Set forth below is the text of an e-mail that I recently received from a site visitor named Sam. Sam had sent me an earlier e-mail and this e-mail of his was in response to my reply to him.
Thanks for your e-mail. I had not seen those ValueWalk articles you wrote yet, and I just read parts One and Two of the Investment Strategy Tester this morning. I’ll bet some people would be surprised about the conclusions that the risk of low stock allocation can exceed that of high stock allocation. I wasn’t particularly surprised because I had perused your PassionSaving site and had embraced your heretical (yet common sense) valuation-informed indexing (VII) philosophy. I need to track down the other articles you published, and peruse them.
When I came across your PassionSaving site a couple of years ago, it was an epiphany. Since I had been losing a lot of money during the most recent market crash, I was highly motivated to search for a better strategy than buy-and-hold (BAH) to navigate through the crisis and to use going forward. Although your arguments were logical, and I realized immediately that VII would certainly beat BAH on a risk-adjusted basis, I was skeptical that it could consistently beat BAH on an absolute basis.
Since I am a math geek/engineer willing and able to create back-test simulations, I created a big interactive spreadsheet that used a user-specified, parameter-based stock allocation versus P/E10 curve (I used a Backwards-S-shaped, hyberbolic tangent function) to model the resulting hypothetical portfolio value based on the historical stock market price and prevailing interest rate data. The output curves plotted the portfolio-value versus time curves of buy-and-hold versus the user-specified stock allocation function. I am working on making a slider tool that the user could use interactively to change the shape of the stock allocation versus P/E10 function instead of plugging in the equation parameters. I would be happy to send you a copy, but it uses macro’s so you’ll get a warning about that. For that reason, I am not certain it is suitable to post at a website. I have attached a couple of screenshot images of a typical stock allocation curve. What you can see is how the VII strategy beats the buy-and-hold over most long holding periods, at much lower volatility.
There are a couple of caveats. Before 1990, trading fees were very high, and no ETF’s existed to easily obtain market performance and diversification. The other caveat is that it is impossible to earn the best interest rate on cash when it needs to be ready to deploy into stocks at the drop of a hat. For example, right now money markets are yielding nil.
The upshot of this is that I am ahead of where I was in June 2007, before the crash, and I am “never ever ever no never!” going to be over 70% in stocks unless the P/E10 drops below 13 again.