This is a guest post written by Rob Bennett, who blogs at A Rich Life. Although I can’t spend enough time on businesses that I’m not involved in to be a real “active” investor, I do follow major financial developments for my own enjoyment and this might be enough to tell when certain asset classes aren’t as good of an investment as they were in the past. Read on for Rob’s take on this!

Millions of middle-class workers are today wondering what happened to their retirement accounts. Investing in stocks wasn’t supposed to cause us to lose most of our life savings. There were studies showing that Passive Investing worked, weren’t there? There was historical data showing that, if we had to suffer through down markets, we would get the money back, no?

No. The historical data has never said any such thing. I’ve checked.

And, no, there are no studies giving any reasonable person cause to believe that Passive Investing (electing not to change your stock allocation even when prices go to insanely dangerous levels) could ever work in the real world. There are 30 years of studies showing just the opposite.

Given the extent of the losses we have suffered, there’s a temptation to conclude that we have all been taken in by a giant con. I don’t think that’s quite right either. I view that explanation as being too cynical.

It was all a great mistake. That’s the reality.

For many years, investors speculated about what was going to happen in the market over the next year or two and changed their stock allocations accordingly. That’s short-term timing.

There was research done in the 1960s and 1970s showing that short-term timing
does not work. This was breakthrough stuff. Lots of people got excited. A new model of understanding stock investing was developed. Passive Investing was born.
It wasn’t until the 1980s that we learned that we had jumped to a hasty conclusion in believing that not only short-term timing but also long-term timing do not work. The new research shows that 10-year stock returns are highly predictable and that long-term timing is REQUIRED for the long-term investor. You must lower your stock allocation when prices get out of control or you are likely to lose years and years of gain in a stock crash that may not come in a year or two but that is sure to come eventually.

Oops!

I can link you to scores of places where the new research is discussed. But rarely do
the big-name “experts” point out how critical it is to engage in long-term timing. A macho attitude prevails in InvestoWorld. The feeling is that any “expert” who acknowledges a mistake can no longer be viewed as a true expert.

Yucko!

The research that brought us Passive Investing is important research. Learning that short-term timing does not work truly was a breakthrough. But if we are going to turn investing into a science (and that is what we are doing when we use research into the historical data to inform our decisions) we are going to need to adopt more than the trappings of science.

Real scientists always remain open to new findings. Real scientists avoid dogma.
Real scientists don’t ignore their mistakes, they learn from them.

Passive Investing has failed us. It was a mistake. It has caused great human misery for millions.

It’s time to move on. This time, we need to encourage the Investing “experts” to
take a far more humble attitude in the presentation of their advice.

We know more today than we did 30 years ago or 50 years ago. But we still do not even come close to knowing it all. Let’s work hard as we try to pull ourself out of the wreckage of the Passive Investing avalanche  not to repeat the oldest mistake of them all — forgetting that Pride Comes Before a Fall.

For more of Rob’s articles and postcasts, see his blog A Rich Life. What do you think – are you sticking to passive investing or trying to second-guess the market wisdom?

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