more overvalued.
At the current stage of bonds where I'm living, (0.3-0.4% real return) I decided to have my bonds allocation in a bank deposit for the next 3 years yeilding 1.2% yearly hedged against local currency inflation..
I think that's the better option currently, but the only problem is like you said, I don't have the rebalancing option between bonds & stocks.

Anyway, I guess I'll just stick to the plan, consider free cash as bonds for the time being
Thanks

xxd091
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by xxd091 » Mon Jun 29, 2020 4:51 am

Just for interest-a Vanguard Global Bond Index Fund hedged to the Pound that I use here in the U.K. is returning a steady 3 to 3.5 %
After doing what a Bond fund does to a portfolio (reducing volatility,maintaining portfolio value etc etc) this is a reasonable bonus for me
xxd091

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Forester
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by Forester » Mon Jun 29, 2020 6:02 am

If you're concerned over high valuations you could; own a global index fund, add a value fund, add hard assets (some gold & gold equities), own quality short term govt bonds.

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omers66
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by omers66 » Mon Jun 29, 2020 6:10 am

xxd091 wrote:
Mon Jun 29, 2020 4:51 am
Just for interest-a Vanguard Global Bond Index Fund hedged to the Pound that I use here in the U.K. is returning a steady 3 to 3.5 %
After doing what a Bond fund does to a portfolio (reducing volatility,maintaining portfolio value etc etc) this is a reasonable bonus for me
xxd091
This actually looks like a great solution..
Only trouble is that my local currency is not pound, nor Euro..
The only possibility I see for this situation is something like 'iShares Core Global Aggregate Bond UCITS ETF' which tracks global bonds in many currencies.
What do you think about that?

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omers66
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Re: Newbies question - Gordon equation & William Bernstein remark

Post by omers66 » Mon Jun 29, 2020 6:16 am

Forester wrote:
Mon Jun 29, 2020 6:02 am
If you're concerned over high valuations you could; own a global index fund, add a value fund, add hard assets (some gold & gold equities), own quality short term govt bonds.
I do global index funds of course (VTI+VXUS) and maybe I'll add a little value tilt exposure..
As of gold, I didn't see any general bogleheads reccomendations to buying gold specifically. Do you think it may be beneficial? Note that my portfolio is probably considered "small".
Maybe gold is more usefull during the stages of wealth preserve, but do you see it usefull at my age? In the stage that I only concern about growing my wealth for future?

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Re: Newbies question - Gordon equation & William Bernstein remark

Post by Forester » Mon Jun 29, 2020 6:32 am

omers66 wrote:
Mon Jun 29, 2020 6:16 am
Forester wrote:
Mon Jun 29, 2020 6:02 am
If you're concerned over high valuations you could; own a global index fund, add a value fund, add hard assets (some gold & gold equities), own quality short term govt bonds.
I do global index funds of course (VTI+VXUS) and maybe I'll add a little value tilt exposure..
As of gold, I didn't see any general bogleheads reccomendations to buying gold specifically. Do you think it may be beneficial? Note that my portfolio is probably considered "small".
Maybe gold is more usefull during the stages of wealth preserve, but do you see it usefull at my age? In the stage that I only concern about growing my wealth for future?
I would avoid gold unless you're already drawn to it. I am a "goldbug" and I believe/hope there will be one or two decades in my lifetime when gold has big returns versus stocks & bonds (and long periods when gold is losing ground).

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Re: Newbies question - Gordon equation & William Bernstein remark

Post by KEotSK66 » Tue Jun 30, 2020 6:42 am

omers66 wrote:
Sun Jun 28, 2020 12:01 pm
Hi, I'm 29 years old and making my first steps as an investor.

I have recently read Dr William Bernstein book "The Investor's Manifesto" and I have been reading in this forum latley and seem to grasp most of the
important stuff. (allocation, diversifisication, buy & hold etc).

There is only one thing that bothers me and that is how should I react to high valuations.
Dr Bernstein suggest calculating expected returns easily with Gordon equation.
Now, what would someone had to do with this information right before the dot-com bubble in 2000 for example?

Dr Bernstein writes about 2000 bubble:
"...investors paid to much attention to historical returns and not enough to the Gordon Equation, which at that time suggested just a 2.4% real return...They also failed to match the risk with the return: The 2.4% expected real return calculated from Gordon equation in 2000 was nowhere near enough to compensate for the ulcers and nightmares that stocks are capable of generating. Something had to give, that something being a fall in equity prices large enough to restore dividend yields to a level high enough to compensate rational investors for bearing the very real risks of owning stocls."

But it's still not clear to me what should investor do in those cases?
Simply keep investing by rebalancing?
Does valuations play any rule for you? or is it simply a tool to know what to expect?
Do you make small/large/ changes to your portfolio as a results of valuations?
For example, I have planed on puting the free available cash from my monthly salary in the stock market? should I stop doing that when valuation are high?

Any thoughts would be highly appreciated.
Thanks
investigate value averaging

say you put away $500/mo

keep doing that on a regular basis but if the market tanks then increase the amount to say $750 and when the market goes back up return to $500/mo

don't try to value the market or your investments and adjust your portfolio, but it is easy to see good buying opportunities

at your age time will gradually erode any ill-effects of having bought high decades earlier

don't try to get out on the high side, buy in on the low side
"i just got fluctuated out of $1,500", jerry

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