Irrational Exuberance Review: Your Stock Bubble Beliefs are Wrong

Irrational Exuberance Review: Your Stock Bubble Beliefs are Wrong

The value in one sentence: Irrational Exuberance argues that the news, productivity, and dividends do not affect stock price movements as much as herd behavior, psychological anchors, and feedback loops.

Who is it by?

Robert J. Shiller, economist, Nobel Laureate, co-founder of MacroMarkets LLC, and professor at Yale University

Who should read it?

Read this if you are or want to be a stock investor, or if you want to learn about how stock market bubbles are formed.

How will I take action after reading this book?

I will identify moral anchors and be skeptical of the effect of news and quarterly earnings reports when analyzing stocks. Instead, I will focus more on the price of the stock relative to its value over the long term. I will also make sure my livelihood doesn’t rely on income from equities.

My Main Takeaways:

The stock market doesn’t always make money in the ‘long run’.

What is the time frame you think of when I say long run? 5 years? 10 years? 10 years is definitely enough time to make money in the stock market, right? So you should just put money in an index fund and wait, right?


Of course, if you put money into an index fund anytime from 2009 to 2017 you should be still making money as of August 2018. Your money would have doubled in the last ten years.

In fact, I also made money in stocks over the last decade. So what’s the big deal? The big deal is that profit has led us to adopt a false belief.

The big deal is that you believe that the stock market will always make money over a long period such as ten years. I had the same belief.

This belief is dangerous. In Irrational Exuberance, Shiller’s data point out that if you put money into the stock market anytime from 1965-1970, your ten-year inflation-adjusted return would have been negative.

This means you would have lost money over the ten year period. And losing money for ten years really sucks, especially if you staked your life savings.

Interestingly, between the years 1980 and 2000, the market quintupled in value. In fact, the S&P 500 rarely loses money over a 20-year period.

So is the stock market is always a one-step backward, two steps forward investment vehicle?

I say yes. If each step is about 7 years long. But most of us think the steps are 2 years long. So if you think long-term means 5 or 10 years, the chances of you losing money increase exponentially.

To show you this, I’ve graphed the total return and total real return of $1 invested in the S&P 500 in 1988. The data is from here and here.

irrational exuberance shiller

Note that using this calculator, the annualized real return of the S&P 500 since 1988 is 7.47% if you reinvested all dividends and 5.19% if you didn’t.

If you put money into an index fund anytime from 1998-2000 at the market peaks and held for ten years, you would have lost money. You would have on average lost more money if it was a mutual fund.

If you think this is bad news, I still want to point out that the U.S. stock market is a positive outlier. According to this article, the median annual return for different international stock markets is 0.8%. In fact, Japanese stocks still haven’t recovered from their drop in 1989.

The “financial experts” that tell you to put your money in a fund and make money in the long-term without defining long-term are being ignorant or irresponsible.

What does this mean for you?

If you want to make money in stocks and you don’t know much about finance, history tells us your surefire holding period should be at least 20 years. Anytime less and your resulting gain or loss depends on market volatility. Keep in mind that even Warren Buffett says timing the market is impossible.

Stock market valuations aren’t driven by news, productivity or even profitability as much as they are driven by the psychology of investors.

Shiller states that news isn’t a cause of price changes as much as they are initiators to changes in investor thinking which eventually translates into stock price movements.

In the book, Shiller also mentions that “[stock] price growth and earnings growth do not correspond well at all” (p. 182). In fact, there is “no substantial long-term historical relationship between corporate profits and stock prices” (p. 252). The same applies to the relationship between dividend growth and stock prices (p. 183).

This questions the significance of daily reporting of changes in the stock market and quarterly earnings forecasts. After reading irrational exuberance, it seems to me that these two things only introduce unnecessary market volatility to investors.

In fact, Warren Buffett spoke against quarterly earnings guidance.

So if news and profit don’t directly affect stock prices, what does?

According to Shiller, one thing that affects the markets is moral anchors. Moral anchors are the beliefs and reasons we tell ourselves that convince us to keep putting money into the stock market. Here are a few popular beliefs today:

  1. The long-term return on the stock market is 8-10%
  2. We should dollar cost average and put money every month into stocks
  3. It is easy to make money in stocks, just put it in an index fund and wait

The combination of these 3 beliefs point towards one course of action, regularly contribute to an index fund because we believe we will continue to profit over time. As long as people keep doing this, stock prices will keep going up.

By doing this, we fail to realize that long-term might mean 20 years, dollar cost averaging is not always the best strategy, and the stock market has under 10% return about 50% of the time.

What does this mean for you?

Even if you are an expert investor, don’t invest your entire savings into stocks. Remember that diversification doesn’t mean buying different stocks.

Diversification should be applied across income streams and asset classes. The wealthy often have multiple income streams ranging from a business, stocks, real estate, books and more. However, before getting there, they likely specialized in one area first. Check out Dan Lok’s 3-minute take on streams of income.



Irrational exuberance was a great read for giving me a reality check on stock market principles. Instead of being sucked into the media’s representation of the market, I can now use the media to identify herd mentalities and moral anchors.

Many investors are overconfident and aren’t ready to bear the risks of loss in the stock market. They think that stocks are a lot more reliable than history tells us.

If you plan on doing investing yourself, understanding irrational exuberance could save you a financial headache in the future. I hope by reading my takeaways you learned some stock market truths as well. Pick up irrational exuberance on Amazon today or get the free audiobook by signing up for Audible.

What are some of your moral anchors for the stock market? How ‘safe’ do you feel about the stock market?


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This Post Has 7 Comments

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