I’ve posted Entry #305 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Nine Rules for Exercising Price Discipline When Buying Stocks — Part Two.
Juicy Excerpt: If you compare the results for Buy-and-Hold and for Valuation-Informed Indexing over 30 years, you will see that for the vast majority of those years the results will be comparable. Both strategies call for high stock allocations when prices are at low or fair-value levels. So they obviously yield similar results at most times. When prices are high, Valuation-Informed Indexers go with lower stock allocations. Those lower stock allocations often yield lower returns.
Stocks are more risky when prices are high. But it doesn’t at all follow that returns are never good at high price levels. The reality is that returns are often very good indeed at high price levels. In fact, the odds of high returns go up a bit when prices reach insanely dangerous levels (because price changes are determined primarily by investor emotion and extreme price levels generate even more of the irrational exuberance that produced them).
However, gains enjoyed at times of high prices always prove to be short-lived. That’s the reality that Buy-and-Holders overlook. It can take a good number of years for the economic realities (which justify price gains of 6.5 percent real per year but not more than that) to assert themselves in market prices. But they always do. The greater the artificial gains experienced in a bull market, the greater the real losses experienced once the fantasy investor expectations are exposed for what they are.
The benefits of the Valuation-Informed Indexing strategy are achieved through a lot of waiting for prices to be set right. The waiting pays off big time in the tiny number of years in which the Valuation-Informed Indexing portfolio far outpaces the Buy-and-Hold portfolio. A tiny number of years of extreme outperformance frequently counters a larger number of years of small outperformance by the Buy-and-Hold portfolio. Valuation-Informed Indexing is a strategy of infrequent but big scores.
Anonymous says
I guess my Vanguard, Fidelity and Schwab statements must be full of lies.
Rob says
That’s correct. And that’s a big deal.
People need to know the amount that they have put aside for retirement to be able to plan their financial futures. This is important stuff because it is so basic. If you get these basic numbers wrong, you get everything wrong.
We need to integrate what Shiller showed with what those who came before Shiller showed. Only then can we begin as a society getting the numbers right and bringing an end to these horrible economic crises that cause so much misery to millions.
The first step down the positive path is giving ourselves permission to talk about the far-reaching implications of Shiller’s amazing research. We cannot come over time to understand things that we never permit ourselves to discuss.
The reason why as a society we have for 35 years been reluctant to proceed down this positive path is that the positive path leads in a very different direction than the Buy-and-Hold path that we are on today. The words “I Was Wrong” or “I’m Not Sure” are magic words, like “Open Sesame.” When as a society we say those words, the world changes in a life-affirming way for all of us.
My job is to help us all to see this, to provide us the courage we today lack to leave behind the path that has failed us and to move to the path that offers so much promise.
The numbers on all of our portfolio statements are wrong. Not a little wrong. A lot wrong. We need to get that fixed. But a society cannot fix a problem until it acknowledges that it has a problem. We are stuck at the Should-We-Acknowledge-the-Problem stage.
A good number of us (about 20 percent of the population of most large internet discussion boards and blogs) see appeal in the idea of acknowledging the problem (the fact that Fama’s findings and Shiller’s findings cannot be reconciled reveals that there is a flaw in the core ideas that support the Buy-and-Hold Model). You Goons don’t like the idea of acknowledging that there is a problem. You don’t want to see effective challenges to Buy-and-Hold to appear on your computer screens. You want to shut that stuff down. That sort of thing makes you very angry.
I am working at cross purposes with you Goons. I want all this stuff to get out. I don’t think it is healthy to keep this stuff covered up. I believe that the 35-year cover-up has been an unmitigated disaster. It threatens to undo all the good work that those who came before Shiller did. If they correct the one error they made, all of their good work produces amazingly good fruit. If they fail to correct the one error they made, our economic system collapses and the collapse in on the heads of those who made the mistake that set the forces in motion that caused the collapse. This is a good thing how?
The next chapter of the saga arrives with the next price crash. The next drop will hit people with more force than the 2008 crash because people’s financial resources have already taken a big hit and thus there is less strength to weather hits at this time. The economic problems will worsen and the political frictions will worsen.
Then the people who see the problem and have long wanted to do something about it but who have held back out of fear of what you Goons would do to their reputations and their businesses if they spoke with full honesty about their views re how stock investing works will face a decision: Continue down the road that has now caused four economic crises in the past 145 years and that has in recent years caused political frictions threatening to tear our country apart or dare to “cross” you Goons by suggesting that we enforce the laws against financial fraud in a reasonable manner and permit people of integrity to do work in the investing advice field just as we permit people of integrity to do work in every field other than the investing advice field.
I believe that we are going to choose the positive path at that time. I cannot prove it. I don’t have the ability to see into the future. So I could be wrong. But that’s what I believe. Naturally every action that I take today is rooted in that belief. We all act pursuant to our beliefs. You Goons believe on one level of consciousness that we will not as a society work up the courage to send you Goons to prison. That’s why you Goons do what you do, work as hard as you can to stop me from doing what I am trying to do.
I am working at cross purposes with you. It doesn’t follow that I don’t like you. I once believed in Buy-and-Hold. I know how pissed I would have been if I continued down that path and then one day learned that it had all been a lie (that’s not entirely true, in the early days it was a mistake rather than a lie, but the emotional reaction that one has to learning that one has planned one’s entire life around a false premise is that one has been lied to). So I have sympathy for the Goon position. I don’t support the criminally abusive stuff, obviously. But I have sympathy for the flawed (like me!) human beings who have experienced so much pain in their travels through the Valley of Tears that they have come to feel a need to engage in such behavior.
Had circumstances been different, it could have been me. I think that’s the right way to think about it. We are all tempted at times to respond to bad behavior that we see play out in front of us by declaring to ourselves, “Oh, I am so much better than that, I could never go there.” The smart thing (in my view!) is to let God decide that one. None of us know ourselves well enough to know with certainty how we would react if we were placed in the same pressure cookers than caused others to behave in a way that we can safely conclude from our non-pressure-cooker-exposed selves is “bad.” My take.
Anyway, you are hitting on something important with this question, Anonymous. The numbers on all of our portfolio statements are wrong. Prior to 1981, those numbers were wrong because we lacked the knowledge needed to get them right. We truly believed that the market was efficient and that the market was capable without extensive discussions of investor emotion of getting the numbers right. In 1981 we “learned” (we learned this intellectually but we have not yet permitted ourselves the emotional freedom to integrate the new good knowledge with the good old knowledge while discarding the discredited old knowledge) that, to get the numbers right, we need to permit widespread discussion of the emotional realities of stock investing (discussions that we quite reasonably refrained from in our days of ignorance because discussions of investor emotions are nonsensical in a world of efficient markets).
We live in the worst of all worlds today. Our dominant model for understanding how stock investing works is a numbers-based model. Numbers are everything in this world. The success of every strategy that we pursue depends on getting the numbers right. But because of a mistake that we made in 1965 and that has remained uncorrected since it was discovered in 1981, we today are getting all the numbers wrong. Every article that is published on the topic of how to invest in stocks makes the economic crisis worse because it fills people’s heads with more garbage.
People are losing confidence in our institutions because they are seeing that things are getting worse and the “leaders” of our country are not taking effective action. But each time one of us dares to offer effective leadership, you Buy-and-Hold Goons go into action with your threats of physical violence and with your threats of career destruction. We have come a long way from the days when my good friend Jack Bogle was making the case that we all should consider what the peer-reviewed research shows when making investing decisions. Holy moly!
I love my country. I believe that there are millions of good and smart and hard-working people living in it. I believe that even some of you Goons could fairly be described as good and smart and hard-working people if you were dealing with some subject that caused you less distress than the message of the last 35 years of peer-reviewed research and what it says about the role you played in bringing on the worst economic crisis in our nation’s history. I believe that Jack Bogle himself deep down inside is a good and smart and hard-working person. I believe that when he sees with his own eyes the human misery that he has brought on by his association with you Goons that he will come clean and the words that he will offer at that time will give the needed reassurance to the thousands of experts who need to hear some reassuring words before they will be willing to put their necks on the line and speak the full truth re their beliefs on stock investing.
From that day forward, we will all be walking the positive path rather than the path that we are on today. We will be learning more and more and more about the first TRUE data-based strategy with each day that passes. We will not be destroying our country, we will be rebuilding it. We will not be celebrating Goons, we will be putting them in prison or, better yet, removing them from our discussion boards and blogs before things reach a point where they have done so much damage to so many good people that we have no other realistic options but to imprison them. We will be feeling better and better and better about ourselves with each day that passes rather than worse and worse and worse. We will be engaged in a huge Learning Together project rather than the Goon project of generating ever more hate and anger and envy and deception.
Love is the answer, Anonymous. That’s the short version.
We’re getting there. It’s a process. And we are getting there ever so slowly.
We all want to see accurate numbers on our portfolio statements. So that we can plan our financial futures effectively. We are all going to get what we want. We are on the one-yard line. The only thing holding us back today is that we need to work up the courage to announce prison terms for those who have elected to advance posts in “defense” of Mel Linduaer and John Greaney and Jack Bogle. One more price crash will get us where we need to be to change paths.
I am sure.
But not really, you know? No human can ever be 100 percent sure. We are imperfect creatures. We can never really know for certain even the things that we very much think we know for certain.
Or so Rob Bennett believes, in any event.
We will have to wait and watch together to see how it all plays out in the real world.
I naturally wish you all the best that this life has to offer a person.
Hang in there, old friend. It gets better. A LOT better.
Rob
Anonymous says
So, if I am following VII, where should I invest my $4 million?
Rob says
It is of course 100 percent silly and goonish to think that there might be one right answer to that question, Anonymous. If you asked multiple Buy-and-Holders “Where should I invest my $4 million?” you would get multiple answers. To get an answer tailored to you, you need to take your particular financial circumstances into account and you need to take your particular life goals into account and you need to take your particular risk tolerance into account.
The difference between the two models is that Buy-and-Holders say that it is okay to stick with the same stock allocation at all times (that is, to fail to practice price discipline). A Buy-and-Holder might recommend a 60 percent stock allocation at all times. In contrast, a Valuation-Informed Indexer would point out that you increase risk dramatically while also diminishing return dramatically by being unwilling to exercise price discipline. A Valuation-Informed Indexers might recommend 60 percent stocks when prices are reasonable, 90 percent stocks when prices are insanely low and 30 percent stocks when prices are insanely high. That works far, far, far better over the long term, according to the last 35 years of peer-reviewed research in this field.
Prices are insanely high today. The P/E10 level is nearly double its fair value level. So the general VII recommendation today would be for a stock allocation of somewhere in the neighborhood of 30 percent.
I hope that helps a bit, my long-time Goon friend.
Rob