The Shiller Revolution – The New Way to Invest

There’s a revolution going on!

You may not have heard about it yet, but it’s been gradually building up strength for three decades now. I predict that you’ll be hearing a lot about it in days to come. It’s about to make all our lives a lot richer than they have been in recent times.

I call it — The Shiller Revolution.

You probably have heard of Yale Economics Professor Robert Shiller. He wrote a book titled Irrational Exuberance that became a critically acclaimed bestseller in early 2000. Unfortunately, there’s been little public debate about the far-reaching claims Shiller puts forward in his book. When that changes (and there’s good reason to believe this is going to happen soon), sparks are going to fly.

Good sparks. We all are going to learn how to obtain far higher returns from stocks while taking on far less risk. I’ll need to explain a little bit of theory to show why this is so. I hope you’ll stick with me for a few paragraphs so that you will be able to appreciate how this revolution in our understanding of how stock investing works is going to enrich your life in highly significant ways.

Many investors don’t appreciate that today’s understanding of how stock investing works is primitive. There’s a good bit of research available to us today. But little of it dates back farther than the 1960s. That’s when the study of stock investing became an object of sustained, systematic study.

That’s important. What that means is that all the things that the experts in this field believe have been “proven” about stocks are really nothing more than tentative theories. We obviously should respect the work that has been done. But it’s a mistake to place too much confidence in it until it stands the test of time. Otherwise, we run the risk of coming to strongly believe in things that are just not so. That can be dangerous indeed.

The two most important discoveries relating to how stock investing works both were produced through research done in the last 50 years.

The second most important discovery was the discovery by University of Chicago Economics Professor Eugene Fama that short-term timing doesn’t work. No one knows where stock prices are headed over the next year or two. Fama’s findings have been widely publicized in recent decades. It is because of Fama’s Efficient Market Hypothesis that we are instructed so often that timing doesn’t work and that stocks are always best for the long run and that it is not possible for the average investor to beat the market.
It is the first most important discovery that few know about it. That’s Shiller discovery that, while short-term timing indeed never works, long-term timing always works. Yes, that’s right. We really cannot predict where stock prices are headed over the next year or two. But we can predict effectively where they are headed over the next 10 years or the next 15 years or the next 20 years.
The implications are far-reaching.

Most people think of stocks as risky. But risk is uncertainty. To the extent that long-term stock returns are predictable, stocks are not risky. A statistical analysis shows that investors who look at the P/E10 level (the price over the average of the last 10 years of earnings) of stocks before they buy an index fund possess 78 percent of the information they need to know the 20-year return. Stocks are no longer a risky asset class for those willing to take valuations into account when setting their stock allocation.

You can now obtain higher long-term returns from stocks while taking on dramatically less risk. The academic research supports this claim. Consider this study by Wade Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies, in Tokyo, Japan, showing that “Valuation-Informed Indexing [the Shiller-inspired strategy] provides more wealth for 102 of the 110 rolling 30-year periods, while Buy-and-Hold did better in 8 of the periods.”

Why haven’t you heard more about this research? Most investors and most experts are reluctant to give up on Buy-and-Hold just yet. But wait until the next stock crash (the historical data indicates that we should be expecting prices to fall 65 percent from today’s levels sometime over the next few years). That will bring on a groundswell of interest in new and and safer and more effective investing strategies.

A revolution is about to hit! For middle-income investors, this will prove to be a very, very good thing.