Hubris and Naivete from the Ivory Tower
Barron’s recently featured an interview with Boston University economist Laurence (Larry) Kotlikoff. The article begins with, “Economist Laurence Kotlikoff thinks most financial planners go about it [retirement income planning] wrong.” My response after reading the entire article is as follows…
“Financial Planner John Robinson thinks Laurence Kotlikoff is the poster boy for academic hubris and naïve decision-making.”
In composing this rebuttal, I could begin by explaining how Kotlikoff completely mischaracterizes the nature of the financial planner/client relationship and how Kotlikoff’s “consumption smoothing” spending methodology, which involves calculating each consumer’s utility function, is both empirically and practically flawed for real-world planning. Instead, to support my admittedly strongly-worded position, I offer Kotlikoff’s own comments on investing in the second half of the interview beginning with the interviewer’s question, “How do you have your own money invested?” Here’ was Kotlikoff’s response:
“It seems to me that the stock market is overvalued and dependent on the Federal Reserve’s support and its commitment to low interest rates. And I view that as an unsupportable policy, so I view the stock market as very risky. About half my assets are in cash, because I think this is a very tricky investment climate.
I pulled out of the market when Covid hit, and the market dropped, and I was very proud of myself. But I didn’t expect the Fed would come back in and support the corporate bond market to the extent it did.”
When I read this, my jaw dropped. Here is one of the most renowned economists in the U.S. seemingly suggesting that timing one’s entries into and exits from the stock market is a prudent long term investment planning strategy. Really, Larry??? This was apparently not lost on the interviewer either who naturally followed up with, “You missed out on part of the rebound?” To which, Kotlikoff answered,
“I missed out on the rebound, staying out of the market for about half a year. And I’ve waded back in with two hedge funds that use arbitrage methods that are independent of how the market does.”
Translation: “Yes, I have missed out on the entire rebound that has led to the S&P 500 Index today being 50% higher than when I cashed out. However, to cover for my foolish investment naivete, I will pretend that my academic street cred gives me access to sophisticated hedge fund strategies that outperform the stock market and are beyond the reach and understanding of the common man.”
Note to Larry: Remember when Warren Buffett won his $1 million wager that blindly stashing money in an index fund for a decade would outperform most hedge fund managers? In case you missed it, here’s a link to the story – Warren Buffett Beat the Hedge Funds. Here’s How. (CNN Business, 2/24/2018).
When I was an undergrad majoring in economics in the 1980s, Princeton Professor Burton Malkiel’s best-selling book A Random Walk Down Wall Street was required reading for our senior seminar on the stock market. The basic premise of the book is that, consistent with the Efficient Market Hypothesis, the stock market at any given point in time incorporates all known information and future expectations, and that, as such, attempts to time the stock market are an exercise in futility. Malkiel was far from alone in highlighting the foolishness of market timing. There are literally hundreds (perhaps thousands) of papers published in finance journals highlighting the naivete of consumers’ (and portfolio managers’ and economists’) efforts to time the stock market. The evergreen nature of this topic is illustrated in the following sampling of recent articles –
Why You Should Ignore the Siren Call of Market Timing (The Economist)
How Market Timing Destroys Wealth (Advisor Perspectives)
The latest edition of Charles Ellis’ investment classic exposes why people make terrible day-traders. (CNBC)
When Do Investors Freak Out?: Machine Learning Predictions of Panic Selling (SSRN)
I frequently opine that the relationship between the academic community and the financial planning community is analogous to that between an architect and a building contractor. The building contractor implements the building plan using the architect’s blueprints and occasionally points out design ideas that are not practically implementable. Similarly, most financial planning guidance, including recommendations pertaining to retirement income sustainability, has deep roots in academic theory. In reading Kotlikoff’s comments and articles over the years, it seems clear that he has very little understanding of how financial planning is actually practiced nor any willingness to accept that his beloved consumption smoothing theory may have flaws that preclude it from being implementable/optimal in practice. While I respect Professor Kotlikoff as an expert on social security planning and I genuinely appreciate his academic contributions on consumption smoothing and consumer utility maximization to the evolution and development of dynamic distribution optimization strategies, with respect to his sermonizing to the financial planning community, I have a simple, vernacular piece of advice: Stay in your lane Bro’.
For the record, I am not the first to call out Kotlikoff for his arrogance. In 2011, financial planning industry thought leader Michael Kitces had the following response to a Kotlikoff article: “Interesting @Kotlikoff piece. Fascinating points, but interspersed w/ straw man arguments so wrong it's embarrassing. Also pretty stunning that he'd actually write an article targeted FOR financial planner members of the FPA and call them "stupid" in the title! Having controversial content is one thing; actually being mean and rude is another!”
Here is a sampling of some of the more colorful comments that readers of the Barron’s article submitted:
I'm a retired college economist, also 70 years old, and much/most of what he says is the truth, and is what I've both taught and followed for years, except how he panic sold at the start of the pandemic. Never sell low, and never panic, if you're in stocks. Corollary: only be in stocks if you're in for the long run, meaning at least 10 years.
He panicked and sold stocks at the bottom and 6 months later meekly gets back into the market through hedge funds using “arbitrage methods.” He has half his money in cash yet suggests people should increase their stock holdings as they age.
Just because someone is an economist doesn't make him a good or smart investment advisor, which he is not. Having a good individualized written financial plan and sticking to it is a better strategy, not letting your emotions rule your decisions, as his obviously did.
“I pulled out of the market when Covid hit, and the market dropped, and I was very proud of myself.” Sorry, he lost all credibility with this statement. He missed out on a huge move by panicking. If his own plan was intact he would have weathered the storm.
He takes advisors to task for charging a percentage, yet he put his money with Hedge Funds which charge huge fees. Oh, and he obviously believes in market timing when he decided to move to cash at exactly the wrong time. History shows that is a poor choice.
I can honestly say I am glad this guy does not handle my finances. He clearly has spent far too much time in the classroom and not in the real world.
Glad I don't take advice from this guy.
This Laurence guy is a terrible investor. Pulled his money out of stocks and missing out on the opportunity of a lifetime. Is he not familiar with Bogle's work? Statistical arbitrage hedge funds are really expensive and most institutional investors only allocate a small percentage to them since they offer uncorrelated but often meager returns.
John H. Robinson is the owner/founder of Financial Planning Hawaii and a co-founder of software-maker Nest Egg Guru.
Securities offered through J.W. Cole Financial, Inc. (JWC) member FINRA/SIPC. Advisory services offered through Financial Planning Hawaii and J.W. Cole Advisors, Inc. (JWCA). Financial Planning Hawaii and JWC/JWCA are unaffiliated entities.
Fee-only financial planning services are provided through Financial Planning Hawaii, Inc, a separate Registered Investment Advisory firm. Financial Planning Hawaii does not take custody of client assets nor do its advisers take discretionary authority over client accounts.
The information contained herein is general in nature. Neither Financial Planning Hawaii nor J.W. Cole provides client-specific tax or legal advice. All readers should consult with their tax and/or legal advisors for such guidance in advance of making investment or financial planning decisions with tax or legal implications.