What is the best way to invest 5,000 dollars? This method follows an investing plan that economics Nobel Prize winner Robert Shiller recommends. Shiller has found a tool that is more accurate than any other in predicting stock prices. First, I’ll show how most stock prediction methods are worthless. Second, I’ll show how remarkable his method is because it beats all other forecasting tools. Third, in the final section of this article, I’ll show how Shiller tells investors to invest according to this method. It’s worth noting that Professor Shiller is one of the most successful financial experts who supports the idea that above average returns are possible.
Best-selling authors Burton Malkiel, a Princeton University Professor, and Charles Ellis (the founder of Greenwich Associates) write in their book The Elements of Investing, “The largest, longest study of experts’ economic forecasts was performed by Philip Tetlock, a professor at the Haas Business School of the University of California–Berkeley. He studied 82,000 predictions over 25 years by 300 selected experts. Tetlock concludes that expert predictions barely beat random guesses. Ironically, the more famous the expert, the less accurate his or her predictions tended to be.”
Robert Shiller’s CAPE Ratio – Vanguard Proves it Beats all Other Predictors
Vanguard, however, has published an outstanding paper called, “Forecasting stock returns: What signals matter, and what do they say now?” Their first primary finding is that, “stock returns are essentially unpredictable at short horizons.” For example, they find nothing can accurately predict the following one year period. Their second major finding is that, “many commonly cited signals have had very weak and erratic correlations with realized future returns even at long investment horizons.” Their third critical takeaway is that, “valuation indicators—P/E ratios, in particular—have shown some modest historical ability to forecast long-run returns.”
Of all these valuation indicators, Yale University professor and Nobel Prize winner Robert Shiller’s is the most accurate. It originated in a paper called, “Valuation Ratios and the Long-Run Stock Market Outlook.” Shiller calls it the P/E 10 or the CAPE (cyclically adjusted P/E ratio). It takes the P/E ratio of the S&P 500 and divides by the average earnings adjusted for inflation from the previous 10 years. In the Vanguard study, they find Shiller’s ratio explains 43 % of the “proportion of variance of future real stock returns” for the following 10 year period. Impressive. Fortunately, the best way to invest 5,000 has two simple methods that follow this plan.
Putting it Into Practice
One can expect higher returns by putting more money into the market when the CAPE is relatively low and putting less in when the CAPE is relatively high. Professor Shiller offers an excel file on his website that shows you the current ratio, which you an use to time your stock purchases. Alternatively, you can let a fund manager do the work for you and invest in Barclays ETN Schiller CAPE ETN (NASDAQ ticker symbol CAPE), which invests solely in sectors with a favorably low ratio.
The evidence is clear: stock market predictions should be based on a long-term horizon of about five to ten years at least. Accordingly, this is not the best way to invest 5,000 dollars short term. Rather, this is the best way to invest 5,000 dollars for the long run, when Shiller’s method truly works its magic.
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Campbell, John Y., and Robert J. Shiller. “Valuation ratios and the long run stock market outlook.” Journal of Portfolio Management 24 (1998): 11–26. Print.
Davis, Joseph, Roger Aliaga-Díaz, and Charles Thomas. “Forecasting Stock Returns: What Signals Matter, and What Do They Say Now?” The Vanguard Group, 29 Oct. 2012. Web. <https://personal.vanguard.com/pdf/s338.pdf>.
Malkiel, Burton G., and Charles D. Ellis. The Elements of Investing. Hoboken, NJ: Wiley, 2010. Print.