Valuation-Informed Indexing #457: Valuation-Informed Indexers Have a Big Edge Over Buy-and-Holders in Trying to Focus on the Long Term

I’ve posted Entry $457 to my Valuation-Informed Indexing column at the Value Walk site. It’s called Valuation-Informed Indexers Have a Big Edge Over Buy-and-Holders in Trying to Focus on the Long Term

Juicy Excerpt: Buy-and-Holders believe that price changes are rooted in economic realities. If that is so, then both price jumps and price drops mean something. Price jumps signal that the economy is doing better than expected and price drops means that the economy is doing worse than expected. Stock investors are hoping that the economy will produce enough growth in their lifetime to finance their retirement plans. How could a Buy-and-Holder not have some emotional reaction to a report that stock prices are signaling whether his hopes in that regard will be realized or not?

Valuation-Informed Indexers approach the investing project with a very different perspective. We start with an assumption that the economy will continue in the future to generate enough wealth to support stock gains of roughly 6.5 percent real per year and ignore gains of more than that as the product of irrational exuberance rather than of anything of lasting economic significance. For us, price gains are no better than price drops. Price gains increase the size of our portfolio (a plus) while lowering the expected long-term return from that point forward (a negative) and price drops diminish the size of our portfolio (a negative) while increasing the expected long-term return from that point forward (a plus). We are able to tune out the emotional noise that the Buy-and-Holders very much take to heart because the positives and negatives of both price gains and price drops cancel each other out.