Larry Swedroe: Valuations Too High?

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Re: Larry Swedroe: Valuations Too High?

Post by gmaynardkrebs » Thu Aug 09, 2018 10:20 am

Call_Me_Op wrote:
Thu Aug 09, 2018 10:01 am
...Isn't the best estimate of value what people are currently willing to pay?
Yes, but probably the most over-rated thought in the history of economics, because it's a truism and reductionist.

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Re: Larry Swedroe: Valuations Too High?

Post by HomerJ » Thu Aug 09, 2018 10:29 am

james22 wrote:
Thu Aug 09, 2018 9:58 am
Are you arguing beta is persistent, pervasive, robust, and has a logical, risk-based and/or behavioral-based explanation?
I think billions of hours of human work is turned into productivity and profit every day. It's not a closed system.
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Re: Larry Swedroe: Valuations Too High?

Post by Leesbro63 » Thu Aug 09, 2018 10:31 am

This article from today's WSJ relates to this post. Says valuations are actually lower than not too long ago:

https://www.wsj.com/articles/valuations ... _lead_pos3


"Despite another robust corporate earnings season, the S&P 500 has inched up just 1.5% over the past three weeks as simmering trade tensions and signs of slowing growth at big technology companies sapped investor confidence. Those issues have helped drive valuations down to their lowest levels of the year, even with the broad stock-market index hovering just 0.5% shy of its January high.

The S&P 500 trades at 18.8 times earnings over the past 12 months, a basement valuation that is lower than February’s trough of 21 times earnings, according to FactSet. At the S&P 500’s peak in January, the index traded at nearly 22 times earnings, well above its current level.

Strong corporate earnings are making stocks look less pricey than they did before. Companies in the S&P 500 have posted double-digit profit growth for the past three quarters to help earnings catch up with the S&P 500’s 7% advance this year. For the latest quarter, profits are on track to rise 24% from a year earlier, the best pace of earnings beats since 2008, according to FactSet."

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Re: Larry Swedroe: Valuations Too High?

Post by HomerJ » Thu Aug 09, 2018 10:45 am

Artsdoctor wrote:
Thu Aug 09, 2018 9:47 am
If you take a look at Larry's summary, he's basically saying that if you've anticipated a relatively high return (historical?) on your investments in an attempt to figure out how much to save, you might perhaps want to dial back those expectations and save more, or cut back on expenses.
He also says
There are other options you can consider, such as increasing your allocation to higher-expected-returning equities like international and emerging market stocks (with their lower valuations)
So he is (as one option) calling for market timing. Changing one's AA based on a metric (valuations).

But that was just one option. He also very reasonably talked about saving more, planning for a more conservative return, working longer, cutting expenses in retirement.

The article is actually very good. I agree with almost all of it.

I'm VERY VERY confused why he still thinks valuations are important after writing that article.

He basically just admitted that CAPE10 changes over time, it has good reasons to be rising, that it's skewed by the one terrible year in 2009 (CAPE8 is FIVE points lower), and that comparing 70+ years of old data to the last 30 years is apples and oranges. He also admits that past predictions have been way off, and that we shouldn't trust "market gurus".
Jeremy Grantham, the highly regarded chief investment strategist at GMO, has been warning investors about this scenario since 2013, when he declared all global assets were once again becoming “brutally overpriced.”

We know today that the market ignored Grantham’s warning. Instead of collapsing, from February 2013, when Grantham made the preceding assertion, through June 2018, the S&P 500 Index posted a total return of 103% and an annualized return of 14%, almost 40% above its long-term average of 10.1%.
(The market did not ignore Grantham's warning. Grantham was WRONG.)

I CANNOT understand how he can possibly say valuations are important or that he can be confident of his calculation of "expected returns" or that we should trust his calculations, as a market guru, in the SAME article where he basically agrees with everything I (and many others) have ever criticized about CAPE.
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Re: Larry Swedroe: Valuations Too High?

Post by Random Walker » Thu Aug 09, 2018 11:36 am

Call_Me_Op wrote:
Thu Aug 09, 2018 10:01 am
Random Walker wrote:
Wed Aug 08, 2018 3:33 pm
http://www.etf.com/sections/swedroe-val ... nopaging=1

Excellent article placing current CAPE in perspective. Larry reviews multiple reasons for CAPE to have drifted upwards over the decades. When we talk mean reversion, what mean do we revert to? Equities may be generously valued, implying lower future expected returns, but not at all necessarily overvalued.

Dave
What does the term "overvalued" mean in this context? Overvalued relative to what? Isn't the best estimate of value what people are currently willing to pay?
I think Larry has commented in the past that when the E/P is less than the TIPS yield, that would be a clear sign of overvaluation. That seems like a pretty extreme circumstance to me.

Dave

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Re: Larry Swedroe: Valuations Too High?

Post by Random Walker » Thu Aug 09, 2018 12:36 pm

Homer J,
No I don’t believe at all that Larry is calling for market timing. He is talking about long term committed changes to the asset allocation. He appreciates that most US individual investors substantially underweight international relative to world market cap weighting. Since a good starting point for equity allocation is world market cap weighting, Larry is simply suggesting that US investors might consider moving in that direction. Since valuations of international are lower, this increases expected return on the equity side a bit. I would consider this sort of opportunistically making an AA change in a more diversified efficient direction. I made this sort of move to 50% US / 50% Int 1-2 years ago, and don’t plan to change based on valuations or anything else in the foreseeable future.

Dave

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Re: Larry Swedroe: Valuations Too High?

Post by FIREchief » Thu Aug 09, 2018 12:54 pm

CantPassAgain wrote:
Thu Aug 09, 2018 9:38 am
james22 wrote:
Thu Aug 09, 2018 9:26 am
CantPassAgain wrote:
Thu Aug 09, 2018 9:13 am
james22 wrote:
Thu Aug 09, 2018 3:16 am
Of course?

Why do you believe buy-and-hold will deliver?
Because when you are investing in public common stocks you are investing in enterprises that are attempting to be productive and profitable for their shareholders by offering products and services that are meant to improve lives and increase standards of living? Ie generating wealth in a capitalistic system.
So? "Everything changes."
Not sure if you are being disingenuous or what. The whole point is that you can't predict what returns are going to be because economies change. The profit motive still remains and we still expect some sort of a return premium to less risky investments. Yeah, we are banking on our capitalistic system/free enterprise to stick around. Does that make us hypocrites or something? "Oh, you said everything changes, but you still think stocks will provide a return, I guess you don't think everything changes hah hah got you"

It's not that hard to figure out is it? Do you think we are living in the same world and economic environment of the 1920's?
In fairness to James22, when his post said "everything changes?" he was quoting my post where I stated:
No it doesn't. It also doesn't account for the fact that the world is ever changing. Companies come and go. Technologies change. Political environments change. World economies change. Everything changes. This is the number one reason that trying to use history to predict the future is a fool's game.
It should have been obvious, but perhaps not, that when I said "everything changes" I wasn't allowing for nuclear war or the fall of capitalism. I was instead, as you eloquently state, "banking on our capitalistic system/free enterprise to stick around."

James22 seems to be critical of "buy and hold," but he hasn't as of yet responded to our requests for him to tell us his alternate approach. Based upon his comments, I'm guessing he really doesn't have one or that he market times based upon articles like Larry's in the OP.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Larry Swedroe: Valuations Too High?

Post by FIREchief » Thu Aug 09, 2018 12:59 pm

Leesbro63 wrote:
Thu Aug 09, 2018 10:31 am
This article from today's WSJ relates to this post. Says valuations are actually lower than not too long ago:

https://www.wsj.com/articles/valuations ... _lead_pos3


"Despite another robust corporate earnings season, the S&P 500 has inched up just 1.5% over the past three weeks as simmering trade tensions and signs of slowing growth at big technology companies sapped investor confidence. Those issues have helped drive valuations down to their lowest levels of the year, even with the broad stock-market index hovering just 0.5% shy of its January high.

The S&P 500 trades at 18.8 times earnings over the past 12 months, a basement valuation that is lower than February’s trough of 21 times earnings, according to FactSet. At the S&P 500’s peak in January, the index traded at nearly 22 times earnings, well above its current level.

Strong corporate earnings are making stocks look less pricey than they did before. Companies in the S&P 500 have posted double-digit profit growth for the past three quarters to help earnings catch up with the S&P 500’s 7% advance this year. For the latest quarter, profits are on track to rise 24% from a year earlier, the best pace of earnings beats since 2008, according to FactSet."
Thank you for posting this. I've been trying to get folks to see how much lower P/E has become due to recent earnings growth (see the third post in this thread), but those with CAPE10 vision apparently have a hard time seeing this. Some seem to be enamored with that "celebrity name nobel prize winning stuff" and simply aren't interested in the current facts and data that real investors on Wall Street are looking at. I seriously doubt any stock analyst ever visited a CEO and spent much time talking about what his company earned ten years ago.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Larry Swedroe: Valuations Too High?

Post by greg24 » Thu Aug 09, 2018 1:04 pm

This entire article is "This time it's different".

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Re: Larry Swedroe: Valuations Too High?

Post by HomerJ » Thu Aug 09, 2018 1:31 pm

Random Walker wrote:
Thu Aug 09, 2018 12:36 pm
No I don’t believe at all that Larry is calling for market timing. He is talking about long term committed changes to the asset allocation. He appreciates that most US individual investors substantially underweight international relative to world market cap weighting. Since a good starting point for equity allocation is world market cap weighting, Larry is simply suggesting that US investors might consider moving in that direction.
I'm not sure where you get that idea from. He didn't mention world market cap weighting at all. His explicit reason in this article to increase one's allocation to international and emerging markets is to "increase your expected return".

If valuations go higher for international in the future than the U.S., why wouldn't he suggest one to switch back to the U.S. for higher likely returns?

(Again, this wasn't a blatant market-timing suggestion. He offered many other reasonable options as well.)
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Re: Larry Swedroe: Valuations Too High?

Post by flyingaway » Thu Aug 09, 2018 2:05 pm

It is interesting that Larry Swedroe has decided not to participate in discussions on this forum some time ago. Yet people continued to put every one of his articles for discussions here as soon as they are published.

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Re: Larry Swedroe: Valuations Too High?

Post by gmaynardkrebs » Thu Aug 09, 2018 2:12 pm

flyingaway wrote:
Thu Aug 09, 2018 2:05 pm
It is interesting that Larry Swedroe has decided not to participate in discussions on this forum some time ago.
Can't say I blame him.

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Re: Larry Swedroe: Valuations Too High?

Post by gmaynardkrebs » Thu Aug 09, 2018 2:14 pm

greg24 wrote:
Thu Aug 09, 2018 1:04 pm
This entire article is "This time it's different".
In what sense?

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Re: Larry Swedroe: Valuations Too High?

Post by Random Walker » Thu Aug 09, 2018 2:43 pm

HomerJ wrote:
Thu Aug 09, 2018 1:31 pm
Random Walker wrote:
Thu Aug 09, 2018 12:36 pm
No I don’t believe at all that Larry is calling for market timing. He is talking about long term committed changes to the asset allocation. He appreciates that most US individual investors substantially underweight international relative to world market cap weighting. Since a good starting point for equity allocation is world market cap weighting, Larry is simply suggesting that US investors might consider moving in that direction.
I'm not sure where you get that idea from. He didn't mention world market cap weighting at all. His explicit reason in this article to increase one's allocation to international and emerging markets is to "increase your expected return".

If valuations go higher for international in the future than the U.S., why wouldn't he suggest one to switch back to the U.S. for higher likely returns?

(Again, this wasn't a blatant market-timing suggestion. He offered many other reasonable options as well.)
I get that idea from both reading the article and perhaps more significantly, reading the article in the context of all the other Larry Swedroe books, articles, posts I’ve read over time. I could be wrong, but I doubt it. Certainly Larry is highly cognizant of valuations and I would say has not used them as a reason to alter recommendations, but instead has used them as minor supporting reason to help catalyze changes he suggests. The reason to move towards 50/50 US/Int is portfolio efficiency. Current valuations perhaps provide a little incentive. The reason to dump REITs is that there are underlying factors that explain REIT returns that can be accessed more efficiently other ways. Doing that when REITs are expensive is just a potential bonus. The reason to drop CCFs from the AA is that better, likewise tax inefficient, portfolio diversifiers that have real expected return have become available. The fact that they were expensive in longstanding contango at the time was perhaps some icing on the cake. I believe Larry’s suggestions are meant to be effectively permanent. The markets are ever changing, new investment vehicles are always becoming available, and financial research progresses. It only makes sense that some recommendations will change over time. Larry may act more on valuations in his own personal portfolio; I don’t know. But as far as advice to others, he always reminds us that his “crystal ball is cloudy”

Dave

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Re: Larry Swedroe: Valuations Too High?

Post by larryswedroe » Thu Aug 09, 2018 3:08 pm

To try to be helpful in clearing things up

First, market timing is based on belief that market is either under or overvalued. And you can add value by changing your AA. My suggestsion have literally nothing to do with market timing. It is based on the facts that your NEED to take risk may have changed. For example, if you lowered you AA in 1999 because returns were 2x what they were expected in 80s and 90s, that has NOTHING to do with market timing whatever anyone says.It has 100 percent to do with lower need to take risk. As example of this, the same decision would be made if instead of market returns being higher than expected you had inherited enough to bring the portfolio to the same level. Thus clearly it cannot be market timing

Second, IMO only a total fool could conclude that valuations don't matter as they matter and they matter a great deal, and you need to know the estimated returns to determine your need to take risk. Now we know there is no precision in estimating returns, because risk premiums can change and even tax rates can change, but that only means we are dealing with uncertainty not risk even. We know that valuations matter a great deal because we know that when valuations are higher the AVERAGE return over long horizons is lower, monotonically in fact (so it's no coincidence), and not only that but the whole distributions of returns shifts to the left, with the worst cases getting worse and the best cases getting less good. So you run MCS to estimate odds of success of achieving your goals because you know there is wide dispersion of potential outcomes. How anyone can conclude that they don't matter is beyond me, they are only making the mistake of believing that forecasts have to be highly accurate to have value. 40% is plenty of explanatory power especially when you know the whole distribution shifts.

Clearly it makes a big difference if forecasted mean returns are say 4% real than if they are 10% real, as that changes your need to take risk greatly.

I literally have not met a financial professional/academic who doesn't believe valuations matter a great deal. Even Bogle uses them, the hero of this board. And he uses them in same way I do, as he doesn't advocate market timing, but uses that so people can make plans based on an expected return.
As I have said, I don't know how anyone can rationally design a plan without estimating returns and then making decisions based on that. I do know of many irrational ways to do so, on the other hand.

Normally I would not bother but there is so much bad advice being given here and this is such an important topic. Note will be my last post on this as have already explained these points

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Re: Larry Swedroe: Valuations Too High?

Post by Random Walker » Thu Aug 09, 2018 3:10 pm

flyingaway wrote:
Thu Aug 09, 2018 2:05 pm
It is interesting that Larry Swedroe has decided not to participate in discussions on this forum some time ago. Yet people continued to put every one of his articles for discussions here as soon as they are published.
Well, pretty much those people are me. As I’ve said before, I’d be happy to post anyone’s good short articles for discussion. I’d like to discuss Roger Gibson’s book on Asset Allocation, but whole books generate a lot less discussion than short articles. Every once in a while I’ve posted something from Asness and Arnott I think. I simply post Larry’s articles because I believe they are excellent, short, BH relevant, and written at a good level for us Bogleheads. Very importantly, I think it’s important that ER focused TSM investors get exposed to a slightly different point of view that considers cost per value added rather than cost alone and looks at the portfolio as a whole instead of individual funds or asset classes in isolation. A typical 3 fund BH may very well learn about tilting, alternatives, etc and very rationally choose to stay on the simpler and lower cost route. But much better to actively, cognizantly, and rationally choose that path with knowledge of the alternate path and associated trade offs, than to be blind to other possibilities. The more informed investor is more likely to stick with his plan when the going gets rough.

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Re: Larry Swedroe: Valuations Too High?

Post by FIREchief » Thu Aug 09, 2018 3:27 pm

larryswedroe wrote:
Thu Aug 09, 2018 3:08 pm
To try to be helpful in clearing things up

Normally I would not bother but there is so much bad advice being given here and this is such an important topic. Note will be my last post on this as have already explained these points
I haven't seen much advice given in this thread, bad or otherwise. More like differing opinions, which is what a discussion forum should be about. Hopefully those of us who feel that valuations are not very useful in planning (as demonstrated countless times in recent history) will be allowed to draw our own conclusions on the matter. :sharebeer
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Re: Larry Swedroe: Valuations Too High?

Post by willthrill81 » Thu Aug 09, 2018 3:27 pm

Random Walker wrote:
Thu Aug 09, 2018 2:43 pm
HomerJ wrote:
Thu Aug 09, 2018 1:31 pm
Random Walker wrote:
Thu Aug 09, 2018 12:36 pm
No I don’t believe at all that Larry is calling for market timing. He is talking about long term committed changes to the asset allocation. He appreciates that most US individual investors substantially underweight international relative to world market cap weighting. Since a good starting point for equity allocation is world market cap weighting, Larry is simply suggesting that US investors might consider moving in that direction.
I'm not sure where you get that idea from. He didn't mention world market cap weighting at all. His explicit reason in this article to increase one's allocation to international and emerging markets is to "increase your expected return".

If valuations go higher for international in the future than the U.S., why wouldn't he suggest one to switch back to the U.S. for higher likely returns?

(Again, this wasn't a blatant market-timing suggestion. He offered many other reasonable options as well.)
I get that idea from both reading the article and perhaps more significantly, reading the article in the context of all the other Larry Swedroe books, articles, posts I’ve read over time. I could be wrong, but I doubt it. Certainly Larry is highly cognizant of valuations and I would say has not used them as a reason to alter recommendations, but instead has used them as minor supporting reason to help catalyze changes he suggests. The reason to move towards 50/50 US/Int is portfolio efficiency. Current valuations perhaps provide a little incentive. The reason to dump REITs is that there are underlying factors that explain REIT returns that can be accessed more efficiently other ways. Doing that when REITs are expensive is just a potential bonus. The reason to drop CCFs from the AA is that better, likewise tax inefficient, portfolio diversifiers that have real expected return have become available. The fact that they were expensive in longstanding contango at the time was perhaps some icing on the cake. I believe Larry’s suggestions are meant to be effectively permanent. The markets are ever changing, new investment vehicles are always becoming available, and financial research progresses. It only makes sense that some recommendations will change over time. Larry may act more on valuations in his own personal portfolio; I don’t know. But as far as advice to others, he always reminds us that his “crystal ball is cloudy”

Dave
When he still posted here, I confronted Larry on this specific issue. Changing your AA on the basis of valuations is precisely what Larry has recommended, and that is market timing by definition. He doesn't like that term, but that's what it is. Changing your AA on the basis of market conditions is market timing. I don't necessarily have a problem with that since I'm a trend follower myself, but let's call a spade a spade.
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Re: Larry Swedroe: Valuations Too High?

Post by willthrill81 » Thu Aug 09, 2018 3:36 pm

larryswedroe wrote:
Thu Aug 09, 2018 3:08 pm
Second, IMO only a total fool could conclude that valuations don't matter as they matter and they matter a great deal, and you need to know the estimated returns to determine your need to take risk.
Valuations may (we can't be sure) have mattered somewhat (40% explanatory power at best) in the past, but we don't know if that will be the case going forward. CAPE has been relatively 'high' since 1992 for U.S. equities, yet real returns from then until now have been slightly above average. It doesn't seem that 'high' valuations suppressed returns. Conversely, we can find lots of markets where valuations have been low for a long time and they still had poor returns.

I've not heard anyone else say that we need to estimate returns in order to determine our need to take risk. It seems to me that my need to take on risk is driven far more by my savings rate than by the rate of return of my investments. With a very high savings rate, I don't need to take on any risk at all, but I may still choose to do so.
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Re: Larry Swedroe: Valuations Too High?

Post by nedsaid » Thu Aug 09, 2018 4:19 pm

larryswedroe wrote:
Thu Aug 09, 2018 3:08 pm
To try to be helpful in clearing things up

First, market timing is based on belief that market is either under or overvalued. And you can add value by changing your AA. My suggestsion have literally nothing to do with market timing. It is based on the facts that your NEED to take risk may have changed. For example, if you lowered you AA in 1999 because returns were 2x what they were expected in 80s and 90s, that has NOTHING to do with market timing whatever anyone says.It has 100 percent to do with lower need to take risk. As example of this, the same decision would be made if instead of market returns being higher than expected you had inherited enough to bring the portfolio to the same level. Thus clearly it cannot be market timing.
Nedsaid: I will fess up. I have practiced market timing in its mildest forms, based upon not only valuation but also upon market sentiment and thus increased risk. When a family member takes up day trading, that is an indication to me that the risks in the market have increased. Or when Joe Kennedy or Bernard Baruch get stock tips from the shoe shine boys on Wall Street. It is when you get enough euphoria in the market that there are no new buyers left to drive prices higher.

So in early 2000, I sold 15% of my stocks. In July of 2013, I started my program of mild rebalancing from stocks to bonds. In 2016, I sold 20% of my REITs. Each time, the move was made as an evaluation that certain risks were getting to be greater than what I was willing to take.

So whatever Larry chooses to call it, I admit that it is a mild form of market timing. It is like the old joke where one employee tells another that around here we can name our own salary. I call mine Fred. Larry can call it risk adjustment or whatever and I call it mild market timing.

The thing is, whatever you call it, what Larry did in 1997 or so and what I did in 2000, 2013, and 2016 were an attempt to control certain risks in our portfolios. Larry had his reasons for doing what he did and I had my own reasons.
Second, IMO only a total fool could conclude that valuations don't matter as they matter and they matter a great deal, and you need to know the estimated returns to determine your need to take risk. Now we know there is no precision in estimating returns, because risk premiums can change and even tax rates can change, but that only means we are dealing with uncertainty not risk even. We know that valuations matter a great deal because we know that when valuations are higher the AVERAGE return over long horizons is lower, monotonically in fact (so it's no coincidence), and not only that but the whole distributions of returns shifts to the left, with the worst cases getting worse and the best cases getting less good. So you run MCS to estimate odds of success of achieving your goals because you know there is wide dispersion of potential outcomes. How anyone can conclude that they don't matter is beyond me, they are only making the mistake of believing that forecasts have to be highly accurate to have value. 40% is plenty of explanatory power especially when you know the whole distribution shifts.
Nedsaid: This is what I mean about putting the odds in your favor as an investor. Larry doesn't have a timing system where he blows the whistle like a lifeguard and tells everyone to get out of the water. In a similar fashion, he doesn't blow the whistle and tell everyone when it is safe to get back in. He is merely saying that as valuations increase, that future expected returns decrease. As valuation increases risk also increases. You get a diminishing future reward for taking on more and more risk.

There seems to be a mean around which the market fluctuates. Someone posted a chart showing the upward motion of the market compared with a straight line drawn upwards, sometimes the market was above the line and sometimes below it, but always fluctuating around the line. Future returns are subdued when the market is above that line and higher when it is below the line.

Jack Bogle often talks about reversion to the mean and if valuations didn't matter, there would be nothing to revert back to. So it is not a matter of precise predictions but a matter of likely outcomes.
Clearly it makes a big difference if forecasted mean returns are say 4% real than if they are 10% real, as that changes your need to take risk greatly.
Nedsaid: Yep. You might still get 10% real returns for a while after such a forecast has been made but that would cause future returns after that to be even more subdued.

Over long periods of time, economic return and stock returns are identical. In the short run, emotion and speculation can cause excess returns above economic returns. But it all evens out. Certainly, there are higher risks in an overvalued market than in an undervalued market. Problem is bear markets can happen in undervalued markets and bull markets can happen when markets are overvalued. When you look longer term valuations matter a whole lot even if they don't seem to in the short run.
I literally have not met a financial professional/academic who doesn't believe valuations matter a great deal. Even Bogle uses them, the hero of this board. And he uses them in same way I do, as he doesn't advocate market timing, but uses that so people can make plans based on an expected return.

As I have said, I don't know how anyone can rationally design a plan without estimating returns and then making decisions based on that. I do know of many irrational ways to do so, on the other hand.
Nedsaid: I am in agreement here.
Normally I would not bother but there is so much bad advice being given here and this is such an important topic. Note will be my last post on this as have already explained these points.
A fool and his money are good for business.

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Re: Larry Swedroe: Valuations Too High?

Post by larryswedroe » Thu Aug 09, 2018 4:23 pm

Nedsaid,
I'll one thing, what I did in 1998 was clearly market timing, though I only did it personally, not what I recommended to clients who have very different perspectives and understandings and tolerances than I do. I kept my equity allocation the same, but got out of all but value due to valuations of non value stocks being almost no premium, Note by March 2000 they were IMO negative premium

Over time I lowered my equity allocation which had NOTHING to do with market timing but all to do with my lower need for risks due to increased wealth.

Larry

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Re: Larry Swedroe: Valuations Too High?

Post by nedsaid » Thu Aug 09, 2018 4:27 pm

FIREchief wrote:
Thu Aug 09, 2018 12:59 pm
Leesbro63 wrote:
Thu Aug 09, 2018 10:31 am
This article from today's WSJ relates to this post. Says valuations are actually lower than not too long ago:

https://www.wsj.com/articles/valuations ... _lead_pos3


"Despite another robust corporate earnings season, the S&P 500 has inched up just 1.5% over the past three weeks as simmering trade tensions and signs of slowing growth at big technology companies sapped investor confidence. Those issues have helped drive valuations down to their lowest levels of the year, even with the broad stock-market index hovering just 0.5% shy of its January high.

The S&P 500 trades at 18.8 times earnings over the past 12 months, a basement valuation that is lower than February’s trough of 21 times earnings, according to FactSet. At the S&P 500’s peak in January, the index traded at nearly 22 times earnings, well above its current level.

Strong corporate earnings are making stocks look less pricey than they did before. Companies in the S&P 500 have posted double-digit profit growth for the past three quarters to help earnings catch up with the S&P 500’s 7% advance this year. For the latest quarter, profits are on track to rise 24% from a year earlier, the best pace of earnings beats since 2008, according to FactSet."
Thank you for posting this. I've been trying to get folks to see how much lower P/E has become due to recent earnings growth (see the third post in this thread), but those with CAPE10 vision apparently have a hard time seeing this. Some seem to be enamored with that "celebrity name nobel prize winning stuff" and simply aren't interested in the current facts and data that real investors on Wall Street are looking at. I seriously doubt any stock analyst ever visited a CEO and spent much time talking about what his company earned ten years ago.
One reason that you don't automatically sell all of your stocks when valuations get high is that sometimes earnings will rise and catch up with those high expectations. So I have seen the paradox of the market seemingly both rising and getting cheaper at the same time. Earnings and earnings expectations have been rising faster than the market itself. Someone posted that trailing earnings on the S&P 500 are at about 18 now, this seems way out of whack with Schiller P/E 10 ratios of 33 or so. Something is amiss here.
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Re: Larry Swedroe: Valuations Too High?

Post by FIREchief » Thu Aug 09, 2018 4:35 pm

nedsaid wrote:
Thu Aug 09, 2018 4:27 pm
FIREchief wrote:
Thu Aug 09, 2018 12:59 pm
Leesbro63 wrote:
Thu Aug 09, 2018 10:31 am
This article from today's WSJ relates to this post. Says valuations are actually lower than not too long ago:

https://www.wsj.com/articles/valuations ... _lead_pos3


"Despite another robust corporate earnings season, the S&P 500 has inched up just 1.5% over the past three weeks as simmering trade tensions and signs of slowing growth at big technology companies sapped investor confidence. Those issues have helped drive valuations down to their lowest levels of the year, even with the broad stock-market index hovering just 0.5% shy of its January high.

The S&P 500 trades at 18.8 times earnings over the past 12 months, a basement valuation that is lower than February’s trough of 21 times earnings, according to FactSet. At the S&P 500’s peak in January, the index traded at nearly 22 times earnings, well above its current level.

Strong corporate earnings are making stocks look less pricey than they did before. Companies in the S&P 500 have posted double-digit profit growth for the past three quarters to help earnings catch up with the S&P 500’s 7% advance this year. For the latest quarter, profits are on track to rise 24% from a year earlier, the best pace of earnings beats since 2008, according to FactSet."
Thank you for posting this. I've been trying to get folks to see how much lower P/E has become due to recent earnings growth (see the third post in this thread), but those with CAPE10 vision apparently have a hard time seeing this. Some seem to be enamored with that "celebrity name nobel prize winning stuff" and simply aren't interested in the current facts and data that real investors on Wall Street are looking at. I seriously doubt any stock analyst ever visited a CEO and spent much time talking about what his company earned ten years ago.
One reason that you don't automatically sell all of your stocks when valuations get high is that sometimes earnings will rise and catch up with those high expectations. So I have seen the paradox of the market seemingly both rising and getting cheaper at the same time. Earnings and earnings expectations have been rising faster than the market itself. Someone posted that trailing earnings on the S&P 500 are at about 18 now, this seems way out of whack with Schiller P/E 10 ratios of 33 or so. Something is amiss here.
Yes, and my contention has consistently been that it is the whole CAPE10 religion that is out of whack. I think even Warren Buffet has been quoted along the lines of "why should I be interested in what a company did ten years ago?" I think this especially true when the past ten years include a great recession and years of sluggish growth immediately thereafter.
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Re: Larry Swedroe: Valuations Too High?

Post by nedsaid » Thu Aug 09, 2018 4:45 pm

larryswedroe wrote:
Thu Aug 09, 2018 4:23 pm
Nedsaid,
I'll one thing, what I did in 1998 was clearly market timing, though I only did it personally, not what I recommended to clients who have very different perspectives and understandings and tolerances than I do. I kept my equity allocation the same, but got out of all but value due to valuations of non value stocks being almost no premium, Note by March 2000 they were IMO negative premium

Over time I lowered my equity allocation which had NOTHING to do with market timing but all to do with my lower need for risks due to increased wealth.

Larry
Good to see you fess up. The thing is Larry, you could see this pretty clearly as you have as your profession market research. The numbers were telling you something was going seriously wrong within the market. When a family member took up day trading, that is what got me really alarmed. Shoe shine boys bragging about their paper gains and all of that. You could see increasing risks along with decreasing future rewards for Growth stocks.

My original Four Horsemen of Underperformance: AIG, GE, Microsoft, and Pfizer were classic 1990's growth stocks whose expectations were way too high in comparison to their actual growth rates. Our Lady of Perpetual Disappointment, GE, had a market P/E of 45 when its underlying growth rate was more like 8% when you took out all of the gimmicks. I bought these after the 2000-2002 bear market at "bargain" prices but in retrospect were still too richly priced in relationship with their actual growth potential. Saying that valuations don't matter is pure horse hockey. My Four Horsemen where a textbook example of what happens when expectations get too high.

Ford, which was once in my portfolio is back now. It is below where I bought it and I fear that it is a Value trap. Thus it has replaced Microsoft and later Comtech Communications in my "anti-index". Ford is the opposite reason, a stock that is cheap for darned good reasons.

I still own all four stocks. This is probably my punishment for my investment sins. I have bought more Index Funds as penance. Microsoft has turned into a good investment after being essentially flat for seven years. Pfizer shows signs of life. GE is well GE, thus I have dubbed it Our Lady of Perpetual Disappointment. Not sure even St. Jude, the Patron Saint of Lost Causes can bail out GE.

So Larry as one Boglehead "sinner" talking to another "sinner", I fully understand. In your case, your call on switching your stocks to 100% Value was spot on though it took a couple of years for the worm to turn. In my case, my benefits were more marginal. You showed more conviction than I.
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Re: Larry Swedroe: Valuations Too High?

Post by HomerJ » Thu Aug 09, 2018 4:46 pm

larryswedroe wrote:
Thu Aug 09, 2018 3:08 pm
First, market timing is based on belief that market is either under or overvalued. And you can add value by changing your AA. My suggestsion have literally nothing to do with market timing.
This is EXACTLY what you are doing. You are stating that the U.S. has higher valuations and less expected return than International, and then you state that one option is to add value by CHANGING YOUR AA to have less U.S. and more International.

From your article:
There are other options you can consider, such as increasing your allocation to higher-expected-returning equities like international and emerging market stocks (with their lower valuations) or small and value stocks. All would increase the estimated expected returns of your portfolio, giving you a greater chance of achieving your goals.
That is market-timing. At this TIME, you expect THIS market to out-perform THAT market, so you suggest that one could move money to the market that you PREDICT will have higher returns going FORWARD. How can you say that's not market-timing?

It's not the ONLY option you give. You give other very reasonable options. But that one option above is absolutely market-timing.

It is based on the facts that your NEED to take risk may have changed. For example, if you lowered you AA in 1999 because returns were 2x what they were expected in 80s and 90s, that has NOTHING to do with market timing whatever anyone says.It has 100 percent to do with lower need to take risk. As example of this, the same decision would be made if instead of market returns being higher than expected you had inherited enough to bring the portfolio to the same level. Thus clearly it cannot be market timing
This is correct. I agree 100% with this. But this not what you said in this article.

I have always appreciated your "need, willingness, and ability to take risk" articles. I agree with you wholeheartedly on that subject. When your circumstances change, your need to take risk changes. That may indeed coincide with a market run-up and higher valuations. But it may not.
Second, IMO only a total fool could conclude that valuations don't matter as they matter and they matter a great deal, and you need to know the estimated returns to determine your need to take risk. Now we know there is no precision in estimating returns, because risk premiums can change and even tax rates can change, but that only means we are dealing with uncertainty not risk even. We know that valuations matter a great deal because we know that when valuations are higher the AVERAGE return over long horizons is lower, monotonically in fact (so it's no coincidence), and not only that but the whole distributions of returns shifts to the left, with the worst cases getting worse and the best cases getting less good. So you run MCS to estimate odds of success of achieving your goals because you know there is wide dispersion of potential outcomes. How anyone can conclude that they don't matter is beyond me, they are only making the mistake of believing that forecasts have to be highly accurate to have value. 40% is plenty of explanatory power especially when you know the whole distribution shifts.

Clearly it makes a big difference if forecasted mean returns are say 4% real than if they are 10% real, as that changes your need to take risk greatly.
It makes zero difference for many of us, because I'm not going to change my plans around you predicting 10% real. Because it's really a prediction of 4%-16%. That range is too big.

Valuations don't matter to me because I'm already planning around low returns (positive, but low). So you telling me expected returns are low doesn't change anything. I was already planning for low. And if you came and told me expected returns were high, I still wouldn't change my plans, because you might be wrong. I'm not going to use a plan that requires high returns to succeed.

I'm going to get what I get, and I'll adjust to that. I'll plan for 3%-4% (no matter what you predict), and if I get higher, I'll retire earlier or loosen the purse-strings, and if I get lower, I'll adjust by working longer, saving more, or reducing expenses in retirement (all reasonable options that you mentioned as well).

But by starting with low expectations (like many people here), I don't have to care about valuations at all.

As I have said, I don't know how anyone can rationally design a plan without estimating returns and then making decisions based on that. I do know of many irrational ways to do so, on the other hand.
Millions of rational people have planned for retirement without ever calculating an expected return.

We do "estimate a return". We all assume positive decent real returns long-term. But we don't need exact numbers to live below our means and save money for 30-40 years. Very few of us calculate "expected returns" and change our plans materially if it's 4% or 6% (which really means 0%-10% changing to 2%-12%).

We pick an AA mostly on our "willingness and ability" to take risk for the first 20 years, and we get what we get.
Last edited by HomerJ on Thu Aug 09, 2018 5:01 pm, edited 1 time in total.
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Re: Larry Swedroe: Valuations Too High?

Post by Artsdoctor » Thu Aug 09, 2018 4:54 pm

This is a bit of a runaway train and I can see this spiraling.

When you actually sit down to decide your investment plan, you're going to need to come up with an asset allocation. How do you decide which asset allocation works best for you? I don't think you actually make a decision by saying to yourself, "Hmm, I feel like a 70/30 type of person." We talk about the need, the ability, and the willingness to take risk. Aren't you going to make some sort of reasonable calculation on what investment return you need to reach your goals? How are you going to decide that? You can't just pull a number out of the air. If valuations are very high, aren't you going to dial back your anticipated return? Wouldn't that influence your asset allocation? Likewise, you're going to have to come up with a certain amount of money you're going to invest each year, so how are you going to decide that? Wouldn't one need to come up with a plan that has an estimated return and then figure out how much to invest? You can't just sit down and say, "Studies show that 60/40 asset allocation with 15% of earnings invested should do it."

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Re: Larry Swedroe: Valuations Too High?

Post by Artsdoctor » Thu Aug 09, 2018 4:57 pm

HomerJ, you've done your homework, and you've been investing for years. It also sounds like you're flexible. Perhaps valuations don't affect your plans. However, you can't really deny that there are a lot of people out there who haven't planned properly, and you can even look back on this board 10 years ago to see what happens when people don't put some thought into their investment planning.

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Re: Larry Swedroe: Valuations Too High?

Post by larryswedroe » Thu Aug 09, 2018 5:08 pm

here's an example I thought of to show the absurdity of claim that why I have suggested is market timing---when it is 100% about need to take risk and nothing to do with timing

Clearly it cannot be market timing if two different investors come to different conclusions, one raising equity allocation and other lowering it, because recent past returns were higher than expected due to rising valuations.

Investor A is older and has large portfolio--returns higher than expected due to valuations rising so he lowers his equity allocation due to need to take risk now lower

Investor B is younger and smaller portfolio and he now has to raise equity allocation because expected returns now less than he had expected when first designed plan. And he didn't have much invested yet so he didn't benefit

So how can it be market timing? It cannot, It's ALL about NEED to take risk

Now B could decide to lower goal or save more, etc. as I stated in article

Just amazes me at how people draw the conclusions they do

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Re: Larry Swedroe: Valuations Too High?

Post by Riley15 » Thu Aug 09, 2018 5:21 pm

If very high valuations cause you to choose a more conservative asset allocation that would also mean at very low valuations you should choose a more aggressive asset allocation? I am not sure if that's such a good strategy because you're expecting those valuations to translate into returns which may or may not actually happen.

I see a lot of confirmation bias here. Larry being a finance professional who has spent most of his life studying finance, it would be highly unlikely for him to throw up his hands and say valuations don't matter. I am sure he has seen repeated patterns that makes sense to him but are not obvious to us. Whether those translate to real world results is anyone's guess and can only be examined in retrospect.

Any hint of knowledge can be very dangerous when translated into real world expectations. There's already a risk in the imperfect assumption that's stocks will keep going up over the long term. Any other imperfect assumptions will just add multiple layers to this risk.
Last edited by Riley15 on Thu Aug 09, 2018 5:32 pm, edited 2 times in total.

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Re: Larry Swedroe: Valuations Too High?

Post by HomerJ » Thu Aug 09, 2018 5:27 pm

Artsdoctor wrote:
Thu Aug 09, 2018 4:54 pm
This is a bit of a runaway train and I can see this spiraling.

When you actually sit down to decide your investment plan, you're going to need to come up with an asset allocation. How do you decide which asset allocation works best for you? I don't think you actually make a decision by saying to yourself, "Hmm, I feel like a 70/30 type of person." We talk about the need, the ability, and the willingness to take risk. Aren't you going to make some sort of reasonable calculation on what investment return you need to reach your goals? How are you going to decide that? You can't just pull a number out of the air. If valuations are very high, aren't you going to dial back your anticipated return? Wouldn't that influence your asset allocation? Likewise, you're going to have to come up with a certain amount of money you're going to invest each year, so how are you going to decide that? Wouldn't one need to come up with a plan that has an estimated return and then figure out how much to invest? You can't just sit down and say, "Studies show that 60/40 asset allocation with 15% of earnings invested should do it."
There is no plan for most of us in our early years.

In your 20s and 30s... you don't even really know how much you need to retire. You have no idea what your retirement expenses are going to be. You don't how your career is going to turn out, or how much money you're going to be making in your 40s and 50s. (Or your spouse either).

Without even the basic information of a goal number or how much you're even going to make, how can valuations possibly matter? Is a 30 year-old really going to have a different plan if expected returns are 4% or 6%?

Basically during those years, it's "willingness and ability" to take risk. If they can stay the course, they should be 100/0 or 90/10. If they are more scared of downturns, maybe 80/20 or even 70/30. This decision has NOTHING TO DO with valuations.

In your 40s and 50s, you have an idea of what you need. Now you can use an "estimated" return to see if you are on track to hit your number. I agree with Larry that you need SOME number to see if you need to save more or work longer or change your expenses in retirement.

I think this is why he calls me a fool and irrational. One does need some number... But one doesn't need to use expected return. Instead, I submit it is wiser to always use a conservative number. I use 3%-4% nominal, and I'm prepared to adjust if we get even lower. But we'll probably get higher, and I will adjust to that as well.

I don't care about valuations, because I'm already using a conservative number.

If I was retired and valuations were low, and expected returns were high, I wouldn't start pulling 10% from my retirement accounts. I'd still stick with the 4% withdrawal, and adjust to what I actually get AFTER THE FACT. I wouldn't change my spending on EXPECTED high returns... I might change it later after getting ACTUAL high returns.

Likewise, when saving, I'm not going to change my plan because valuations are low or high. I'm not going to set my AA or my savings on EXPECTED returns... I will adjust based on ACTUAL returns.

I don't understand why this is so hard to understand by Larry and others. If expected returns are 4% today, and next year they are 5%, how exactly should I change my retirement plan, and why am I a total fool if I just keep trucking on? Should I DEPEND on getting 5% instead of 4% and change my AA and savings rate to match 5%?

Or would it be wiser to just keep savings assuming I'm only going to get 4%, and then be pleasantly surprised if we actually get 5%?

Adjust before based on the prediction? Or adjust after based on what we actually get?

"Nobody knows enough" to predict anything accurately. 2%-12% is not a range that helps me make a good retirement plan.
Last edited by HomerJ on Thu Aug 09, 2018 5:31 pm, edited 1 time in total.
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Re: Larry Swedroe: Valuations Too High?

Post by gmaynardkrebs » Thu Aug 09, 2018 5:31 pm

larryswedroe wrote:
Thu Aug 09, 2018 5:08 pm
Investor B is younger and smaller portfolio and he now has to raise equity allocation because expected returns now less than he had expected when first designed plan. And he didn't have much invested yet so he didn't benefit

So how can it be market timing? It cannot, It's ALL about NEED to take risk

Now B could decide to lower goal or save more, etc. as I stated in article
I hope B chooses to save more. Unfortunately, most of the B's in this world act more like Calpers, because the higher expected returns from equities allow them to save less and feel they are being responsible. I don't consider these equivalent choices. Do you, Larry? Having read you for many years, I don't think you do either.

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Re: Larry Swedroe: Valuations Too High?

Post by iceport » Thu Aug 09, 2018 5:42 pm

larryswedroe wrote:
Thu Aug 09, 2018 3:08 pm
To try to be helpful in clearing things up
I appreciate Larry's insights; we are fortunate for his contributions.

I'd just like to comment on the relative importance of valuations on the "need to take risk."
larryswedroe wrote:
Thu Aug 09, 2018 3:08 pm
Second, IMO only a total fool could conclude that valuations don't matter as they matter and they matter a great deal, and you need to know the estimated returns to determine your need to take risk. Now we know there is no precision in estimating returns, because risk premiums can change and even tax rates can change, but that only means we are dealing with uncertainty not risk even. We know that valuations matter a great deal because we know that when valuations are higher the AVERAGE return over long horizons is lower, monotonically in fact (so it's no coincidence), and not only that but the whole distributions of returns shifts to the left, with the worst cases getting worse and the best cases getting less good. So you run MCS to estimate odds of success of achieving your goals because you know there is wide dispersion of potential outcomes. How anyone can conclude that they don't matter is beyond me, they are only making the mistake of believing that forecasts have to be highly accurate to have value. 40% is plenty of explanatory power especially when you know the whole distribution shifts.

Clearly it makes a big difference if forecasted mean returns are say 4% real than if they are 10% real, as that changes your need to take risk greatly.
For me personally the "need to take risk" is not a controlling factor in determining my risk level. Using Larry's valuable "ability, willingness, and need" framework for assessing appropriate risk levels, my own risk level is primarily determined by balancing my "willingness" and "ability" to withstand risk.

Here's my reasoning: My portfolio will never be large enough that I wouldn't "need" more, in a relative sense. Survival is not in question, but the standard of living I aspire to will probably always be out of reach, given other life choices. That means that I will always "need" to maximize risk, and that my appropriate risk level will be limited only by my "ability" and "willingness" to withstand risk.

The ranks of ultra-high net worth individuals Larry is used to dealing with are probably well-represented here. For those folks, I agree, valuations might have significant ramifications on their need to take risk.

But I suspect that the circumstances of the vast majority of investors are closer to mine, in that their objective is to maximize returns to get as close as possible to their goals, which will ultimately remain out of reach for practical purposes.

Thus, I am relatively indifferent to valuations. Lower valuations/higher returns would be welcome, but they wouldn't move my risk needle a bit. I'll always be taking as much risk as I am willing and able to withstand. I read about valuations only out of curiosity and to temper my exceptions for portfolio performance.
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Re: Larry Swedroe: Valuations Too High?

Post by Artsdoctor » Thu Aug 09, 2018 5:54 pm

The CalPERS illustration is an interesting one, and I think you can use it in any argument here.

It's no secret that pension plans have overestimated the anticipated rate of return, often egregiously. Valuations are definitely a factor when future returns are estimated, but there is a huge political component which individual investors don't have to deal with.

CalPERS ultimately kept their 7.0% anticipated rate of return (for 30 years) intact after dialing it back from 7.5% but only because of "advocacy efforts" made by cities across California (they had toyed with a 6.5% return adjustment). However, their anticipated rate of return over the next 10 years was scaled back significantly to 6.2% with a warning that cities could anticipate feeling a lot of pain in 2018-2019 as the required contributions are made.

But the concept holds true for the argument on this thread. However, the individual investor is free to make her own projections (hopefully based on some sort of metric that makes sense) which is devoid of politics. The anticipated rate of return going forward is most likely going to be lower than in previous decades so you'd be wise to save more and spend less. Valuations are certainly taken into consideration when making these projections.

HomerJ, you're somewhat correct when you describe the mindset of certain age groups. However, not all 20-somethings or 30-somethings invest in a vacuum. I have a few "mentees" I work with in that age group and we definitely discuss returns going forward in order to plan their investments. Over the past year, I've definitely suggested bumping up their savings rates because I just don't believe the past 10 years will be mirrored in the next decade. I've not recommending changing their asset allocations based on valuations because I think it would be confusing to them, but I've made sure that they understand the importance of bringing new money into areas where it's needed most.

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Re: Larry Swedroe: Valuations Too High?

Post by Riley15 » Thu Aug 09, 2018 6:01 pm

Artsdoctor wrote:
Thu Aug 09, 2018 5:54 pm
I have a few "mentees" I work with in that age group and we definitely discuss returns going forward in order to plan their investments. Over the past year, I've definitely suggested bumping up their savings rates because I just don't believe the past 10 years will be mirrored in the next decade.

Would you have also suggest to them to bump down their savings rate if the past 10 year were below average returns? If not then there's no value added by suggesting the opposite other than the fact that to be conservative no matter what.

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Re: Larry Swedroe: Valuations Too High?

Post by nedsaid » Thu Aug 09, 2018 6:03 pm

HomerJ wrote:
Thu Aug 09, 2018 5:27 pm

There is no plan for most of us in our early years.
Nedsaid: I think this is right. I just opened an IRA and later a workplace 403(b) and saved as much as I could and invested best I could. No big plan. I just knew that I needed to get started.
In your 20s and 30s... you don't even really know how much you need to retire. You have no idea what your retirement expenses are going to be. You don't how your career is going to turn out, or how much money you're going to be making in your 40s and 50s. (Or your spouse either).
Nedsaid: It seems that I started going to advisors and running numbers in my forties. I could begin to see retirement on the horizon.
Without even the basic information of a goal number or how much you're even going to make, how can valuations possibly matter? Is a 30 year-old really going to have a different plan if expected returns are 4% or 6%? Are they really going to change their AA?
Nedsaid: Well valuations did matter in my case and probably yours. I started investing in 1984, just as the greatest bull market of my lifetime was starting. Interest rates were still relatively high and thus bonds were cheap and stocks were cheap. So the next 16 years or so, I was investing with a strong wind at my back and the compounding effect in my earlier years really helped to get the retirement balances higher. What would have happened had I started in 1973, just before the bear market of my lifetime. I would have faced 11 years or so of headwinds and not tailwinds and my balances would not have been so high.
Basically during those years, it's "willingness and ability" to take risk. If they can stay the course, they should be 100/0 or 90/10. If they are more scared of downturns, maybe 80/20 or even 70/30. This decision has NOTHING TO DO with valuations.


Nedsaid: HomerJ, what I would say is that all of this matters more and more as you get older and older and your retirement balances get to be higher and higher. Your potential losses are much higher in dollar terms with a $1,000,000 portfolio than with a $10,000 portfolio. Plus as you get older, you have fewer years to recover. A younger investor should give all of this nary a thought, older investors should think hard about all of this.
In your 40s and 50s, you have an idea of what you need. Now you can use an "estimated" return to see how you're doing. I agree with Larry that you need SOME number to see if you need to save more or work longer or change your expenses in retirement.
Nedsaid: You've got it. You need SOME number to do some planning. We all assume that stocks will outperform bonds and also assume that stocks will be more volatile than stocks. Thus our portfolios, particularly when we are relatively young, will be stock heavy. The thing is, we don't know that stocks will outperform bonds in the future, we take that on faith based upon market history.
I think this is why he calls me a fool and irrational. One does need some number... But one doesn't need to use expected return. Instead, I submit it is wiser to always use a conservative number. I use 3%-4% nominal, and I'm prepared to adjust if we get even lower. But we'll probably get higher, and I will adjust to that as well.
Nedsaid: Well, I am not calling you a fool. You DO have an expected returns number and are erring on the side of conservatism. But you are using an expected return number. After all, you are likely projecting that stocks will outperform bonds or you wouldn't own stocks at all. Why take the additional risk?
I don't care about valuations, because I'm already using a conservative number.

If I was retired and valuations were low, and expected returns were high, I wouldn't start pulling 10% from my retirement accounts. I'd still stick with the 4% withdrawal, and adjust to what I actually get AFTER THE FACT. I wouldn't change my spending on EXPECTED high returns... I might change it later after getting ACTUAL high returns.
Nedsaid: I don't believe that investors need to obsess about valuations. It is something that should be in the back of our minds. Most of the time, this isn't really all that actionable. If you saw extremes in valuations, it might be time to take action but market extremes have happened maybe three times on the high side and three times on the low side in my lifetime. So you don't need to buy a market timing newsletter. The two times in my lifetime of true market euphoria were in about 1968 and again in 1999. The biggest buying opportunities were in 1975, late 2002, and in 2009. These events are relatively rare.

If your relatives all quit their jobs and take up day trading, it might be a clue to cut back on your stocks.

Again, this is of more importance when you are older and have less capacity to bounce back from bear markets.
Likewise, when saving, I'm not going to change my plan because valuations are low or high. I'm not going to set my AA or my savings on EXPECTED returns... I will adjust based on ACTUAL returns.
Nedsaid: In practice, this is what I have done. We used to call this taking profits, today Bogleheads call this market timing. Those of us who are sensitive to semantics and don't want to be called timers just call it aggressive rebalancing. :wink:
I don't understand why this is so hard to understand by Larry and others. If expected returns are 4% today, and next year they are 5%, how exactly should I change my retirement plan, and why am I a total fool if I just keep trucking on? Should I DEPEND on getting 5% instead of 4% and change my AA and savings rate to match 5%?

Or would it be wiser to just keep savings assuming I'm only going to get 4%, and then be pleasantly surprised if we actually get 5%?

Adjust before based on the prediction? Or adjust after based on what we actually get.

"Nobody knows enough" to predict anything accurately. 2%-12% is not a range that helps me make a good retirement plan.
Nedsaid: The point is that we are weighing odds and not making precise predictions. If valuations are high, the returns will most likely be closer to the 2% and not the 12%.
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Re: Larry Swedroe: Valuations Too High?

Post by FIREchief » Thu Aug 09, 2018 6:07 pm

HomerJ wrote:
Thu Aug 09, 2018 5:27 pm
There is no plan for most of us in our early years.

In your 20s and 30s... you don't even really know how much you need to retire. You have no idea what your retirement expenses are going to be. You don't how your career is going to turn out, or how much money you're going to be making in your 40s and 50s. (Or your spouse either).

Without even the basic information of a goal number or how much you're even going to make, how can valuations possibly matter? Is a 30 year-old really going to have a different plan if expected returns are 4% or 6%?
The only input I needed in my 20s and 30s was a basic fear of a future which could be filled with unknown expenses, career disappointments, failure of government support programs and other such very expensive and very unknowable factors. I also had a healthy understanding that God was under absolutely no obligation to honor any plans I came up with. Consequently, my only financial plans were to save a lot and live below our means.
I don't care about valuations, because I'm already using a conservative number.

I don't understand why this is so hard to understand by Larry and others.
It is very easy to understand HomerJ, and you've explained this very clearly. Either others understand but refuse to acknowledge the folly in their own thinking, or they are fools.

Note: I'm not the first person to use the word "fool" in this thread.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Larry Swedroe: Valuations Too High?

Post by larryswedroe » Thu Aug 09, 2018 7:00 pm

To help those for whom this seems difficult

First, when young and starting out on your investment career, unless lucky to be born to wealth, your AA should be dominated by your ability and willingness to take risk. Valuations won't matter much if at all because you should be saving and investing as much as possible. And you should hope for poor returns with valuations falling so you can invest more at lower valuations and earn higher expected returns with larger amounts of assets.

Then as age and gain wealth and get closer to goals the need to take risk should begin to play a more dominant role, though of course tempered by ability and willingness to take risk. If actual returns exceed expected, likely should lower equity as don't NEED as much risk. Has NOTHING to do with timing market. No different decision would be made if returns were the same as expected but inherited money. You lower equity allocation because your need to take risk is lower. And perhaps vice versa, depending on ability and willingness to take risk.

Very simple. And exactly the same thing I've said for almost 25 years now.

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Re: Larry Swedroe: Valuations Too High?

Post by willthrill81 » Thu Aug 09, 2018 7:18 pm

larryswedroe wrote:
Thu Aug 09, 2018 7:00 pm
To help those for whom this seems difficult

First, when young and starting out on your investment career, unless lucky to be born to wealth, your AA should be dominated by your ability and willingness to take risk. Valuations won't matter much if at all because you should be saving and investing as much as possible. And you should hope for poor returns with valuations falling so you can invest more at lower valuations and earn higher expected returns with larger amounts of assets.

Then as age and gain wealth and get closer to goals the need to take risk should begin to play a more dominant role, though of course tempered by ability and willingness to take risk. If actual returns exceed expected, likely should lower equity as don't NEED as much risk. Has NOTHING to do with timing market. No different decision would be made if returns were the same as expected but inherited money. You lower equity allocation because your need to take risk is lower. And perhaps vice versa, depending on ability and willingness to take risk.

Very simple. And exactly the same thing I've said for almost 25 years now.
Then valuations alone have no actionable impact on the individual investor's strategy?

If that's what you're saying, I completely agree.
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Re: Larry Swedroe: Valuations Too High?

Post by larryswedroe » Thu Aug 09, 2018 7:34 pm

will

I have basically said that for 24 years. And it should have been perfectly clear from my posts as it was all about the NEED to take risk, not valuations. How Homer or anyone else could draw any other conclusion is beyond my ken. As it was very clear in my writing---have not gotten one question about that from anyone but a few people here, and that includes tens of thousands of our clients and other readers of my blogs. I've been very clear about high valuations not signalling overvaluation and thus cannot or should not be used to time markets. I've even highly critisized Grantham and Hussman for doing so, pointing out why I thought they were wrong. Yet despite that, some keep saying I'm recommending changing AA based on valuations. NO< NO< NO< It's that high valuations are the result of high past returns and it's the high past returns that can reduced (or increase) NEED to take risk. And that is the driver, always.

The exception for those with discipline (and the problem is if you get out have to be able to get back in and there is never a clear all green signal) is when TIPS yields above E/P, which was the case in 2000. That is IMO definition of a bubble. And IMO in that case it's prudent to move to safer investments. Now I will add that while I had done that personally (though I did not change equity allocation because value stocks were only slightly above long term value valuations, so I went all value, and that was earlier in 1998) as a firm we did not advise clients to do so for whole variety of reasons. Mainly typical investor doesn't have patience, discipline, etc and confuses strategy with outcomes.

I will add this, we invest in equities even though they are riskier. Reason we anticipate a risk premium. Now at some point you should believe the risk premium isn't worth it. That is a different level for every person. The ERP has historically been high because wealthy people have little need to take risk, they have the money, and what can entice them to buy stocks is a high ERP. Lower it and they might move to safer bonds. At some point that should be true for everyone. But it's tough to know that. So the only sure thing to me is when TIPS yields are above E/P and thus have a negative risk premium for stocks, that's a good signal to pay attention to. Other than that, likely should ignore for most people,.

And now I'm really done, spent way too much time on it.

Hope that is helpful

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Re: Larry Swedroe: Valuations Too High?

Post by willthrill81 » Thu Aug 09, 2018 8:18 pm

larryswedroe wrote:
Thu Aug 09, 2018 7:34 pm
will

I have basically said that for 24 years. And it should have been perfectly clear from my posts as it was all about the NEED to take risk, not valuations. How Homer or anyone else could draw any other conclusion is beyond my ken. As it was very clear in my writing---have not gotten one question about that from anyone but a few people here, and that includes tens of thousands of our clients and other readers of my blogs. I've been very clear about high valuations not signalling overvaluation and thus cannot or should not be used to time markets. I've even highly critisized Grantham and Hussman for doing so, pointing out why I thought they were wrong. Yet despite that, some keep saying I'm recommending changing AA based on valuations. NO< NO< NO< It's that high valuations are the result of high past returns and it's the high past returns that can reduced (or increase) NEED to take risk. And that is the driver, always.

The exception for those with discipline (and the problem is if you get out have to be able to get back in and there is never a clear all green signal) is when TIPS yields above E/P, which was the case in 2000. That is IMO definition of a bubble. And IMO in that case it's prudent to move to safer investments. Now I will add that while I had done that personally (though I did not change equity allocation because value stocks were only slightly above long term value valuations, so I went all value, and that was earlier in 1998) as a firm we did not advise clients to do so for whole variety of reasons. Mainly typical investor doesn't have patience, discipline, etc and confuses strategy with outcomes.

I will add this, we invest in equities even though they are riskier. Reason we anticipate a risk premium. Now at some point you should believe the risk premium isn't worth it. That is a different level for every person. The ERP has historically been high because wealthy people have little need to take risk, they have the money, and what can entice them to buy stocks is a high ERP. Lower it and they might move to safer bonds. At some point that should be true for everyone. But it's tough to know that. So the only sure thing to me is when TIPS yields are above E/P and thus have a negative risk premium for stocks, that's a good signal to pay attention to. Other than that, likely should ignore for most people,.

And now I'm really done, spent way too much time on it.

Hope that is helpful
Thanks for clarifying that Larry.
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Re: Larry Swedroe: Valuations Too High?

Post by Johnnie » Thu Aug 09, 2018 8:28 pm

I found this bit very interesting in Larry's article, and it seems to address some of the quibbles about the value of CAPE 10:
However, as Graham and Dodd observed, there’s really nothing special about using the 10-year average. Other time horizons also provide information on future returns. With that in mind, I’ll analyze how changing the horizon can impact our view of the market’s valuation.

While the current U.S. CAPE 10 is 33, the current CAPE 8—which has about the same explanatory power as the CAPE 10 but excludes the very bad and temporarily depressed earnings figures from 2008 and 2009—is 5 points lower at 28. (Comparable figures for non-U.S. developed and emerging markets are about 19 and 15, respectively.)

That’s not all that much higher than the CAPE 10’s mean of 25.6 from 1990 through April 2018. A CAPE ratio of 28 results in an earnings yield of 3.6%, while a CAPE ratio of 25.6 results in an earnings yield of 3.9%. That’s not much of a difference. It is also just 1 percentage point lower than the average CAPE 10 earnings yield of 4.6% for the period starting from 1980. There’s no way to know if that is the right earnings yield.

Additionally, if we use the CAPE 8 of 28, and make the adjustments for the accounting changes and the reduction in dividends, we get what we might call an adjusted CAPE 8 of about 23.5. That provides a forecast for real returns of about 4.3%, or about 1 percentage point higher than the real return forecast using the current CAPE 10. That’s the good news. The bad news is that it still leaves you with expected U.S. stock returns well below historical levels, and probably well below the expectations of most investors.
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Re: Larry Swedroe: Valuations Too High?

Post by Random Walker » Thu Aug 09, 2018 8:40 pm

larryswedroe wrote:
Thu Aug 09, 2018 7:34 pm

I will add this, we invest in equities even though they are riskier. Reason we anticipate a risk premium. Now at some point you should believe the risk premium isn't worth it. That is a different level for every person. The ERP has historically been high because wealthy people have little need to take risk, they have the money, and what can entice them to buy stocks is a high ERP. Lower it and they might move to safer bonds. At some point that should be true for everyone.

Hope that is helpful
I think this is especially true when we keep in mind that all estimates of future returns are only means with big dispersions. Generous past returns result in current high valuations and lower future expected returns. Those lower future expected returns represent a whole dispersion which has shifted left: good outcomes that are less good and bad outcomes that are worse. Knowing from behavioral finance that the pain of a loss is way more than the happiness from an equal sized gain, at a certain point the risk seems silly. For someone around retirement, an extra 2-4% above bond yields as the ERP just doesn’t seem worth the risk represented by the left side of the potential return distribution.

Dave

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Re: Larry Swedroe: Valuations Too High?

Post by golfCaddy » Thu Aug 09, 2018 8:50 pm

In theory, you should save more when expected returns are low during the accumulation phase. In practice, it seems like most people are wired as spenders or savers, and CAPE10 won't convince either group to change their spending and lifestyle.

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Re: Larry Swedroe: Valuations Too High?

Post by HomerJ » Thu Aug 09, 2018 10:44 pm

larryswedroe wrote: I have basically said that for 24 years. And it should have been perfectly clear from my posts as it was all about the NEED to take risk, not valuations. How Homer or anyone else could draw any other conclusion is beyond my ken. As it was very clear in my writing---have not gotten one question about that from anyone but a few people here, and that includes tens of thousands of our clients and other readers of my blogs. I've been very clear about high valuations not signalling overvaluation and thus cannot or should not be used to time markets. I've even highly critisized Grantham and Hussman for doing so, pointing out why I thought they were wrong. Yet despite that, some keep saying I'm recommending changing AA based on valuations. NO< NO< NO< It's that high valuations are the result of high past returns and it's the high past returns that can reduced (or increase) NEED to take risk. And that is the driver, always.
You just said valuations don't matter when picking an AA. Which I agree with. 100%.

If valuations were high or low, I'd still be 50/50 at this point.

So we agree that valuations don't matter when picking an AA. Instead of using expected return, I use a low conservative return as a planning point.

You say "How Homer or anyone else could draw any other conclusion is beyond my ken."

The reason I have drawn a different conclusion is because in the past, you have also EXPLICITLY posted that valuations are super important, and one would be an irrational idiot not to use expected returns to determine an AA.

Edit: I replied to Dave below asking how to use expected returns to determine an AA or savings rate.
Last edited by HomerJ on Thu Aug 09, 2018 11:49 pm, edited 6 times in total.
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Re: Larry Swedroe: Valuations Too High?

Post by Random Walker » Thu Aug 09, 2018 11:12 pm

Homer,
We basically agree. As we get older and accumulate wealth, past returns, current valuations, expected returns, and our own net worth become tremendously interrelated. We choose an AA based on our ability, willingness, need to take risk. All of those are related to what the market has given us, what expected future returns are, and our realistic financial goals. Adjusting our AA according to our current circumstance and goals is about meeting goals with as little risk as possible, not so much timing the market. The default is to stick with the current plan, but if a realistic assessment of where one is relative to his goals reveals that he should take more or less risk, then he should make the AA change. Need to incorporate current valuations and expected returns into the estimates of how much risk to take. Pretty sure we’re pretty much on the same page.

Dave

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Re: Larry Swedroe: Valuations Too High?

Post by HomerJ » Thu Aug 09, 2018 11:33 pm

Random Walker wrote:
Thu Aug 09, 2018 11:12 pm
Need to incorporate current valuations and expected returns into the estimates of how much risk to take.
Okay, so this is what you and Larry are talking about. How does this work in practice?

How different is my retirement plan if expected returns are 5% (really -1% - 11%) or 6% (0%-12%) or 7% (1%-13%)?

What if expected returns were 7%? I guess I can cut back on savings, or have less stocks, right? Since I'm likely to make more return going forward? Should I plan around 7%?

But 7% is really 1%-13%. Should I really make significant changes to my savings rate or my AA? What if we only get 3%?

Maybe I should plan around getting 3%, since that's on the low end of all three expected return ranges above. That's a pretty conservative way to go.

And then if I get more (likely), I can just retire earlier, or loosen up the purse strings a bit, or have more cushion in retirement.

And if I get less, say 1%, at least it won't be too much less. I was planning for 3%.. I can probably survive 1%.

If I planned around 7% and only got 1%, I might be in big trouble.

Do you see what I'm saying here? I don't see any significant changes to my AA because valuations and expected returns change. 5%, 6%, 7%, doesn't really change anything. I'm still going to use a conservative number on the low end of the expected return ranges, the low end of historical returns.

I say ignore valuations, plan on a low conservative return, and adjust on ACTUAL returns (which will likely be higher than my plan).

This may get me saving too much early on, but if returns are good, I can ease up fairly quickly, and if returns are bad, I'll be happy I've saved more.

Pretty sure we’re pretty much on the same page.
I agree... except for caring about valuations. But everything else, absolutely.
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Re: Larry Swedroe: Valuations Too High?

Post by marcopolo » Thu Aug 09, 2018 11:50 pm

larryswedroe wrote:
Thu Aug 09, 2018 7:00 pm
To help those for whom this seems difficult

First, when young and starting out on your investment career, unless lucky to be born to wealth, your AA should be dominated by your ability and willingness to take risk. Valuations won't matter much if at all because you should be saving and investing as much as possible. And you should hope for poor returns with valuations falling so you can invest more at lower valuations and earn higher expected returns with larger amounts of assets.

Then as age and gain wealth and get closer to goals the need to take risk should begin to play a more dominant role, though of course tempered by ability and willingness to take risk. If actual returns exceed expected, likely should lower equity as don't NEED as much risk. Has NOTHING to do with timing market. No different decision would be made if returns were the same as expected but inherited money. You lower equity allocation because your need to take risk is lower. And perhaps vice versa, depending on ability and willingness to take risk.

Very simple. And exactly the same thing I've said for almost 25 years now.
Larry,

I think this makes a lot of sense. If i understand it correctly, the point above is that "your assets have grown a LOT because we have had a great run (some of it due to expanding valuations), so maybe you don't need to take as much risk going forward, so consider lightening up".

It was not clear to me that this was the message in the linked article that was the subject of this thread. That article seemed to be all about valuation, and what to do in response to them being high in certain areas such as save more, lower future expenses, or shift investments to other areas of the market with lower valuations. I think it is this last one that comes across as advocating market timing based on valuations.

Perhaps that is why there has been so much reaction to this article, as it came across as quite contradictory to the message you have been sending for some time.

Despite some of the rancor, this has been an interesting discussion. If nothing else, it has had the effect of engaging you in some of the discussion. I hope that is a trend that will continue in other discussions as well. While I don't always agree with your point of view, I always find them well thought out and makes me think about my own assumptions and conclusions. Which can only help me improve as an investor.
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Re: Larry Swedroe: Valuations Too High?

Post by Random Walker » Fri Aug 10, 2018 7:56 am

Homer J,
I totally get your point. I think it’s very important that, like you, people focus as much (or more) on the potential dispersion of returns as the mean. I think we’d agree that not much of this is actionable for the young investor. Whether expected returns are 3%, 5%, or 7%, he just needs to save, invest, take risk. For those of us who are older, have accumulated, and have more to lose, I think the story is very different. In that setting, with knowledge that higher valuations have caused the whole distribution of potential returns to shift left, and bonds yielding say 2%, rational investors may take a whole lot more risk off the table when expected returns only 3% (1% above bonds) versus 7% (5% above bonds). As Larry wrote, one explanation for the equity risk premium is that wealthy individuals who don’t need to take risk, need enough enticement to encourage them to take risk. Everyone will individually decide how much potential excess return is enough to be enticed. But knowledge of the entire potential distribution, and looking over one’s shoulder at the big left negative portion of that distribution, the differences between 3%, 5%, 7% expected returns can very much affect an older individual’s AA. Like I said, pretty sure you and I pretty much on the same page.

Dave

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Re: Larry Swedroe: Valuations Too High?

Post by larryswedroe » Fri Aug 10, 2018 8:14 am

To be helpful here

Again, it's not that valuations don't matter to AA, they do matter a great deal because they impact expected returns and that in turn impacts your need to take risk. And it's the need to take risk that should drive your AA, along with ability and willingness to do so. So as valuations change that can causes the need to take risk to change. And if the need to take risk changes, then clearly one of the assumptions upon which you built your plan should change. That's just common sense, which is unfortunately all too common as some people cling to what is referred to as foolish consistency, consistency for it's own sake is foolish (in the face of changing facts/circumstances). It's no different than when life events change your ability or willingness to take risk, you should change your AA and not remain foolishly consistent.

Thus, there is a big difference if expected returns are 7% than 5%. The difference is that at 7% investors have a choice they can make. They can increase their withdrawal rate (that's what the assets are for, to spend and enjoy life, and spending now is more valuable than spending later, so want to avoid being excessively conservative), or can lower equity allocation if your preference is to "sleep better." Being conservative is fine and the right choice for many. But others will choose, right for them, to spend more currently, perhaps donating more to charity every year, or traveling more. No right answer, it just depends on personal situation. But clearly it matters.

For some investors we have had to deliver news that indicated they should cut back spending or donations to charity. At other times, we can deliver the good news that they can spend more and still have high odds of success (especially if have options can consider). Thus it clearly matters what returns are expected, and it also matters that you have to consider the wide potential dispersion of returns (and have that Plan B in place if the left tail risk shows up).

I hope that is helpful and ends this part of the questions.


Larry

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Re: Larry Swedroe: Valuations Too High?

Post by Artsdoctor » Fri Aug 10, 2018 8:27 am

Riley15 wrote:
Thu Aug 09, 2018 6:01 pm
Artsdoctor wrote:
Thu Aug 09, 2018 5:54 pm
I have a few "mentees" I work with in that age group and we definitely discuss returns going forward in order to plan their investments. Over the past year, I've definitely suggested bumping up their savings rates because I just don't believe the past 10 years will be mirrored in the next decade.

Would you have also suggest to them to bump down their savings rate if the past 10 year were below average returns? If not then there's no value added by suggesting the opposite other than the fact that to be conservative no matter what.
Yes. Several years ago, when valuations were much lower, we designed a specific savings rate. Now that valuations have increased and anticipated returns are more likely to be lower (not assured, but more likely), I asked them to consider bumping up their savings rates if possible. This was really not my decision alone, it was recommended by Vanguard on multiple podcasts and interviews.

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