A Rich Life

The Old Ideas on Saving & Investing Don't Work -- Here's What Does

Wade Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies: Valuation-Informed Indexing Works

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Wade Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies in Tokyo, Japan, has posted at his blog preliminary research showing that Valuation-Informed Indexing works.

Juicy Excerpt #1: I will take steps in my final paper to test a wide variety of assumptions about asset allocation, valuation-based decision rules, whether the period is 10, 20, 30, or 40 years, lump-sum vs. dollar-cost averaging, and so on, and to show that the results are quite robust to changes in any of these assumptions.

Juicy Excerpt #2: I don’t like the term “long-term market timing.”  Market-timing is much too pejorative, and is also too easy to confuse with short-term market timing.  Also, market-timing seems to be associated with extreme strategies: either 100% stocks or 100% Treasury bills.  I don’t like that either.  I think the best term for this is “Valuation-Informed Indexing.”

Juicy Excerpt #3: Valuation-Informed Indexing [is] a term coined by Rob Bennett, who is banned from posting at the Bogleheads Forum.

Juicy Excerpt #4: Rob Bennett in his podcast “RobCast #137, Nine VII Portfolio Allocation Strategies,” indicates some preference for his high-medium-low strategy, which would be 60% stocks in the baseline, but would switch to 30% stocks when the PE10 ratio moves above 21, and would switch to 90% stocks when the PE10 ratio moves below 12.  My example will be a variation of this strategy that captures the spirit of what he suggested.

Juicy Excerpt #5: What you see in the top part of the graph for each year is the amount of wealth accumulated after 30 years for someone following buy-and-hold against someone following VII…. VII provides more wealth for 102 of the 110 rolling 30-year periods, while buy-and-hold did better in 8 of the periods.

Juicy Excerpt #6: The underperformance of VII [in the eight cases] is minimal…. In these final years, buy-and-hold was performing as well as it ever had at any point since 1880, and the slightly lower VII numbers also provided wealth that was on the high end of the spectrum compared to what buy-and-hold had provided in the past.  This seems like a small price for VII to pay for insurance against market crashes when valuations are out-of-control.

Juicy Excerpt #7: I welcome your comments and criticisms about this.

“I Cite You and John Walter Russell as the Earliest Advocates of [New School SWR Research]”

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Wade Pfau, an Associate Professor at the National Graduate Institute for Policy Studies in Tokyo, wrote a comment to an earlier blog entry this morning that describes a research paper he has written (the paper is still in its first draft) about the New School Safe Withdrawal Rate concept that I developed with John Walter Russell (and with the help of hundreds of our fellow community members in the Retire Early and Indexing discussion-board communities). Set forth below is the text of his words. I sent an e-mail to Wade thanking him for letting us know of this exciting development. Who could have predicted on the morning of May 13, 2002, where this New School SWR business was going to lead?

Dear Rob,

I just became aware of your past research in September.  Since then, I’ve read archives from many Discussion Boards and websites, and I always find your writing to be very interesting and intriguing.

I just finished writing up a paper about using earnings valuations to predict withdrawal rates.  But I think it is also important to consider dividend yields and bond yields as well, since these are the income sources of returns.  With these measures, I find that withdrawal rates continue falling even after 2000.  With PE10, you found the lowest withdrawal rates in that year.

I do cite you and John Walter Russell in my paper as the earliest and strongest advocates of this approach.  I understand that John Walter Russell has passed away, sadly.

If you wish to see my paper, it is at:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1726225

I’m hoping it will be publishable in a finance journal. This is just the first draft, so if you have some comments or anything, I can still make revisions.  Thank you very much for your consideration.

Best wishes,

Wade