People spend more when stock prices are high.
It’s so obvious that it’s a silly thing to say. But I think it needs to be said at a time when most stock investors are ignoring Robert Shiller’s Nobel-prize-winning research showing that valuations affect long-term returns. Shiller offered us the means to combating irrational exuberance and of thereby reining in the wasteful and destructive spending that takes place as the result of improperly high stock prices.
Improperly High Stock Prices
Say that an individual earns $80,000 per year at her job. She of course pays taxes on that amount and has a mortgage to cover and makes an effort to put aside 10 percent of her income as savings. She finds it a struggle to pull that off. It’s a struggle for everyone, no matter how great or small his or her income.
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The reason why it is always a struggle is that money is the fuel we use to enhance our enjoyment of life. Once we have paid for the basics of life, our need for money becomes less urgent but not less important.
After groceries and health insurance have been covered, we turn our attention to vacations and eating out with friends and making our home more comfortable and taking night classes. Non-essential but valuable stuff.
So there is always a struggle going on in one’s mind to decide “should I take this vacation?” or “can I afford to remodel the kitchen?” There are always pros and cons.
Say that the woman earning $80,000 has $200,000 in her stock account. She has made some rough calculations as to how much she needs to have put aside for her old-age retirement and determined that she is a little behind where she needs to be but not too terribly far behind.
She makes it her New Year’s Resolution to be a little more cautious with her spending decisions, to make more progress on her savings goals.
Then the market goes nuts. The next four years see the sorts of stock gains that we saw in the last four years of the 1990s. Four years down the road her stock account is valued not at $200,000 but at $400,000. She is now no longer a small bit behind where she needs to be but far ahead of the pace.
Should she just thank her lucky stars and continue doing as she has been doing?
She has been denying herself important enhancements to her enjoyment of life during the time when she was trying to stick to that New Year’s resolution. She didn’t take a vacation during those four years; she thought that vacations would be an easy thing to cut out as a means of making quicker progress on her saving goals.
A friend came to her at one point and suggested that they quit their corporate jobs and start a business that would likely produce less income for the two of them for a number of years but that had the potential to make them both very wealthy in the long run. She turned down that opportunity even though it excited her.
She wanted to stay on track re the saving goal. Starting a new business did not seem to her to be the sensible thing for someone barely meeting her saving goals to do.
Four years down the road, all that has changed. She’s rich! Not really. She’s not independently wealthy. She still needs to work for a living. But she is far ahead of where she thought she would be at this stage of her life a few years earlier.
It hits her that she can now afford to take a vacation, a long, expensive, luxurious one. And she notices herself feeling some regret that she turned down the business opportunity. She decides that, if another such opportunity presents itself to her, this time she is going to give it a go.
The Purpose Of Life
Those are sensible decisions, are they not? The purpose of life is not to accumulate money. The purpose of life is to live. She evidenced a sufficient amount of prudence when prudence was called for. She is now in a position to take some chances.
Life is short. You have to take chances when the prospects are right to do so. The performance of the stock market has changed this woman’s prospects in a dramatic way. She should be changing her thoughts about just about all of her spending choices in a significant way.
But what if Shiller’s Nobel-prize-winning research is legitimate research? What if most of the stock gains of the past four years were just the product of irrational exuberance and did not possess any lasting economic significance?
In that case, most of those gains will be going “Poof!” in the not-too-distant future. In that case, this woman should be continuing to live her life in the manner in which she was living it in the days before stock prices went insane. She should not be letting the irrational exuberance change her thinking about all of her spending choices.
I hate irrational exuberance. It’s the only subject that I have been writing about for 20 years now. I would like to see all investors talking about it and thinking about it on a daily basis.
I believe that Shiller’s research revolutionized (that word appears in the subtitle of Shiller’s book) our understanding of the subject of stock investing but that we have unfortunately not yet gained the benefits of the Shiller revolution because we have elected to ignore what his research teaches.
The big thing of course is that people will lose lots of money when the next price crash hits. That is indeed bad. But I am even a bit more horrified by the millions of poor spending choices that we all make at times when irrational exuberance gets out of control because the presence of phony stock gains in our portfolio causes us to believe lies (that’s what the false beliefs encouraged by a bull market really are, aren’t they?) about where we stand financially.
Rob’s bio is here.