Investors are not compensated for taking on Actual Risk. They are compensated for taking on Perceived Risk. You can beat the market easily (in the long term, not in the short term) by knowing the difference.

When the market is wildly overpriced, Perceived Risk is low but Actual Risk is high. You beat the market by lowering your stock allocation until a day comes when Perceived Risk is high and Actual Risk is low.\

To beat the market, you need to be able to see when the market is wrong. That means being willing to look at valuations and being willing to stick with your rational position long enough for the market price to return to a reasonable place.

Rob

And thanks for talking about risk of alternative investments like insurance cat bonds. Although some people are comfortable with more or less risk than an index fund can offer them. Know thyself as someone important once said.

If only this were so!

Both the idea that you don’t need to time the market at all (Passive Investing) and the idea that you can be sure of seeing benefits from timing within a year of making the allocation change (Short-Term Timing) are emotional approaches. I advocate Rational Investing, which argues for trying to overcome the most negative investing emotions and to accept that short-term timing doesn’t work and that long-term timing is required for those seeking to have a realistic hope of long-term success.

There have been Rational Investors since the first stock market opened for business (Benjamin Graham advocated Valuation-Informed Indexing in his book Security Analysis, published in the 1930s). The trouble is that it is 50 times easier to promote either Short-Term Timing or Passive Investing, as both possess great appeal to the emotions and most marketing pitches depend on emotional appeal for their success.

It is my belief that things changed when we made middle-class investors responsible for the financing of their own retirements. That represented a raising of the stakes in the stock investing field. I believe that we need to begin teaching middle-class investors what they need to know to be able to invest effectively or see the entire U.S. economy go over a cliff. I don’t believe that we can continue to treat marketing considerations as paramount.

Rob