A Rich Life

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

“My Hope Is to Persuade You to Steer the Indexing Revolution to a More Promising Path”

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Set forth below is the text of an e-mail (entitled “We Need Your Help to Open the Indexing Boards to Honest Discussion of Valuation-Related Topics”) that I sent yesterday to Vanguard Group Founder John Bogle (with a copy to www. IndexUniverse.com Publisher Jim Wiandt):

Mr. Bogle:

This is Rob Bennett, author of the “A Rich Life” blog and owner of the www.PassionSaving.com site. I hope that things have been going well with you since the last time I wrote. You may recall that my May 2006 e-mail introduced you to the Valuation-Informed Indexing concept. To refresh your memory of the contents of the earlier e-mail, here is a link to a blog post setting forth its text:

http://arichlife.passionsaving.com/2006/05/17/my-e-mail-to-john-bogle/

I was excited to see your almost-but-not-quite endorsement of Valuation-Informed Indexing in your recent video interview with Jim Wiandt of www.IndexUniverse.com. I wrote a blog entry reporting on your comments and on my thoughts as to their significance:

http://arichlife.passionsaving.com/2009/07/28/bogle-says-valuation-informed-indexing-can-work/

I hope that you will appreciate the great need for me to convey to you the message below despite the delicacy of the matter.

We humans often need to experience pain before we can open our minds to the consideration of new ideas. Have you not found this to be so?

My hope for this e-mail is to persuade you to take actions that you are uniquely situated to take that would steer the Indexing Revolution to a new and (I believe) far more promising path than the one it is on today.

I believe that Passive Indexing, the indexing strategy that you pioneered, is the indexing strategy of the past. I believe that Valuation-Informed Indexing, the indexing strategy that I developed with the help of thousands of middle-class investors participating in discussions held over the last seven years in the Retire Early and Indexing discussion-board communities, is the indexing strategy of the future.

My view is that you did work of huge importance in developing the Passive Indexing strategy (your insights are of course the foundational insights for the new strategy), but that you committed terrible mistakes in your crafting of the first-draft indexing approach. Indexing works for the long-term investor only if he is open to making allocation shifts in response to big valuation changes and many Passive Investors are highly reluctant even to consider the possibility. Investing passively for years causes investors to become emotionally incapable of making the allocation shifts required for long-term success.

I understand that you do not believe this today. I believe that I possess a reaonably good (but far less than perfect) understanding of why. It has taken me seven years of intense study to develop the insights that I now make use of on a daily basis in the podcasts, articles, blog entries, and calculators published at my site. I want to make these insights available to you and to all of the indexers who look to you for guidance (which obviously number in the millions).

That sounds patronizing.

It’s not my intent to patronize. You are one of my heroes. I feel great respect and affection for you because of the work you have done for middle-class investors over  a long and fruitful and shining career. It was by reading your book that I learned where stock returns come from and thereby walked the first step that led me years later to development of the Valuation-Informed Indexing strategy. There is obviously no benefit to me if I come off sounding patronizing in an e-mail to my hero and thereby cause him to feel disinclined to help out in the important cause in which I am seeking to enlist him.

But you know what?

There’s nothing that I can do about it.

I sincerely believe that Valuation-Informed Indexing is superior to Passive Indexing in every possible way. I am 99 percent certain of this, as certain as I am of the fact that the moon is not made of green cheese. If I were to suggest some doubt re this point in my words to you, I would be engaging in an act of dishonesty. So I have to deliver the message in the only way in which it can honestly be delivered and hope that you have had some life experience that helps you understand where I am coming from. I have read that you faced a good deal of flak when first leading the charge for the indexing concept.  Perhaps there were times when you had to say things that you knew to be so that caused some pain to some people on “the other side” to whom you very much did not want to be causing pain.

I have been learning more and more and more about how stock investing works in the real world in the  seven years since I put forward the fateful post to the Motley Fool site that kicked off The Great Safe Withdrawal Rate Debate. I am highly confident that this is what you would have wanted those who followed in your footsteps to do. I am highly confident that, had it been I who pioneered indexing and you who discovered the errors in the first draft of the concept, you would have worked as hard as I have to learn everything possible about the errors made in the first draft and about the changes that need to be made to salvage the indexing concept in the wake of the great human misery it has caused in recent years. In any event, the path that I have taken is to learn all that I could possibly learn. My experience has been that, once I abandoned the idea that Passive can work, there has been seemingly no limit to the learning experiences that have opened to me.

As I am sure you know, the indexing movement is a troubled movement today. There are some who have become so dogmatic about their belief that only Passive Indexing can work that they have engaged in a great deal of ugliness to block thousands of community members who have expressed a desire to explore new ideas. My sense is that, while you remain unconvinced that Passive needs to be replaced, you do not feel comfortable with the tactics that have been employed on discussion boards that carry your name or your company’s name to silence the many community members who have developed doubts about the conventional approach in recent years. Our community needs you to act to bring this ugliness to an end.

My ultimate goal is to convince you and all other Passives that Valuation-Informed Indexing is superior. That is not work that can be done in a day. The transition to a new model can only be achieved gradually, as the thousands of questions that those who have long favored the Passive strategy are answered by those of us who have come to lose confidence in that strategy. I do not ask you to endorse Valuation-Informed Indexing today. I ask you to endorse an end to the ugliness that has blocked civil and reasonable debate on these questions for a good number of years now. The indexing movement needs to leave that ugliness behind us once and for all.

Can you help?

It’s possible that I am wrong. We all have an inclination to overlook the flaws in our own arguments. If I am wrong, I want to know that. The best way for me to learn it is for my ideas to be challenged in civil and reasoned discussions by those who believe in the Passive strategy. The idea of opening our boards to honest and civil and informed and serious (and fun!) discussions is a win/win/win/win/win. We either move the Indexing Revolution in an exciting new direction or we learn that no new direction is needed. Neither of these favorable options is available to us for so long as we give in to fear and refrain from taking the steps needed to get fruitful discussions started.

If you have any questions about what I am writing about here, please know that I am happy to help in any way possible to get things moving in a constructive and positive and encouraging direction. Thanks again for all the wonderful work you have done for middle-class investors and for whatever time you are able to give to consideration of this request.

Rob

http://arichlife.passionsaving.com

Bogle Says Valuation-Informed Indexing Can Work

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Vanguard Founder John Bogle in a recent video interview with the IndexUniverse.com site offered an almost-but-not-quite endorsement of the Valuation-Informed Indexing strategy, the investing strategy explored at this site. Bogle’s comments come in the wake of a growing wave of opinion that the Passive Buy-and-Hold strategy long advocated by Bogle has been proven a failure by last year’s stock crash.

“Big moves out of stocks should not be done at all,” Bogle told interviewer Jim Wiandt, publisher of the www.IndexUniverse.com site. But “tactical asset allocation — I should say strategic asset allocation rather than tactical — can be done at very rare times, so rare and so difficult to observe, maybe six times in an investor’s lifetime, three times when the market is stupidly high and three times when stupidly low.”

Valuation-Informed Indexing rejects the idea that Passive Investing (sticking with the same stock allocation even when stock valuations change dramatically) can ever work in the real world for the long-term investor. This strategy is rooted in the Rational Investing model (the alternative to the now-dominant Passive Investing model), a model that accepts the academic research of the past 28 years showing that valuations always affect long-term returns. Valuation-Informed Indexers adjust their stock allocations as needed to keep their risk levels roughly constant rather than keeping their allocation levels constant and thereby permitting their risk levels to get wildly out of whack from what they had determined was right for them when they set them. Thus, Valuation-Informed Indexers lost far less in the crash and will be benefitting from greatly enhanced compounding returns for decades to come. The historical stock-return data shows that there has never yet been a time in U.S. history when Passive Indexers have done better than Valuation-Informed Indexers although there have been many cases in which the valuation-informed strategy soundly beat the passive strategy.

Bogle distanced himself from the position advanced by Mel Lindauer (author of The Bogleheads Guide to Investing) during his Campaign of Terror against the Vanguard Diehards discussion-board community (which expressed great interest in learning more about Valuation-Informed Indexing); Lindauer said that those who follow valuation-informed strategies are not properly thought of as “Bogleheads” and that it is “dangerous” for indexing boards to permit civil and honest discussion of the academic research of the past three decades showing that valuations affect long-term returns. In contrast, Bogle invited those who find appeal in valuation-informed strategies to “be my guest” in following them (and presumably in discussing them amongst themselves and with any of their friends who happen to be Passive investors).

However, it cannot be said that Bogle gave a full and clear endorsement to the new indexing strategy, a strategy developed by the thousands of members of the Retire Early and Indexing discussion-board communities participating in the controversial series of discussions collectively known as “The Great Safe Withdrawal Rate Debate.” He expressed skepticism as to investors’ ability to take advantage of the message of the historical data, saying that Valuation-Informed Indexing works only “if you can pick the times” to make the necessary allocation shifts. “I don’t do it myself — I’m not smart enough to,” the Vanguard Founder (and father of the Indexing Revolution) added. Bogle did not offer any explanation of why he does not view himself as “smart enough” to follow this exceedingly simple strategy (but his expression of concern over picking the right times to make allocation shifts suggests that he may not yet possess a clear understanding of the key distinction between short-term timing and long-term timing — that picking market high and lows is not necessary for success as a long-term timer).

Still, Bogle made two major concessions that no big-name Passion Investing advocate has made before.

First, he conceded (in the words quoted above) that Valuation-Informed Indexing is a strategy, not a tactic. Passive dogmatists have often played word games in which they pretended (perhaps to themselves as well as to others) to acknowledge the academic research of the past three decades while ignoring a key finding of that research — that changing one’s stock allocation in response to price changes works only when applied strategically (to obtain long-term benefits) and not when employed tactically (to obtain short-term benefits). The historical data shows both that tactical (short-term) timing never works and that strategic (long-term) timing always works. Bogle’s acknowledgment that the benefits of long-term timing are strategic rather than tactical is potentially a highly significant development; Passive Investing dogmatists have long taken advantage of the general public’s confusion over what the academic research says about timing (that short-term timing is a bad idea and that long-term timing is required for long-term success) to thwart efforts of investors to learn the realities of stock investing by  planting the suggestion that advocates of Valuation-Informed Indexing are promoting a doomed tactical change rather than a common-sense strategic one.

Second, he noted that knowing when to lower or increase one’s stock allocation “might not be quite as difficult as it seems.” This statement suggests that Bogle has been educating himself about the message of the historical data in the months since the crash. There have been numerous good discussions of the merits of Valuation-Informed Indexing at the Bogleheads.org board since September 2008, when the ban on discussion of the academic research of the last 28 years was eased but not entirely lifted.

Wiandt imposed a partial ban on discussion of the investing realities at the www.IndexUniverse.com site after first expressing excitement about publishing articles on the Valuation-Informed Indexing strategy and then learning from his senior editor (who has ties to Mel Lindauer and other “leaders” of the Bogleheads.org board community) of Lindauer’s position. However, Wiandt too has evidenced a softening in recent months. His site recently published an article by Rob Arnott, former editor of the Financial Analysts Journal, arguing that most of the conventional investing wisdom of today (insights developed under the Passive Investing model) is the product of “myth and urban legend.” Arnott has said that we are today living in the early days of a “revolution’ in our understanding of how stock investing works.

Podcast #70 — Reversion to the Mean: We Are Losing Sight of What Bogle Got Right

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I’ve posted Podcast #70 to the “RobCasts” section of the site. It’s called Reversion to the Mean — We Are in Danger of Losing Sight of All that Bogle Got Right.

Bogle made one big mistake. I wish that his “supporters” could accept that and not feel a need to deny all the great stuff he did as a result of trying to “protect” him from coming to terms with the one big mistake.

Podcast #41 — Bogle and Valuations

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I’ve added Podcast #41 to the “RobCasts” section of the site. It’s called Bogle and Valuations.

Bogle recently pointed out that the market now values U.S. businesses at about $9 trillion less than it did just one year ago and that that’s crazy. He’s right. The market was not valuing things properly one year ago. That means that the market is not efficient. That means that Passive Investing cannot work.

Podcast #7 — I Know More About Investing
than John Bogle (and You Can Too!)

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I’ve added Podcast #7 to the “RobCasts” sectionn of the site. This one is entitled I Know More About Investing than John Bogle (and You Can Too!)

Today’s Passion: The Podcast makes reference to the time when I announced plans to attend a meeting of the Vanguard Diehards at which I would have been able to ask Bogle questions about his views on the effect of valuations on long-term stock returns. Surprisingly enough, some took exception to this idea. And I ended up writing a blog entry on The Questions Bogle Wasn’t Asked at the Vanguard Diehards Meeting.

My E-Mail to John Bogle

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John Bogle is the leader of the indexing revolution. He recently started a blog. He invited questions from readers and said that each month he will pick five questions from submitted e-mails and answer them.

Set forth below is the text of my e-mail to Bogle:

Mr. Bogle:

My name is Rob Bennett. I am a fan of your writings. I learned a lot from your explanations of how to determine rationally long-term stock returns.

I write on investing at my web site, PassionSaving.com. I advocate an approach that I call “Valuation-Informed Indexing.” The distinction from the conventional approach to indexing is that Valuation-Informed Indexers lower their stock allocations at times of extremely high valuations and increase them at times of extremely low valuations. I favor the use of P/E10 as a valuation-assessment tool.

My view is that the typical investor should go with a stock allocation of about 50 percent at times of moderate valuation, increase that to about 75 percent at times of low valuation, and lower it to about 25 percent at times of high valuation (like today).

I do not favor frequent changes in allocation levels. I do not favor short-term timing.

I believe that changes in valuation affect the long-term value proposition offered by a stock investment. If an investor determines that he should have a stock allocation of X at moderate valuation levels, he needs to lower his stock allocation at times of high valuation levels in order to maintain the same risk level.

I would be most grateful to hear any thoughts that you could share regarding this approach.

Rob