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.