VII #62 — Valuation-Informed Indexing Will Keep Working After Everyone Finds Out About It

I’ve posted Entry #62 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Valuation-Informed Indexing Will Keep Working After Everyone Finds Out About It.

Juicy Excerpt: If knowledge of the realities spreads, price volatility will be greatly diminished. In a world of Valuation-Informed Indexers, there will never again be another bull market. Each time prices go up more than the amount justified by the economic realities, investors will lower their stock allocations because the long-term value proposition of stocks has been diminished. Those sales will bring prices back to fair-valuation levels. Stock market prices are self-regulating in a world in which investors have access to accurate information about how stock investing works.

Valuation-Informed Indexers will obtain lower returns in a post-Buy-and-Hold world. But the return they obtain will not be bad at all. The return obtained when stocks are selling at fair-value prices is 6.5 percent real. That’s good enough to help most of us finance retirements beginning at a reasonable age.

And we would be obtaining that return in a world of minimal stock volatility. That’s another way of saying that we would be obtaining that return in a world of minimal stock risk. A 6.5 percent real return from an asset class of little risk — I can live with that! I bet you can too.


  1. what says

    What evidence/thoery/explanation do you have that stocks would return 6.5 or that valuation indexers would capture this return?

    You seem to just state it as fact without supporting it at all. Its pretty scary actually, it sounds like you have no idea what you are talking about.

  2. Rob says

    From a Buy-and-Hold perspective, I don’t have any idea what I am talking about, What. Buy-and-Hold is based on the Efficient Market Hypothesis. Valuation-Informed Indexing is based on Shiller’s research, which discredited the Efficient Market Hypothesis. Buy-and-Holders and Valuation-Informed Indexers are starting from opposite premises about what stock price changes represent.

    Say that stock prices increase by 30 percent in a year. What does that mean?

    To a Buy-and-Holder, it means that the value of the stocks increased by 30 percent that year. The Efficient Market Hypothesis says that investors rationally set the price where it should be, given whatever economic developments have taken place.

    Valuation-Informed Indexers do not believe that. We believe that stock prices increase each year by the amount of gain supported by the annual productivity of the U.S. economy — that’s 6.5 percent real — plus or minus whatever amounts emotional investors elect to add or subtract that year. 6.5 percent of gain is a lasting increase in wealth. 23.5 percent of gain is only a temporary increase in wealth, fated to be blown away in the wind as prices revert to the mean yet once again.

    Nothing that Buy-and-Holders say makes sense to Valuation-Informed Indexers and nothing Valuation-Informed Indexers say makes sense to Buy-and-Holders. The two schools of thought proceed from opposite premises. Everything that both schools say is the product of reasoning from the particular premise on which the model being used is based.

    The only point of difference between the two schools of thought is the question of whether the market is efficient or not. If the market is efficient, the Buy-and-Holders are right and Buy-and-Hold is the ideal strategy. If valuations affect long-term returns (as Shiller has shown to be the case), Buy-and-Hold is the purest and most dangerous Get Rich Quick scheme ever concocted by the mind of mortal man.

    It’s one or the other. Either the hypothesis is legitimate or the hypothesis has been discredited by the last 30 years of academic research.

    Are you sure that you are right about which way it comes down, What? Absolutely sure? If you are wrong and if you elect to ban honest posting because you are so sure, you will end up causing the worst economic crisis in the history of the United States, one far worse than what we saw in the Great Depression. Are you sure enough to take that risk?

    I am not sure enough of anything to take that sort of risk, What. My view is that we should permit honest posting by both Buy-and-Holders and Valuation-Informed Indexers. That way, everyone gets to hear both sides and we can decide as a society how to proceed. That approach seems to work well in all areas of life endeavor other than stock investing and I have a funny hunch that it might just work with stock investing too.

    Call me madcap.


  3. what says

    So you basically have no idea why stocks return 6.5 real other than it must have something to do with the US economy. What metric of the US economy causes stocks to have a perpetuity of 6.5% real CAGR?

  4. Rob says

    You know what they used to tell us back in Catholic school when we would ask how there could be three persons in one God?

    It’s a mystery.


Leave a Reply

Your email address will not be published.

Comments links could be nofollow free.