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If you believe in tactical asset allocation, as I do, then all you're arguing is that bonds make more sense right now than stocks, given current prices and conditions.

We're not arguing here. If you believe in tactical asset allocation and think that there is below average risk of losing real economic growth by avoiding stocks (sorry for the triple negative - in English I'm saying that if you think the economy won't grow fast enough to prop up stock prices), then you will want to be underweighted in stocks and overweighted in bonds. For you, that means at least 100% net long in bonds and at most 0% net long in stocks.

My point is only that by buying bonds, you lose the opportunity to participate in surprisingly good inflation-adjusted economic growth. You are infinitely tolerant of this risk at the moment because you think it has a very low probability, but it's still a risk.

I believe that the equity risk premium is currently negative, even for your nephew. That doesn't mean he should never invest in stocks, just that he shouldn't do so right now.

Mathematically, I understand what you're saying. Economically, I disagree. If the risk premium is negative, then that means the expected value of return on a stock investment is less than the expected value of return on bonds. But I think you'll agree that the volatility on stocks is higher. So say I have some amount of money that is basically useless to me (say $100), and you give me two choices: put it in a bond fund and pay me a certain $200 ten years from now, or put in in stocks and have a 90 percent chance of losing it all and a 10 percent chance of making $1500 ten years from now. If $200 has little more utility to me than $0, but $1500 has a lot more utility than $200 (more than ten times as much, to make the math work on the 10% probability of success), then it is economically rational to make the stock investment despite the negative risk premium.

I think a fair number of baby boomers are in this position. They haven't saved enough for retirement - their current funds are insufficient, and whatever they'd get from a bond investment is insufficient as well, even at fairly attractive rates. So they roll the dice, voluntarily taking on risk in order to speculate on an outlying result.

The extreme example is the poor person buying a lottery ticket. The Fool can tell these guys all they want that if they would save that $1, they would have $10 waiting for them when they retire. But that $10 doesn't do them any good, from a utility standpoint. They'd rather have a snowball's chance in hell of $100 million. And while the math is against them, in terms of economic utility it's a rational decision.

Of course, none of this means that you shouldn't take advantage of mispricing due to this probably temporary utility preference. We'd all get together and set up a consortium to sell lottery tickets if we could. But tactically, you have to evaluate the cause of the mispricing and analyze whether it will continue, get worse, or revert to the mean - rather than just looking at the mispricing itself and saying that it has to get back to the mean sometime. If your answer to that is that you're willing to wait it out, that's fine - but I think that's more strategic thinking than tactical.

But I think this is a better argument for investing in foreign markets (e.g. India, China) than for investing in U.S. multinationals.

The question is who reaps the benefits of a foreign market's economic growth: its native companies or US multinationals. Or actually, I guess the question is whether the market correctly allocates the expected benefits in pricing the companies - if the market unreasonably thinks multinationals will beat out the native companies, then the native companies are the smart bet. Figuring out what's reasonable or unreasonable is the hard part.

If I'm going to wait out a long-term position in equities (be it short or long), then I want to have valuation behind me.

For me, I agree. But if you're in a position where you need the volatility in order to achieve your goals, then I can understand somebody who invests against the mathematical odds because their circumstances make them risk-loving rather than risk-averse or even just neutrally risk-tolerant. And if these people make up the majority of the market, then you have to be open to the possibility that their aggregate behavior may continue to have an impact on equity prices for some time.

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