Set forth below is the text of a comment that I recently posted to the discussion thread for one of my columns at the Value Walk site:

As always, you ignore the key point and filibuster on a side remark.

Rob, I’ll make a deal with you. Just answer one question directly and I promise I’ll leave you alone forever. (In fact, I might anyway, because unlike you, I do get tired of this.) Here is my question:

Define the precise formula for implementing VII.

But your usual nonsense is not acceptable. This is the start of a formula: “An investor should be in x% stocks and y% bonds when PE10 is at z.”

These are not formulas: “Buy low, sell high.” “It depends on the person.” “It depends on the market direction.” “I’ll tell you after the next crash.” “We need more people talking about it to figure it out.”

In other words, if your answer cannot be measured, it fails.

What fails in your eyes does not necessarily fail in my eyes or in the eyes of millions of other middle-class investors, Dan. You are not the ultimate authority re this stuff. Nor am I, to be sure. Each investor gets to decide for himself or herself how to play it.

There is no one formula that applies for all investors. Each investor decides for himself what formula he will follow.

That’s exactly how it is done in Buy-and-Hold. You have never heard Jack Bogle say “all investors should go with an x percent stock allocation.” He says that you need to take the investor’s risk tolerance into consideration. He says that you need to take the investor’s age into consideration. That makes perfect sense. I don’t find fault with Bogle for not stating a single formula for Buy-and-Hold and it is my view that you should not either.

I don’t see anything wrong with there not being a single formula for Valuation-Informed Indexing either. Different Valuation-Informed Indexers have different risk tolerances too. They should take that into consideration. And different Valuation-Informed Indexers have differing levels of confidence in Valuation-Informed Indexing. They should take that into consideration.

Someone who is seeking a mix of Valuation-Informed Indexing and Buy-and-Hold would want to limit the number and size of the allocation shifts that he employed in his strategy. For example, he might go with 70 percent stocks at all times when the P/E10 level is below 25 and with 40 percent stocks when the P/E10 level is at 25 or above. That’s not Buy-and-Hold. With Buy-and-Hold, there are no allocation shifts in response to changes in valuations. But it is pretty darn close to Buy-and-Hold. The research shows that that investor would receive a big benefit from switching to Valuation-Informed Indexing but not as much of a benefit as those who were open to making more allocation shifts and bigger allocation shifts.

Why do you feel a need to demand a single formula? What does that add?

I prefer it the other way. The more open we are to different approaches, the more people there will be who will feel comfortable offering their thoughts. I might favor one particular allocation strategy and might write an article advocating it. Someone else might come along and write an article making the case for something different. Isn’t that a plus? Isn’t there a good chance that someone other than me will have some good ideas? That sounds like an absolute lock to my ears. So why discourage people from offering their thoughts? I would like to see as much of that as possible. I would like to see a national debate in which we see thousands of good and smart people stepping up to the plate and taking their swings.

I am a “Let a thousands flowers bloom!” sort of guy, not a “Here is the one acceptable formula and don’t anyone dare question it” sort of guy. It’s dogmatism that got us into the mess that we are in today. So I am not too excited about taking the dogmatism poison that killed Buy-and-Hold and injecting it into Valuation-Informed Indexing. If there is one formula that is clearly better than all others, that will become evident over time. People are not dumb. People can be trusted to figure these things out for themselves.

I personally doubt that there will ever be a single formula that works for all people and for all circumstances and for all times. I am not even on the look-out for a single formula. I think we all learn by talking that sort of thing over. I might argue for one formula on Monday and for another on Tuesday in the way that law students argue one side of a case on Monday and the other on Tuesday. Crafting the arguments helps clarify one’s thinking.

So far as I am concerned, someone could say that his formula is always to stay at the same stock allocation until he got close to retirement. That’s Buy-and-Hold! If a guy wants to say that Buy-and-Hold is his formula for implementing Valuation-Informed Indexing, I am not going to lose any sleep over it. I define “Valuation-Informed Indexing” as a strategy in which the investor makes allocation shifts in response to valuation shifts (because valuations affect long-term returns). So that formula as a technical matter does not fit the definition. But it wouldn’t bother me if some fellow wanted to walk that path with his own money. It’s his money, you know? Who am I to tell him that he is not allowed to do what he wants? Why would it even matter what I said anyway?

My thoughts.

Rob

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site;

You stated 2016 as the absolute latest date before you started seriously reevaluating your position. Well 2016 has come and gone and it looks like you have changed nothing.

Yes, it matters when the crash date is. For example, if it is in 2020 instead of 2010 then 2012 then 2014 then 2016 then doesn’t really matter you could spend an extra decade in a thriving market instead of sidelined waiting for a crash. If your market timing gimmick can’t predict within the correct decade it is worthless.

My prison sentence will be never.

I don’t have precise recall re what you are saying that I said re 2016 being “the absolute latest date.” I have a vague recollection that there may have been a date that I gave that after which I said that I would need to re-evaluate. I try to re-evaluate all the time. I believe very strongly in Valuation-Informed Indexing. I believe it is the future. But I also believe that every one of us humans is flawed, obviously including myself. So I do think think there’s a need to question one’s self. That’s why I interact with you here, Anonymous. You are giving the other point of view. You are challenging my thinking. That part of our interaction is part of a healthy process.

No, I haven’t changed my beliefs. I still believe that Valuation-Informed Indexing is the future. I don’t want to stop questioning, I don’t want to stop re-evaluating. Doing that helps me to learn new things. So I need to continue doing that. But you are correct that my confidence is probably greater today than it has ever been.

The question you raise in your second paragraph is an important one. I don’t agree even a tiny bit with your conclusion that “if your market timing gimmick can’t predict within the correct decade, it is worthless.” I suspect that this impression you have is at the core of the dispute. I can see how intuitively it might seem that that is the case. The numbers do not back up what you are saying, not at that extreme. I know because i have done hundreds of runs with the Scenario Surfer. There have been many occasions where I made an allocation change thinking that valuations were such that I would see a payoff within a limited amount of time and then the payoff was denied for many years and yet ultimately I ended up with a bigger portfolio than I would have had following the Buy-and-Hold strategy. Crashes hurt much more than you would think they would. They have a counter-intuitively big negative impact on long-term portfolio growth.

We need more research on this question. I asked John Walter Russell to look into this question and he did a little bit of work in this area a long time ago. But he died before he was able to produce results that I considered definitive and compelling. So we need someone else to take up the ball. You are right that there is some risk in remaining with a low stock allocation for an extended period of time. This is one of the big risks of Valuation-Informed Indexing, that we don’t know what return scenario will come up and some will provide better results than others and that you can get locked out of the market for extended periods of time by following a valuation-informed strategy. So I do see this as an important area of inquiry.

Our disconnect re this question results from the fact that your conclusion is based on a gut reaction rather than an analysis of the numbers. I don’t have a solid analysis of the numbers to point to either. But I do have experience with the Scenario Surfer, which is the best tool that I know about to simulate the possibilities. It indicates that the issue that you are pointing to is real. In fact, in about 10 percent of cases, the Buy-and-Hold strategy produces better numbers at the end of 30 years. I have run scenarios where that has happened. So I believe this is real.

But it is amazing how often the opposite is true. It is amazing how far behind the Valuation-Informed Indexer can be and still come out ahead in the end. There is a counter-intuitive power to this that you are missing. Also, you need to include a consideration of risk in your analysis. In those rare cases in which the Buy-and-Holder ends up ahead, he ends up only a little bit ahead while the Valuation-Informed Indexer usually (not always) ends up far ahead. It might be that there’s some crazy scenario where things would not end up that way. I don’t think we have enough data to rule out that possibility. But we have enough data to say that the possibility is a bit remote. It is certainly not the likely case.

Please look at the return scenario that we are seeing play out today. You Buy-and-Holders have a way of suggesting that Buy-and-Hold has done well in recent years. It has not done at all well for the entire 20 years since prices first reached insanely dangerous levels in 1996. From 2000 forward, Valuation-Informed Indexing is ahead. That should never happen under the Buy-and-Hold theory. IBonds, a risk-free asset class, have beaten stocks for close to 17 years running. That’s just not supposed to be possible. But it obviously IS possible since it just happened. That reality should cause all Buy-and-Holders to stop and think for a moment. Buy-and-Hold is ahead going back to 1996. But not by much. Add in a risk factor of 2 percentage point (say that it is worth 2 percentage point of return to be in a risk-free asset class rather than in a high-risk asset class) and Valuation-Informed Indexing beats Buy-and-Hold from every possible starting date in recent history. Wow!

That’s BEFORE factoring in the effect of the next price crash, Anonymous. Factor in another crash and then all the many years of compounding losses that will result from it for the Buy-and-Holders and there is no comparison between the two strategies. Valuation-Informed Indexing is going to end up pulverizing Buy-and-Hold once again, just as it has been doing for the entire history of the market up until now. All signs from the real world point to that ultimate result.

I want to be able to make stronger research-based claims re this particular aspect of the question. I would like to have available to me research that would permit me to say that “even if the P/E10 value remains above 20 for five more years, the odds of Buy-and-Hold prevailing in the end are less than 20 percent” or whatever. I cannot be that precise in my claims today. The data is there. I just don’t know that I have the statistical abilities to work the numbers in the way that they need to be worked to make accurate and precise claims re this question.

I sure would like to be able to do so. If you Buy-and-Holders were thinking clearly, you would want to know precise answers to the question you are raising here too. You would make it happen. With all those people who post at the Bogleheads Forum, you could get this research done. You should be working that hard. We all should be working together to make that happen. And we should not be trying to prove a point when we go about doing it. We should be trying to LEARN. We all need to learn the REALITIES re the question you raise here. Bogle should be leading this effort. I am not being funny. He started Valuation-Informed Indexing. He should be working hard to show how powerful a strategy it is. If he were thinking clearly today, he would be leading this effort today.

Those are my sincere thoughts, Anonymous. I do agree that prices have remained high much longer than I thought they would. You are right on re that one. And it is an important reality. I do believe that there comes a point when prices remain high so long that Valuation-Informed Indexing begins to lose appeal as a strategy. But everything that I have seen indicates that that time-period is much longer than those who jump to a quick conclusion without studying the numbers closely would first imagine. You have to dig into the numbers and think things through carefully to come to learn the reality and, if you do this, I am confident that you are going to modify your thinking a bit. Probably not enough to be in full agreement with me. But I am confident that, if you look at this question in a serious way, you will modify your thinking at least a bit. It is looking at this sort of thing that impressed me so much and that over time has made me a strong believer in the Valuation-Informed Indexing concept.

Super question. I AM going to try to force myself to continue to re-evaluate. That is important. That is what I ask my Buy-and-Hold friends to do and so that is something that I need to do as well. But I have not been coming to the conclusions that you seem to think that I should come to when I perform my re-evaluations. For me, the case for VII keeps getting stronger. Yes, prices have remained high for a longer time than I once thought at all likely. But the odds that VII will in the long term absolutely kill Buy-and-Hold remain very strong according to every fair-minded analysis that I have looked at. I myself would not have expected that to be the case once upon a time. But I believe in looking at the numbers. And that is indeed what the numbers say (at least according to my own assessments of them).

We’ll see about the prison sentence. I believe that we are just going to have to let thing play out to see how that one goes. My belief re this one is not the same as yours. But I am rooting for you. And you never know, right? Crazy things happen in this mixed-up world of ours from time to time.

I hope that helps a bit, my good Buy-and-Hold friend.

Rob

 

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:

Shiller quite clearly said don’t time the market. Unless you can produce a quote that contradicts that (and you never have) there’s no need to keep asking him the same question.

Anyway, here’s a new peer reviewed paper: “Shiller’s CAPE: Market Timing and Risk”
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2876644

Juicy excerpt:

“We find that stocks outperform 10-year U.S. Treasurys regardless of CAPE, except when CAPE is very high (as mentioned above, the reference point is 27.6). In other words, consistent with market efficiency, ‘buy and hold’ is generally a good strategy even when stock valuations appear to be high by historical standards. Despite the strong negative relationship between CAPE and long-horizon stock returns documented by prior researchers, it is difficult to take much advantage of this apparent market inefficiency. The stock market as a whole appears closer to being efficient than not.”

Comments?

That’s much for the link to the research paper, Anonymous. That’s obviously a huge help.

There’s a good chance that I will write a column re this paper. The comments below are in response only to the abstract. So this is just an initial reaction.

I don’t agree even a tiny bit that the results shown here are consistent with market efficiency. If the market is efficient, there cannot be ANY overvaluation. “Efficiency” means that all factors are being considered. If all factors are being considered, the market is properly priced. If there is any overvaluation at all, the market is not properly priced. So I don’t get that statement at all.

It’s an analytical mistake to make the comparison to 10-year Treasuries. That greatly biases the result. TIPS were paying 4 percent real in 2000. That was the risk-free return at the time. No investor would have chosen Treasuries as an alternative to stocks at a time when a 4 percent real risk-free return was available. Make the comparison to the rational alternative to stocks and you of course get a very, very different result.

However, I do agree with the general point that the valuation level for stocks has to be very high for stocks to be beat by a risk-free asset class. John Walter Russell did research at the SWR Research Group showing this. He showed that an investor who went with a heavy stock allocation whenever the P/E10 level is below 20 would do fine.

That doesn’t mean that all investors should follow that strategy, only that it is one reasonable option. But it does show how powerful the long-term value proposition is for stocks in ordinary circumstances. One of the reasons why the benefits of long-term timing (price discipline) have remained hidden from many of the experts in this field for so long is that it is a rare event for the P/E10 value to go above 20. So there have not been many circumstances in which long-term timing was required or even that beneficial.

Recent years (the time-period from 1996 forward) have very much been an EXCEPTION. This is the first time in the history of the U.S. market in which we have seen so long a time-period in which going with a low stock allocation was a good idea according to the peer-reviewed research in this field. It doesn’t change the reality to point out that today’s reality is an unusual one. But it does go a long way toward explaining why lots of good and smart people have had a hard time recognizing this important (and otherwise easy to understand) reality.

I of course very much disagree with the conclusion that it is not possible to take advantage of market inefficiency. But it appears to me that this is an important study, one that everyone who works in this field needs to take a look at. I am most grateful to you for having brought it to my attention, Anonymous,.

Please take good care.

Rob

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:

“Over time, I’ve become more comfortable with the idea of making more allocation changes. I still don’t make them at all frequently. But I permit myself an allocation change whenever a significant valuation change takes place.”

What allocation changes? You got out of stocks in 1996, according to your posts and you never got back in, including the buy if a lifetime in 2009.

Part One of the article explains that it is about what I have learned about the how-to aspects of stock investing through use of the five VII calculators posted at this site. I have not made any allocation changes in my personal account since the Summer of 1996 (I have been at zero stocks during that time). But I make allocation changes in the portfolios I create with the Scenario Surfer. I am comfortable today making more allocation changes in the runs I do with the calculator that I made in the old days. However, I still do not make many changes. There is no need to do so.

If you truly think that stocks provided the “buy of a lifetime” in 2009, you do not possess a strong understanding of the past 35 years of peer-reviewed research, Anonymous. The fair-value P/E10 value is 15. The lowest we ever got in early 2009 was 13. Stocks represent a very strong long-term value proposition when they are priced at fair-value levels or a bit below, to be sure. But it is silliness to suggest that investors are being offered the “buy of a lifetime” when stocks are offered at fair prices. There has never once in the history of stock investing been an extended time-period in which investors were not able to purchases stocks at prices well below fair-value levels. I have a funny feeling that it’s not all going to turn out different this time than how it has ever turned out before. Just one of those crazy hunches that I have been known to experience from time to time.

I also find it worth noting that a long-time Buy-and-Hold Goon feels okay with using the phrase “buy of a lifetime.” If you truly believed in Buy-and-Hold, you would believe that stocks offer the same value proposition at all times (that’s the only possible rationalization for staying at the same stock allocation at all times).

You’re not the only Buy-and-Holder who does this sort of thing, Anonymous. I see it all the time among Buy-and-Holders. When prices are insanely high, they tell themselves that “oh, price doesn’t really signify anything of importance, the value proposition of stocks is always the same.” And when prices are moderate or low, they say “wow, look at those prices — stocks are really a good buy now!”

It’s marketing garbage planted in their heads through the relentless promotion of Buy-and-Hold “strategies” by the Wall Street Con Men. The come on is: “Come buy our product because it is always a good buy regardless of how insanely overpriced it is!” Then, when overpriced stocks wipe out their marks, the new push is: “Oh, don’t let that bother you, just because we lied about stocks being a good buy before doesn’t mean that we are lying about it today — stocks really ARE a good buy after all you marks have been wiped out and the only people with the money to buy them are us Wall Street Con Men!”

Heads the Wall Street Con Men win, tails the millions of middle-class investors whom they view as their marks lose. Funny how it works out that way with the pure Get Rich Quick approach. And people said Bernie Madoff was dishonest!

Buy-and-Hold! Buy-and-Hold! Buy-and-Hold!

The New Science!

Rob

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:

This just sounds like far out conjecture to create scenarios where you don’t look like a fool for the past 20 years. If it gets to 30 and you haven’t pulled ahead you should just give up.

But what would “give up” mean in this context?

Would “give up” mean that I would endorse Buy-and-Hold? Buy-and-Hold has never once in 145 years produced good results. I am going to endorse that? Huh?

“Give up” could mean that I would stop endorsing Valuation-Informed Indexing. That makes a bit more sense to me. If we are still at very high valuation levels 10 years from now, then, yes, I certainly believe that that would be cause for me to pull back on the strength of my endorsement of Valuation-Informed Indexing. It would suggest that there is some flaw in the model, some error in the understanding of how stock investing works that is behind it. I can go that far.

But I don’t think that giving up entirely on Valuation-Informed Indexing would quite make sense even in that extremely unlikely circumstance (what you are describing has never once happened in 145 years). It would be a reason to pull back, not to give up. We have to do something with our retirement money as we save it, no? Buy-and-Hold and Valuation-Informed Indexing are the only two research-based models we have. Are we going to give up on all research? If not, then we have to at least lean on one of the two models. If both have failed at some point but one has failed only in one case and the other has failed in all but one case, it still seems to me that the evidence is heavily weighted in favor of the model that has only failed once. A model that has only failed once is not a perfect model but it is a far better model that has only worked once.

And it is not entirely clear that, if we do not see a crash that takes us to a P/E10 level of 8 within the next 10 years, that Valuation-Informed Indexing will have actually failed for the first time. My first reaction is to see that as a failure since the predictions would not have worked. But it is always important to remember that VII is a long-term strategy. VII has been producing AMAZING numbers for 145 years now. If its predictions fail for the first time in history and it still has produced solid numbers that are better than Buy-and-Hold for most investors, is that really a failure?

I don’t think we can call it a success. If the model’s predictions fail, that is telling us something and it is not telling us something good about the model. I definitely would see it as a negative mark for VII if its predictions failed to come through for the first time in history. But it still seems to me that VII would remain the best model that we have available to us and that is a “success” of a limited sort.

For me to give up entirely on VII, I would have to see some evidence that it is actually INFERIOR to Buy-and-Hold. That I have never seen and that I would not see (at least not entirely, perhaps in a limited way) even if we did not see another price crash for another 10 years.

All that said, I do NOT think that VII is a 100 percent proven model at this point. It has far outperformed BH for 145 years running. That is a very big deal. But the mistake that the Buy-and-Holders made was to fall in love with a model that they truly believed was the answer before all the evidence was in. Now they feel too embarrassed to acknowledge even the possibility that they made a mistake.As a result, they no longer are even willing to discuss the peer-reviewed research of recent decades. I obviously do not want to repeat that mistake. So I want to work hard to keep my mind open to evidence that VII might not be everything that the evidence available to us today certainly indicates that it is.

That was a good question, Laugh. That raised some fresh points.

Rob

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:

interest rates establish THE COST OF MONEY.

I’ll add a few more words on this particular point because I find your overall question fresh and interesting.

I understand why you say that interest rates establish the cost of money. That is the conventional take.

Shiller’s revolutionary finding of 1981 will be changing the conventional understanding as we all begin to explore the IMPLICATIONS of his Nobel-Prize-winning work. Shiller’s research suggests that establishing the cost of money is not so simple a matter as we once imagined.

An interest rate of x in 2015 is not the same as an interest rate of x in 2000. In 2015, we are probably one or two or perhaps three years away from a stock crash that will pull the most likely 10-year annualized return on stocks up to 15 percent real. In 2000, we were 16 or 17 or perhaps 18 years away from that crash. Do you see the difference?

People who share my doubts about the wisdom of buying stocks today have a hard time lowering their stock allocations because they HATE the idea of accepting the low returns offered today by the super-safe asset classes. They believe that they cannot finance their retirements on such returns. In a surface sense, they are of course correct. Today’s returns are horrible in a surface sense.

But long-term investors need to look deeper. Over a 10-year basis, investors who earn 2 percent real for the next two years and then 15 percent real for the following 8 years will be earning a return far in excess of the 6.5 percent real return that is the average return for stocks. That’s AMAZING. Today’s returns on super-safe asset classes are great. They look bad. But the story is very different when you take the implications of Shiller’s revolutionary finding of 1981 into consideration.

To understand this better, it helps to take into consideration the REASON why interest rates are so low today.

Interest rates are low because the Fed is trying to hold off the coming price crash. I don’t believe that they can do this because the primary cause of the coming crash is that investor psychology needs to change for market to be able to continue to function. But the next crash is going to cause a deepening of the economic crisis and that has huge political implications and so the Fed naturally is motivated to do what it can to hold back that crash. And keeping interest rates low certainly has delayed the crash for a good amount of time.

In a surface sense, interest rates can be said to reveal the cost of money. But that’s not really true in a deep sense and in a long-term sense. Money being held in stock form is massively overpriced today. Lots of people want to move their money from stocks to more appealing asset classes. There are political reasons why the Fed does not want to see that happen. So the cost of money is temporarily being kept artificially low. But the value of the money obtained at today’s low prices will be revealed as very great once the crash hits and the long-term return on stocks skyrockets. The long-term value of the money that can be obtained at today’s low interest rates is off the charts.

The core problem of all analyses done under the Buy-and-Hold Model is the root assumption of that model that economic transactions are rational transactions. Rationally, the price of money should reflect its value. But this just isn’t so! That’s what Shiller showed! He showed that investors are NOT rational. All overvaluation is irrational and all undervaluation is irrational and both are 100 percent real phenomena that investors need to take into consideration when developing their strategies. Money is artificially and irrationally priced today.

The material in this post probably doesn’t matter much for the average investor. He just needs to keep his head down, keep it simple and lock in that 6.5 percent real long-term return. But it doesn’t hurt to think through the theory that explains how things are playing out.

I think this question is a helpful one. I am grateful for it. I wish we saw more questions of this nature being brought up on a daily basis in all sorts of venues. We need to launch a national debate re this stuff and to thereby launch a massive learning experience.

Please take good care.

Rob

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:

RM – What do you think will happen to interest rates?

RB – “I do not focus on interest rates very much. I am very much a long term investor. Interest rates will go up and go down over the long term.”

Rob, interest rates establish THE COST OF MONEY. Surely anyone fashioning themselves as a Valuation informed Investor, who insists on price discipline in all things, who eschews stocks for the safety of bonds, would find the price of money to be an essential piece of information, and along with yield, to be one of the PRIMARY factors driving investment decisions. How do you defend your answer, given what I think is obviously the truth, as I just outlined?

Good question.

Shiller described his finding that valuations affect long-term returns as “revolutionary.” That means that it changes everything that we once thought we knew about how stock investing works.

Stocks provide an average long-term return of 6.5 percent real. That’s outstanding. It’s possible for some super-smart investors to beat that. But there is no need for the average person (the person to whom my words are directed) to do much better than that. A return of 6.5 percent real is good enough to finance a decent retirement for the vast majority of people. So the primary goal is to lock in that 6.5 percent real return as your personal long-term return or at least get close to it. That’s the name of the game.

You can’t do that without taking valuations into consideration. The most likely 10-year annualized return on stocks in 2000 was a negative 1 percent. That’s 7.5 percentage points off the mark for a significant stretch of time (most of us build our retirement portfolio from about age 25 to age 65 — so 10 years is 25 percent of the time we have to build our retirement portfolio). That doesn’t cut it. So you needed to move away from stocks in 2000. TIPS were paying 4 percent real. That’s good enough, especially for an asset class that is super-safe. You can make up for the difference between the 4 percent TIPS return and the 6.5 percent goal by investing in stocks following the next crash, when the likely 10-year return will be about 15 percent real.

You are adding a layer of complexity when you start worrying about interest rates. It’s not crazy to take interest rates into consideration. I won’t object if you do so. But it is not necessary. You don’t have to consider interest rates to lock in that 6.5 percent real return. And there’s risk in considering factors that you don’t need to consider.

Bogle argues the merits of keeping your investing strategy simple. This is one where I think he is 100 percent right. This is one of many points that Bogle has made that cause me to call him a “genius,” second only to Shiller in my assessment. You might incorporate the interest-rate factor into your strategy in an effective way. But the more complicated you make things, the more likely you are to out-smart yourself. How much do you really add by mixing in that factor? How much added risk are you taking on by making your plan more complicated?

I consider valuations because the valuations factor is huge. It’s 80 percent of the stock investing story. Ignore valuations and you are ignoring pretty much everything. You are shooting in the dark.

But interest rates are not a huge deal. Please look at the historical data going back to 1870. Investors who paid zero attention to interest rates did just fine. You can’t say that about valuations. Investors who ignored valuations hurt themselves in a big way. They took on far more risk than they needed to and they reduced their long-term return dramatically. For what purpose?

There are super-smart people who can earn a slightly higher return by taking factors like interest rates into consideration. They should go for it. But it is not for the average person, in my assessment. It complicates things and the complication is an unnecessary one and with added complexity comes added risk. I think it makes more sense just to lock in that 6.5 percent real and be satisfied with a plenty-good-enough return. That’s the strategy consistent with Bogle’s thinking and he is the king when it comes to investing strategies for the average person (with the exception of the mistake he made re valuations because all the research was not yet in when he took his initial stab at creating a research-based strategy).

I hope that helps a bit, Anonymous.

I could be wrong! It’s been known to happen! If it were happening again, I would probably be the last to know! I suffer from biases, like all the other humans!

Rob

Set forth below is the text of a comment that I recently posted to another blog entry at this site:

Here’s what a team of Vanguard PhDs and CFAs say:

Figure 2 reveals that the predictability of valuation
metrics has only been meaningful at the 10-year
horizon. Even then, P/E ratios have explained only
approximately 40% of the time variation in real
stock returns.

https://personal.vanguard.com/pdf/s338.pdf

Uh oh.

I view the Vanguard paper as being highly supportive of Valuation-Informed Indexing principles. At one point it states that “returns are better stated in a probabilities forecast” and that in the short term returns are not predictable at all. That’s Valuation-Informed Indexing! That’s what I have been saying over and over again since the first day. That’s what the Return Predictor shows. So I have not until now been able to figure out why you keep bringing up this paper.

I re-read your comment above and it hit me. I say over and over again that valuations are 80 percent of the game and the paper says that P/E ratios explain only 40 percent of the time variation in real returns. You are viewing the difference between the 80 percent number and the 40 percent number as a discrepancy.

I am NOT saying that valuations are responsible for 80 percent of the return in any given year. I stand by my statement that understanding and acting on valuations is 80 percent of the strategic stock-investing game.

There are two broad types of factors that affect returns: (1) rational factors; and (2) irrational factors.

The rational factors are all the things that should and do affect stock prices, all of the things that affect the profitability of the underlying businesses. Fama showed that all of these factors are quickly incorporated into the price of stocks. The Valuation-Informed Indexer does not dispute this finding. We endorse it. The Vanguard study is saying that all of these factors added together comprise 60 percent of the price.

The irrational factors are the emotional factors that cause mispricing (overvaluation or undervaluation). These factors are non-business, non-economic factors. They are emotional factors. The significance of these factors at any given point in time is signaled by the P/E10 value.

As an investor there is nothing you can do about the 60 percent of rational factors. So no strategic considerations come into play. If rational factors determined 100 percent of the market price, the market would be efficient (because there would be no emotional factors throwing things off) and Buy-and-Hold would be the ideal strategy. If there were no emotional/non-rational factors to take into consideration, risk would be constant. The investor would always be justified in having an expectation of a long-term return of something near 6.5 percent real.

There IS something you can do about the 40 percent emotional factors.

This study (and every other study that has looked at the question in an even remotely reasonable manner) shows that the market is NOT efficient and that RISK is variable, not constant. Buy-and-Hold does NOT make sense. Investors MUST change their stock allocations in response to big valuation shifts to have any hope whatsoever of keeping their risk profiles roughly constant over time.

The 40 percent of the total return that depends on the P/E10 level is the only portion of the total return to which the investor can respond in a strategic way. The logical response is to increase one’s stock allocation when prices are low and risk is low and to lower one’s stock allocation when prices are high and risk is high. That’s Valuation-Informed Indexing. That’s the entire concept. That’s the approach that lowers stock investing risk by nearly 70 percent, according to the famous Bennett/Pfau research paper (the only research paper so compelling that it caused the Buy-and-Holders to threaten to destroy the careers of the two authors of the paper so desperate was their desire to keep millions of middle-class investors from learning about its findings).

Valuations are not 100 percent of what determines the market price. Rational, economic factors obviously play a huge role. But there is nothing that the investor can do about those factors. They are a given.

The investor MUST change his stock allocation in response to the 40 percent of emotional factors. So far as allocation changes go, valuations are 100 percent of the game. There is no other factor that permits a high degree of predictability, according to the research. So I believe that valuations are the ONLY factor that an investor should be looking at when making the necessary allocation changes.

I reason why I don’t say that valuations is 100 percent of the game is because there are considerations other than getting one’s stock allocation right that come into play. For example, it makes sense to limit one’s fees. If one company has lower fees than another, that will affect the investor’s long-term level of success. That is a non-valuation factor. Another example of a non-valuation factor that matters is that most investors should be going with index funds rather than picking individual stocks. Failing to go with indexes is not a fatal mistake. But I do believe it is a mistake for all investors except those who possess the skill and willingness to do research needed to win at the stock-picking game.

My claim is that getting your stock allocation right is the most important thing (80 percent of the game). And that the investor MUST take valuations into consideration to get his stock allocation even roughly right. If you ignored valuations, you might have gone with a 74 percent stock allocation in 2000 (the Greaney study identified this allocation as “optimal” at all times). If you considered valuations, you probably went with an allocation of about 20 percent. That’s a big difference and getting that one right is going to pay off big time in the long run if valuations are indeed responsible for 40 percent of the market price (that is, if stocks continue performing in the future anything at all as they always have in the past).

The Vanguard study shows that the valuations factor is huge. It is the ONLY significant factor to which the investor can respond in an effective manner. All he needs to do is to look at the P/E10 value and make the required allocation changes. If he fails to do that, he hurts himself big time.

There is no excuse for any investment advisor to fail to stress the importance of valuations in the year 2014. A factor that determines 40 percent of the market price is far too important a factor to be ignored. I would go so far as to say that it is financial malpractice for any advisor to ignore the valuations factor (responsible for 40 percent of the market price according to Vanguard!) in the year 2014. Shiller did not publish his revolutionary research last week or last month or last year. He published it in 1981. That’s 33 years ago!

There are legitimate differences of opinion as to HOW MUCH one should change one’s allocation in response to valuation shifts. That’s why we need a national debate on these questions. We need to get all viewpoints re these matters aired! But the issue of whether valuation-informed allocation changes are required for those seeking to have some realistic hope of long-term investing success has been settled beyond any reasonable dispute. Even Vanguard (the lead promoters of Buy-and-Hold investing strategies) is on board! Bogle hasn’t given his “I Was Wrong” speech yet but the company he founded has published research showing why he needs to make it to come clean about false and deceptive claims he has made in earlier days which have done great financial harm to millions of middle-class investors.

Come clean, Old Saint Jack!

Do it before the close of business tomorrow!

Don’t worry about Mel Lindauer! I will take over the Bogleheads Forum and I will protect you from him!

Rob

Set forth below is the text of a comment that I recently poster to another blog entry at this site:

Perhaps you feel your VII is superior but in that case shouldn’t buy and hold simply be seen as sub-optimal not broken and never capable of working.

I believe that Valuation-Informed Indexing is superior to Buy–and-Hold. It always either increases return or decreases risk.

This can be tested with The Investor’s Scenario Surfer. In the hundreds of tests I have run, VII ha produced higher 30-year returns in 90 percent of the cases. In the other 10 percent, Buy-and-Hold produced higher returns. But there is obviously more risk with a strategy that only works in 10 percent of the possible scenarios. So I think it is fair to say that VII always produces better risk-adjusted returns.

You say that some people have been able to retire using Buy-and-Hold. Stocks are an amazing asset class. It’s hard to come up with a strategy that is so bad that not one person using it would be able to retire. There are people who put all their money in lottery tickets who end up being able to retire. I see that as too low a bar. If one strategy ALWAYS produces lower long-term risk-adjusted returns than another, I think it is fair to say that it never works. The aim of an investing strategy is to produce HIGHER returns with LESS risk. Buy-and-Hold hurts you in both departments.

I of course have zero objection to the idea of people USING Buy-and-Hold because they personally find appeal in it. Those who like it should of course use it. But they should not make exaggerated claims for it. They should just use it and be happy that they have something they like to use.

If they know what they are getting into, there is no reason why they should be angry that others use other strategies. That’s what I see with you Goons — you are ANGRY that others use Valuation-Informed Indexing. That’s a very bad sign, in my assessment. Anger is a negative emotion. If using Buy-and-Hold is making people angry, there is something very wrong with Buy-and-Hold.

I pick up from your comments that Buy-and-Hold is being pushed for MARKETING reasons. The idea seems to be — This is good enough for all the investors who are not capable of gaining sufficient control over their emotions to follow a Valuation-Informed Indexing strategy. I see this as a chicken-and-egg thing. EVERYONE is capable of following VII strategies successfully so long as they hear about them frequently. It’s because they don’t hear about them often that the ideas cause confusion.

In any event, no one has a right to use abusive strategies to stop people from learning about a strategy they might like. If people want to push Buy-and-Hold as the strategy that is good enough for people who would have a hard time following a VII strategy, that’s fine. But it is up to the investors to decide for themselves which category they fit in. Everyone has a right to promote VII strategies at every discussion board and blog on the internet. Just as everyone has a right to promote BH strategies at every discussion board and blog on the internet.

Rob