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7 Steps To The Launching Of A National Debate On The Realities Of Stock Investing

By Rob Bennett Step One: The Buy-and-Holders Accept That a Debate Is Inevitable. This is a turf battle. Eugene Fama and Robert Shiller have both won Nobel prizes for saying opposite things about how stock investing works. It’s not possible that both are right. The natural thing would have been for the debate to have been launched in 1981, when Shiller published his “revolutionary” (his word) research findings. Things got held up because there is so much money to be made in this field, and by the time Shiller published his research, thousands of people had built careers promoting Buy-and-Hold strategies. These people were naturally not too excited about the idea of acknowledging that they had been giving bad advice for a long time. The reality is that sooner or later, they are going to have to at least acknowledge that possibility. A Nobel prize cannot be denied. And, if Shiller is right, the promotion of Buy-and-Hold strategies caused an economic crises. This affects everyone. So, the debate has to come. Once that is widely recognized, the question changes from whether or not to have the debate to how to proceed with the important business of launching it. Step Two: Industry Leaders Recognize How Much Money There Is to Be Made by Moving Forward. I often hear a cynical response when I make the case for the launching of a national debate. People say that there is too much money made promoting Buy-and-Hold for the industry to permit a debate that might discredit the strategy. I don’t think that’s right. Valuation-Informed Indexing reduces risk dramatically. Millions of middle-class people resist the lure of stocks because they are turned off by the idea of taking on too much risk with their retirement money. A transition to the Shiller model would increase profits for those in the stock-selling industry, not diminish them. The problem, for many years, has been that profits were good enough as a result of the huge bull market, and so, there was a feeling that there was no cause to rock the boat. The next price crash will change that. After prices fall hard again, the industry will be feeling the pinch and will go looking for ways to restore public confidence in the market. That’s when people will see that the model of the future has been available to us for 35 years – it’s just been a question of us developing an interest in taking advantage of the opportunity. Step Three: Jack Bogle Says “I’m Not Entirely Sure” Whether Fama or Shiller is Right. The debate has been delayed because the Buy-and-Hold Model was established first, and getting investing right is so important that the Buy-and-Holders have thus far not been able to acknowledge even the possibility of their having made a mistake. That changes on the day when Bogle says the words “I’m” and “Not” and “Sure” in a public place and his words are written up on the front page of the New York Times . Everyone who works in this field would interpret those words as giving them permission to talk openly about the case against Buy-and-Hold. Once there are people speaking openly, clearly and firmly on both sides of the story, we will all be engaged in an amazing learning experience. Step Four: Behavioral Finance Experts Seek to Distinguish Themselves By Drawing Sharp Contrasts Between Their Advice on Strategic Questions and the Advice Offered by the Buy-and-Holders. Behavioral Finance has been a growing field for many years. But it has had little impact in the practical realm, because the Behavioral Finance experts have shied away from showing how a model that considers the effect of human psychology on investing choices leads to very different advice on strategic questions (particularly, asset allocation questions). For so long as Buy-and-Hold has remained dominant, it has seemed “rude” to point out that the Buy-and-Hold advice on just about every question is dangerous if Shiller is right that valuations affect long-term returns and that risk is thus not static, but variable. Once the floodgates are opened by Bogle’s historic speech, each of the Behavioral Finance experts will tap into a healthy competitive instinct to distinguish himself or herself by showing how different his or her advice is from the conventional Buy-and-Hold advice. We will see 35 years of insights developed and explained and promoted and explored in the space of a few years. Exciting times! Step Five: Thought Leaders Recognize the Need to Help the Buy-and-Holders Save Face. We need to see a battle of ideas, not a battle of personalities. We want the Buy-and-Holders working with us, not against us. The Buy-and-Holders built the foundation on which Valuation-Informed Indexing is built. It would be as crazy for us to come to see them as enemies once the debate is launched as it has been for them to see us as enemies during the decades in which it has been delayed. Wise heads will prevail. We will see that we are all in this together. As a result, things will move ahead at a quick pace once things begin moving ahead. The Buy-and-Holders have a lot to contribute, and they will do so as long as we are careful to acknowledge their many genuine achievements. Step Six: The Political Implications of Shiller’s Breakthrough Come to Be More Widely Appreciated. It was the promotion of Buy-and-Hold strategies that caused the economic crisis (by encouraging stock prices to soar to insanely dangerous levels, and then by causing the economy to lose trillions of dollars of buying power when the bubble popped). The economic crisis affects all of us, not just the investing industry and not just those who buy stocks. The debate will go into high gear when it becomes widely understood that we all have a stake in ensuring that we all have access to sound, responsible and research-backed investing advice. The stock-selling industry has been dragging its feet for a long time. But this is bigger than the stock-selling industry. Step Seven: Outsiders Flood into the Stock-Selling Industry. The launching of the debate need not be perceived as a threat to those currently working in the field and promoting Buy-and-Hold strategies. But it will speed things up when initial discussion of the new model shows the need for the industry to welcome new types of experts. We will be seeing a transition from a focus on math-based skills to a focus on psychology-based skills. The new blood will bring the field alive (but we are, of course, always going to need lots of people with math-based skills in this field). Disclosure: None.

AGG: A Solid Bond Fund Offering Low Expenses And Diversification

Summary The expense ratio on AGG is one of the drawing factors for this fund. At .08% it is one of the cheapest bond funds in the market. The fund has extensive diversification in the maturity of the bonds which provides more diversification in the risk. The credit ratings are fairly high with a significant allocation to treasury securities. Allocation to MBS does not thrill me since mREITs are available at material discounts to book value, but the low expense ratio still helps the expected return. Overall, there is more to like about this fund than to dislike. The major risk factor facing the fund is rising domestic rates. The iShares Core Total U.S. Bond Market ETF (NYSEARCA: AGG ) is a highly diversified bond fund with a reasonable yield, great expense ratio, and great liquidity. Expenses When I’m looking for a bond ETF, I normally want to see diversification in the holdings. The only real exception would be if I’m looking for treasuries with a fairly steady maturity date. Getting any thorough due diligence on the bonds in a fund can require having a higher expense ratio to cover the costs of doing research. The challenge for a bond fund with a high expense ratio to create solid returns is that it requires them to be doing sufficient research to consistently produce superior default estimates to those available in the market or to have a method for acquiring bonds at a discount by dealing in illiquid bonds where counterparties are more difficult to find. Some funds are able to offer low expense ratios and mitigate their risks by strictly dealing in the most liquid bonds where pricing is most likely to be efficient and relying on the market to ensure that the risk/return profile is appropriate. Generally I favor ETFs that have low expense ratios and strictly deal in highly liquid bonds where the pricing will be more efficient. The expense ratio for AGG is a .08%. This is one of the funds falls into my desired strategy of using highly liquid securities and a very low expense ratio to rely on the efficient market to assist in creating fair values for the bonds. Yield The yield is 2.41%. The desire for a higher yield should be fairly easy for investors to understand. Bond funds that offer a higher yield are offering more income to the investor. Unfortunately, returns are generally compensating for risk so higher yield funds will usually require an investor either take on duration risk or credit risk. In many situations, an investor will take on a mix of the two. Junk bond funds generally carry a high degree of credit risk but low duration risk while longer duration AAA corporate funds have only slight to moderate credit risk combined with a significant amount of duration risk. Theoretically treasuries have zero credit risk and long duration treasuries would have their risk solely based on the interest rate risk. Duration The following chart demonstrates the sector exposure for this bond fund: At the present time I’m concerned about taking on duration risk in early December because of the pending FOMC (Federal Open Market Committee) meeting. I believe it is more likely than not that we will see the first rate hike in December. I think a substantial portion of that probability has already been priced into bonds, so investors willing to take the risk prior to the meeting could see significant gains if the Federal Reserve does not act. Even though most of the impact is priced in, I suspect it will happen and that there will be some impact on rates which may trigger a solid opportunity for starting investments in bonds. I’ll be looking to increase my positions in interest sensitive assets if rates move higher. I’ve been focused on bond funds that are free to trade for me or have a longer duration exposure to corporate debt, but AGG is a pretty solid option for investors looking to add bonds in December. Credit Risk The following chart demonstrates the credit exposure for this bond fund: The exceptionally high rating to triple AAA stocks includes positions in treasury securities. The very high credit rating of this fund is excellent for investors looking for something that can withstand a sharp decline in the equity market. Rather than declining with equity markets this bond fund should see strength in share prices when investors are scared about the risk of higher defaults and weaker equity performance. When things look ugly, this fund should perform well. When things look great, this fund should underperform some of the riskier options. Sectors The following chart demonstrates the sector exposure for this bond fund: I have some concerns about the sector allocation including a substantial allocation to MBS Pass-Through securities. There are several mREITs where investors can get MBS exposure at a substantial discount to book value. On the other hand, that exposure also includes exposure to hedging the portfolio with Eurodollar Futures contracts in most scenarios and the expenses of management for an mREIT will dramatically exceed the .08% expense ratio of holding AGG. Conclusion Overall the diversification here is pretty solid and I don’t see much to complain about. This is one of the largest bond funds on the market and it offers great liquidity, a decent but not incredible yield, and a very low expense ratio. That liquidity extends to the point of millions of shares trading in a single day. That keeps the bid-ask spread small and makes trading in and out the ETF much easier for investors that want to use it to stabilize their portfolio value.