Set forth below is the text of a comment that I put to a recent blog post by Matthew Amster-Burton put to the Minto.com site and titled Timing the Market Using Stock Valuations.
I suspect Pfau and Kitces are onto something. If so, however, I suspect their approach will be less profitable in the future than it has been in the past, for the reasons Mike Piper laid out.
It’s super that you are writing about this, Matthew. My name is Rob Bennett. I am the person who developed the strategy being explored today by Pfau and Kitces (If you check the Acknowledgments page of Wade’s study, you will see that he credits me there and I have been in e-mail correspondence with Michael for years now). I invite you to check out the wealth of materials on Valuation-Informed Indexing available at my site. There are over 100 articles there on this approach. And 200 podcasts. And 5 unique calculators. And hundreds of blog entries. I also write three weekly columns on Valuation-Informed Indexing, which I believe is the future of stock investing.
I’ve also engaged in extensive discussions about this with Mike Piper. Mike’s point is valid. But he is missing something very, very, very important.
Yes, the huge edge that Valuation-Informed Indexers have held over Buy-and-Holders over the 140 years for which we have records will disappear when Valuation-Informed Indexing becomes well publicized. But consider how it is that that edge will be made to disappear!
When we all become Valuation-Informed Indexers, bull markets will be a thing of the past. If everyone gets it that the long-term value proposition provided by stocks drops with increases in valuations, people will lower their stock allocations when prices get too high. The sales of stocks will bring prices down. Then we won’t have overvaluation anymore!
Stock prices are self-regulating so long as investors are informed as to what is in their best interests. The trouble we are having today is a consequence of the fact that the research showing the effect of valuations had not yet been published at the time the Buy-and-Hold model was developed. So the people who developed Buy-and-Hold left out the part about investors having to change their stock allocations in response to big price swings.
Once we all become open to the idea of changing our stock allocations as needed to keep our risk profiles roughly constant, there can never be another bull market. Which means there can never be another bear market (every big bull market has led to a big bear market and there has never been a big bear market that was not preceded by a big bear market). Which means that in all likelihood we will never see another economic crisis (we have had four economic crises since 1870 and each and every one followed an out-of-control bull market — it is the huge financial losses suffered during bear markets that cause economic crises).
Yes, Valuation-Informed Indexers will only be earning the 6.5 percent real return provided by stocks once everyone learns about the benefits of Valuation-Informed Indexing. But they will be doing so by taking on only a tiny fraction of the risk that stock investors take on today. Once investors become able to invest in their own self interest (this was not possible until the research showing the effects of valuations was published), price volatility will be a thing of the past. Volatility is caused by investor emotion and investors acting in their own self interest are not emotional. It is price volatility that makes stocks risky. So doing away with price volatility is doing away with risk.
You are writing about something of huge importance for the history of stock investing, Matthew. Please feel free to contact me if you have questions about Valuation-Informed Indexing and would like to learn more. I have been working this full time for ten years now. We very much need more people helping us to get the word out!