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Rob Bennett’s Responses to Academic Researcher Wade Pfau: #17 — How Valuation-Informed Indexing Will Reach Its Tipping Point

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Wade says that I “desperately” want to hear researchers and other experts in this field say that the Old School safe-withdrawal-rate studies need to be corrected. The suggestion is that I place too much importance on this matter. Others have said similar things. My ten-year effort to get the errors in the retirement studies corrected has been referred to as my “obsession.” I have been told that I am on a “crusade.” It has been said that my passion re this matter causes me to suffer “death by verbosity.”

I don’t buy it.

When I gain the right to post honestly on the internet re SWRs and many other critically important investment-related topics, it won’t be only Rob Bennett who gains that right. Robert Shiller (the author of Irrational Exuberance) will gain that right. Vanguard Founder John Bogle will gain that right. William Bernstein (author of The Four Pillars of Investing) will gain that right. And on and on and on.

When I gain the right to post honestly, we ALL gain the right to post honestly. There’s huge leverage in that. We have denied ourselves the right to speak openly and plainly and honestly and realistically about how stock investing works for 30 years now. Behind the scenes, we have achieved huge advances in our understanding of the realities during those three decades. When we give ourselves permission to talk about what we have learned (and thus for the first time to fully understand it — we humans take in knowledge by talking it over), we will shoot ahead at an amazing pace. Can you imagine where we would be today in the electronics field if a law had been passed in 1981 saying that advances in that field had to cease because it would hurt the feelings of the people who didn’t know everything there was to know about electronics in 1974 for us to continue to move ahead? There’s huge leverage to be had by permitting thousands of smart and good people to use their brains again and help us all learn how stock investing really works even when telling that story means pointing out that there was a time decades ago when we didn’t know it all perfectly.

The Buy-and-Holders did something potentially wonderful back in the early 1970s. They developed an investing strategy rooted not in vague and subjective impressions and opinions but in the hard stuff, academic research based on an examination of the historical return data. It’s that breakthrough that has permitted us to make so much progress. There would be no Valuation-Informed Indexing today had it not been for work the Buy-and-Holders did in earlier times arguing that we should research investing questions rather than just offer off-the-cuff subjective opinions about them. What we didn’t see in the early 1970s was how the power of research could be used to hold us back rather than to push us forward. It is the claim that Buy-and-Hold is rooted in research that has made it so influential a strategy. But, because the Buy-and-Holders got it wrong, all that influence has been used to steer investors in the wrong direction. The road out of this economic crisis is to permit the researchers to report honestly and accurately what they learn when they study the data. It’s not putting numbers into tables that is the purpose of investment research. It’s discovering truths about investing that is the purpose. To discover truths, we need to become able to acknowledge errors when we make them.

That’s why this is such a big deal. That’s why I am “desperate” to see the Old School SWR studies corrected. Causing millions of people to suffer failed retirements is a big deal. The Buy-and-Holders want to avoid acknowledging the errors they made in the studies in the worst way. The Old Boys Club has sent down the word — you spill the beans re this one and you’ll never be able to get work in this field again. But what happens if the economic crisis grows so terrible that even people in the investing field begin to feel the need to take action to bring it to an end? I believe that we will then see forward movement. And it won’t be a little bit of forward movement. Valuation-Informed Indexing is close to its Tipping Point as a breakthrough idea. Once we get a few of the big names in this field developing the courage to stand up to the Goons, we will see an avalanche of investing insights. We will as a society experience the benefits of 30 years of insights over the course of about six months of time. It will be something else!

We need to get to that Tipping Point. There’s nothing intellectually we need to do. We have the data that shows that Valuation-Informed Indexing is superior. We have the research that shows that Valuation-Informed Indexing is superior. We have the expert statements showing that Valuation-Informed Indexing is superior. What we need is a means to spread the word to the millions of middle-class investors crying out for a more sensible and effective way to invest. There’s a sense in which we even have that. The internet is a powerful communications medium. We could spread the word quickly if those who knew what works were not afraid of what will be done to their careers if they dare to speak up. And we even have rules in place at all our boards and blogs protecting those people from the brutal tactics of the Buy-and-Hold Goons. We are on the 99-yard line. All we really need today is effective enforcement of the rules that in theory already are in place at the web sites where we need to be spreading the word.

Set forth below are 10 examples of experts who would love to be able to tell the truth about stock investing, if only as a society we were willing to do what we need to do to make them feel safe doing so.

1) I learned about the errors in the Old School safe-withdrawal-rate studies by reading John Bogle’s book. Bogle explained that Reversion to the Mean is an “Iron Law” of stock investing. If high prices always lead to low prices, the safe withdrawal rate obviously cannot be the same when prices are high as it is when prices are low. Bogle would love to feel free to tell the truth about stock investing, as revealed by the last 30 years of academic research. We should let him.

2) Years before all of the major publications in this field acknowledged the errors in the Old School studies, one of the Goons asked William Bernstein whether he agreed with my claim that the Old School studies employed an invalid methodology. Bernstein said that “of course” the methodology used was valid but that anyone who was giving thought to making use of one of the Old School studies to plan a retirement would be well-advised to “FuhGedDaBouDit!” The second part of his statement is obviously just a down-to-earth way of saying that the methodology used in the studies was analytically invalid (if a valid methodology had been used, the numbers generated by the studies would not have been so wildly off the mark). Bernstein would love to feel free to tell the truth about stock investing, as revealed by the last 30 years of academic research. We should let him.

3) Yale Economics Professor Robert Shiller described the theory behind the Valuation-Informed Indexing concept in his bestselling book Irrational Exuberance. But Shiller held back from including even one paragraph in the book telling investors how they should invest now that we know that Buy-and-Hold strategies can never work in the long run. Shiller told us why in an interview in which he said that he has never dared to go public with all he knows about how stock investing works because he would be smeared as “unprofessional” if he did so (I have a funny hunch that I might know what investing strategy it would be that would inspire its followers to do something like that). I wouldn’t be at all surprised to learn that Shiller has already written Irrational Exuberance II, the book that describes what it is that investors need to do now that they know how dangerous it is not to practice long-term timing. Shiller would love to feel free to tell the truth about stock investing, as revealed by the last 30 years of academic research. We should let him.

4) Philip Taylor is a blogger who organizes the annual Financial Blogger Conferences. I submitted an article on Valuation-Informed Indexing for inclusion in the conference magazine. Phil rejected the article not because he does not see merit in the investing strategy but solely because he knows that bloggers don’t today know enough about the dangers of Buy-and-Hold and the benefits of Valuation-Informed Indexing to appreciate how much they would be helping their readers to lead the transition to the new strategy. He told me: “I assure you, my rejection of your article has nothing to do with my opinion on your particular strategy. I don’t need convincing of anything. Your way is perfect as far as I am concerned. Go preach it to the nations. #FinCon12, though, is not the right pulpit for this topic. The bloggers just don’t care. They have shown time and time again in the surveys that these types of topics are not of interest. Please respect that I know my audience.” Phil is right in what he says about out fellow bloggers. I have experienced this indifference to the new strategy on hundreds of occasions. But what if Bogle and all the others came out with public statements saying that Buy-and-Hold is the past and Valuation-Informed Indexing is the future? Would financial bloggers not be thrilled to lead the effort to get accurate and honest and realistic information about how to invest in stocks out to their readers? The question answers itself. Taylor and all other financial bloggers would love to feel free to tell the truth about stock investing. We should let him.

5) Mike Piper is the author of the Oblivious Investor blog. I had a long talk with him at last year’s Financial Bloggers Conference about the ban on honest posting in place today at his site and in place today at a good number of other sites. Mike told me that “there is nothing I would like more” than to see a lifting of the ban. But Mike has a problem. He permitted honest posting at his site for a time and my daily comments pointing out the dangers of Buy-and-Hold enraged his readers, most of whom follow the Buy-and-Hold strategy. If Mike were to permit honest posting, would he be able to retain his readership? If Bogle and all the others spoke out, he sure could. If Mike were giving honest and accurate and research-supported investing advice, his readership would skyrocket and all those Buy-and-Hold readers who are upset today to read the truth about stock investing would be thrilled to do so. But Mike needs our help. He needs Bogle and lots of others to give him “cover.” Mike would love to feel free to tell the truth about stock investing. We should let him.

6) Financial Planner Michael Kitces wrote at his blog that: “There are time-periods where stocks are a terrible addition to that portfolio. Yet inexplicably, we as planners STILL tend to suggest that it is ‘risky’ to not own stocks when in reality the only material risk is to our business and ability to keep clients, NOT to the clients’ goal.” I think it would be fair to say that Michael very much looks forward to the day when he can tell his clients the truth about stock investing. He has told me in e-mail correspondence that he knows of numerous financial planners who were in the days following the 2008 crash discussing the possibility of starting to let their clients in on some of the stuff that all those who work in this field today know about but dare not give voice to in public comments. Michael would love to feel free to tell the truth about stock investing. We should let him.

7) New York Times Financial Blogger Carl Richards has said of my work: “I have read everything I can about Valuation-Informed Indexing. What you are doing has huge value.” But Carl too banned me from his site. Again the reason was the burning rage that my reports on what the academic research says about stock investing caused in many of his readers, people who were trying to maintain a belief in Buy-and-Hold principles three decades after the research showed that there is precisely zero chance that Buy-and-Hold can ever work in the long term. Carl would love to feel free to tell the truth about stock investing. We should let him.

8) In the wake of the onset of the economic crisis, a federal commission was formed to identify its cause. The effort bore no good fruit. Democrats on the commission blamed the policies of Republicans. Republicans on the commission blamed the policies of Democrats. No one paid any attention to what the commission said because we all hear Democrats yelling at Republicans and Republicans yelling at Democrats on a daily basis. I have a funny hunch that the members of the commission would have loved to have felt free to identify the obvious true cause of the crisis. Stocks were overpriced by $12 trillion in 2000. Even John Bogle, the King of Buy-and-Hold, acknowledges that stock prices always return to fair-value levels after the passage of 10 years or so. Bogle calls this an “Iron Law” of stock investing. So everyone paying attention knew in 2000 that roughly $12 trillion of consumer buying power would be disappearing from our economy by sometime near the end of the first decade of the 21st Century. There’s your economic crisis! The members of the economic crisis commission would love to feel free to tell the truth about stock investing. We should let them.

9) Rajiv Sethie, a Professor of Economics at Columbia University, said of my work: “Rob Bennett makes the claim that market timing based on aggregate PE ratios can be a far more effective strategy. I can see how it could be true.” Rajiv would love to do the research proving it to be so and to win the Nobel prize that would follow from doing so. If he weren’t aware of what was done to Wade Pfau when he did this and what has happened to numerous others in this field who have dared to speak honestly about what the last 30 years of academic research shows us, Rahiv would have done that research a long time ago. If he hadn’t, hundreds of other fine academic researchers would have jumped at the chance to win that Nobel prize. Rajiv and hundreds of other fine academic researchers would love to feel free to tell the truth about stock investing We should let them.

10) The first two words in the February 2005 e-mail sent to me by Dallas Morning News Columnist Scott Burns in response to my e-mail pointing out the errors in the Old School SWR studies were: “You’re right!” Scott asked me in that e-mail for my telephone number so that he could interview me in preparation for an article letting his readers know of the dangers of following the Old School studies. He thought better of it. Scott later wrote an article pointing out that “some people” believe that the Old School studies are analytically invalid. But he was careful not to let his readers know of his personal viewpoint that these criticism are on the mark. And he was careful not to mention the name of the person who pointed out the errors in the studies to him. And he was careful not to include a link to my Retirement Risk Evaluator calculator (which reports the SWR numbers accurately) in his article. And he was careful to put forward numerous defamatory comments about me to keep himself in the favor of the Lindauerheads and the Greaney Goons. Scott would love to feel free to tell the truth about stock investing. We should let him.

We all want to feel free to tell the truth about stock investing. Why wouldn’t we? We all benefit from knowing how stock investing works. And we can only understand things that we feel free to discuss. Permitting honest posting on safe withdrawal rates and many other critically important investment-related topics is a win/win/win/win/win.

So why don’t we do it?

We don’t like to have death threats directed at us. We don’t like to have tens of thousands of acts of defamation directed at us. We don’t like to be banned from the internet sites we frequent. We don’t like to have internet Goons sending defamatory e-mails to our employers in efforts to get us fired from our jobs.

Once even a small number of influential people speak out in opposition to the Campaign of Terror, it’s all over. Buy-and-Hold is no more at that point. Valuation-Informed Indexing is the new dominant model at that point.

The Tipping Point is one price crash away. It is the next price crash that will change things in a way that will permit us to to begin work on bringing about the greatest period of economic growth ever seen in U.S. history. There is a reason why it’s darkest before the dawn. It often takes a whole big bunch of darkness to help the humans work up the courage to do what deep in their hearts they knew for many years very much needed to be done.

Rob Bennett to Academic Researcher Wade Pfau: “I Strongly Believe That There Are Things You Must Do and Things You Must Not Do to Protect Your Reputation As An Ethical Person. I Believe Today That There Is Serious Reason to Question Whether You Have Managed to Stay on the Right Side of the Line…. Are You Insane, Man? Please Think!”

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Yesterday’s blog entry reported on an e-mail that I sent to Academic Researcher Wade Pfau on January 1, 2012. My next e-mail to Wade was dated April 5, 2012, and was titled “Concerns Re You Going to the Dark Side.” The text is set forth below.

Wade:

I hope things are going well with you.

This e-mail will not be a pleasant one to write (or to read). I don’t think I have any choice but to write it, given recent developments.

Before I start, I want to state the obvious preface. I have great feelings of respect and affection for you personally and I admire your research work probably more than anyone else alive on Planet Earth today. In ordinary circumstances, that would be the basis for a wonderful relationship. As you know, there have been things that stood in the way of that since our first communications. Those obstacles have always saddened me. My strong sense is that the problem side of the relationship has grown much worse since your postings at my blog re whether Bill Bengen should correct the errors in his SWR study. The purpose of this e-mail is to (1) attempt to confirm whether that is indeed the case or not; and (2) get some things off my chest that I need to get off my chest to fell that I have always dealt with you in good faith.

You are of course aware that there has been an organized effort on the internet to destroy my reputation which has been led by Mel Lindauer and John Greaney  and which has made it impossible for me to earn a living for 10 years now. I believe you know that I plan to bring lawsuits against the sites that have permitted the Lindauerheads and the Greaney Goons to engage in defamation and death threats and other tactics to block numerous board and blog communities from learning what they need to learn what the last 30 years of academic research says about safe withdrawal rates and other important investment-relarted topics.

I believe that we all have a responsibility as part of the ethical demands of our respective professions to speak up when we see this sort of behavior. I have of course spoken up. You have spoken up on a few occasions in small ways but generally have kept quiet re this aspect of things. It’s not easy to say where precisely the line should be drawn re speaking up or not speaking up. My problems are of course not your problems and I of course do not expect you to feel as  great a concern re this aspect of the question as I feel since I am directly involved. That said, I strongly believe that there are things you must do and things you must not do to protect your reputation as an ethical person. I believe today that there is serious reason to question whether you have managed to remain on the right side of the line.

I was questioned the other day by one of the Goons as to whether we were still in e-mail communication. My answer was that I presumed we were. I don’t recall us having a back-and-forth discussion since the day you posted on the Bengen blog post. My recollection is that I sent you a copy of an e-mail that I sent to a visitor at my site because he referenced you in the e-mail and I wanted you to see both his words and my words. I did not receive a response to you re that e-mail but I did not see that as being a big deal.

Today, I was communicating with another financial blogger and wanted to send him a link to the blog post in which you explored Valuation-Informed Indexing and found that it beat Buy-and-Hold in 102 of 110 of the rolling 30-year time-periods in the historical record. As you obviously know, this post of yours was a big help to me in trying to overcome the Campaign of Terror against me and the many board communities in which numerous community members have expressed a desire that honest posting on SWRs and other valuation-related topics be permitted. The goal of the Internet Sewer Rats has been to persuade my potential readers and customers that I have not done important work and your mention of my name in a post that shows that I was right all along made it impossible for them to continue to maintain that position.

You have removed my name from the post. Why?

You of course have a right to re-write posts. In this case, however, the action is an exceedingly odd one. You have been attacked by Lindauer yourself. You have acknowledged in posts that Drip Guy has sent you e-mails and you have changed positions you have taken in discussions at the Bogleheads board as a response to his threats. When you contacted the Trinity authors about correcting the errors in their SWR study, the Greaney Goons put up posts threatening to get
you fired from your job if you followed through and you then retreated from your position after letting me know that you were indeed concerned that you might lose your job as a result of their actions. We of course both know that the Sewer Rats have employed similar tactics in numerous other cases.

I believe you are making a huge mistake, Wade.

Please don’t hear that as a threat. I hope you will hear it as a friend speaking to a friend. I said similar words to Greaney 10 years ago and he is where he is today because he ignored those words (Greaney was my personal friend in earlier times). I said similar words to Lindauer. It breaks my heart to see another one of my friends take this horrible path. Are you insane, man? Please think!

I am a journalist, Wade. My job is to tell this story in as honest and as complete and balanced way possible. I take the responsibilities of my profession seriously and I will honor them. I WILL let personal friendships influence me (I have done
this with Greaney on many occasions). I think it would be inhuman of me not to do so. But I WILL also honor my responsibilities to my readers.

There are millions of middle-class people who have been done great harm by this economic crisis. They need to know the story here. The hardest question for them to understand is — Given that the academic research has shown for 30 years that Buy-and-Hold can never work for any long-term investor, why are there still people today advocating it? I need to tell BOTH sides of that story. That’s my job.

My strong hunch is that you would prefer to stick to the research and keep away from all this ugly junk. Guess what? Every single one of us feels the same way. The full reality here is that the reason your research has not received the attention it merits (I understand that you have received a great deal of attention and that that attention is fully deserved) is because people cannot come to terms with the ugly, emotional side of all this. If our free market economy is to survive for much longer into the future, we all need to work up the courage to deal with that side of things. We need to do so with love, to be sure. But we need to do so with honestly as well. There is no other way.

If I hear a response from you that indicates that you want to deal with the issues at stake here in a responsible way, I will do whatever I can to put in place a process that will work to help every single person involved come out of this looking as good as it is today possible for them to look. That’s the love part of the formula.

The honesty part of the formula is that, if I do not hear from you, I need to report on what you have done in this case and in your other interactions with the Goons on the Bogleheads Forum and elsewhere. I hate being put in these circumstances as I know you hate being put in these circumstances. The bottom line here is that these are the circumstances into which we were born and we both need to work up the courage to make the best of them.

Please always know that, if you see something that I have written and you feel that I have not told things in a precisely fair way, I will be thrilled to give you space in the article or blog post to tell your version of events in your own words. My preference is that it be done in that way.

Please also know that I will of course always respect the work you have done. I very much still believe that you are someday going to win that Nobel Prize and that we are going to see your name on the front page of the New York Times. It will be a great day for all of us when that happens.

Please also know that I will do everything I can to slant things as much as I can in your favor without failing to honor my obligation to my readers to provide them with the detail they need to hear to  make sense out of the amazing circumstances that apply in InvestoWorld today.

Please also know that I will always think of you as a friend and will always wish the best for you and will always be\ honored to be associated with you in any way (even if this crazy mixed-up world of ours puts me in circumstances in which I need to name you in lawsuits at other times!).

I will close by letting you know of three things that I have in mind at the moment (the purpose of this e-mail is to assure myself that I have done every last thing that I can do to avoid going ahead with these steps):

1) I am going to start a thread at the Goon Central board letting them know that I have sent you this e-mail (without posting the text).  Drip Guy asked me about you directly yesterday, which suggests to me that he feels you have been compromised. I argued yesterday that this was not the case. I don’t want the Goons thinking that I play games re this sort of thing and I have been careful always to respond honestly to their questions. So I think I need to let them know that my sense of where things stand has changed as a result of what I learned today;

2) I expect to post the text of this e-mail at my blog within another week or two. This is obviously an important development in the saga. If you have indeed gone to the Dark Side, that is a major win for the Goons, who have been feeling greatly weakened in recent months aside from this development; and

3) I am in the process of writing a long article that will detail 101 incidents of this nature (you are not the only one who is afraid of what the Goons will do to your reputation if you state your honest beliefs about investing in clear terms!). You are certainly not the focus of the piece. But my expectation is that you will be mentioned in five or so of the incidents. I just want you to know that that is in the works as I feel that each time we go a step down the dark path, it makes it harder to move to the better path for all concerned. How I wish that others could see this point as clearly as I do!

The Goons are not going to win, Wade. They CANNOT win. If we don’t help people learn what they need to learn about stock investing, the numbers show that the whole thing is going to go down (please ask if you have questions about this
aspect of things). There was a big change in people’s attitudes after the 2008 price crash. I’ve been doing this for 10 years and I can tell you that nothing had as much impact as that. The next crash is going to hurt worse (because it follows on
so many down years) and is going to cause a much bigger change in public opinion. You want to be positioned on the right side of things when that happens. We are going to need to act quickly then and we need you working with us!

If you have particular concerns or questions, please let me know of them and we can do out best to resolve them when they can be resolved with relative ease.

I cannot post dishonestly on safe withdrawal rates. It is insane that I was ever asked to do this and it is insane that there is even one responsible person who ever thought that it might be possible that I would go along with such a demand. Just
about anything else is negotiable because, once we achieve the right to post honestly on that topic, a lot of the ugly feelings of shame will dissipate. I cannot give an inch on that one. For reasons that should be obvious to all reasonable people.

Sorry for the long e-mail. I hope it leads to good things!

I wish you the best in all your future endeavors, my good (non-Goon, please?) friend!

Rob

Peer Review Report for Academic Researcher Wade Pfau’s Breakthrough Research on Valuation-Informed Indexing: “The Elephant in the Living Room Question Is — What Is the Ultimate Criterion for One to Conclude With Confidence That One Strategy Is Better Than the Other?”

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Yesterday’s blog entry reported on an e-mail that I sent to Academic Researcher Wade Pfau on May 31, 2011. I next heard from Wade on August 12, 2011.

Wade shared with me “the referee report” for his research paper on the Fisher/Statman paper showing (incorrectly, according to Wade’s research) that long-term market timing does not work.

The report stated: “To me, the elephant-in-the-room question is: what is the ultimate criterion for one to conclude with confidence that one strategy is better than the other? Or, put it in another way: should the data last longer, can we have a better idea what will happen? Not really. We need look no further than Figure II to appreciate the challenge: up to 1930, 100% stocks buy-and-hold was superior; from then to mid 1990s, the market-timing strategy fared better; they switched positions again after approximately 2008. It is disappointing for a reader to think that all the difference is only due to the choice of end period.”

It added: “This is not just an abstract question of intellectual interest, for an individual with finite years of life wants to know for sure, given the cohort she is in, what is the optimal investment strategy for her life of 80 years or so. Barring from an altruistic bequest motive, one cannot care less what’s the portfolio value 150 years later. Even though it may be unfair to demand a satisfactory answer from the author (F&S does not remotely address it, either), it would be nice if the author can feature his analysis with this backdrop in mind.”

It continued: “As market timing strategy incurs more transactions costs, is it still dominating buy-and-hold after taking into account of reasonable transactions costs? As the balance grows, the associated transactions costs may not be easily dismissed. Moreover, considering that in earlier years there were no index funds available, how could an investor, even a buy-and-hold type, implement the strategy without piling up substantial transactions costs? A hypothetical percentage transactions cost scheme would be a good start.”

Bogleheads Forum Poster in Thread Discussing Academic Researcher Wade Pfau’s Finding that Valuation-Informed Indexing Strategies Have Provided Higher Returns Than Buy-and-Hold at Lower Risk Throughout the Entire Historical Record: “The Paper Refutes a Central Tenet of the Boglehead Investing Philosophy. It’s a Big Deal.”

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Yesterday’s blog entry reported on an e-mail that I sent to Academic Researcher Wade Pfau on May 18, 2011. My next e-mail from Wade arrived on May 31, 2011.

Jacob Irwin, publisher of the My Personal Finance Journey blog, posted an analysis comparing Valuation-Informed Indexing with what he calls “Passive Investing” (what I call “Buy-and-Hold” — sticking with a single stock allocation in the face of big changes in the price being charged for stocks):

http://www.mypersonalfinancejourney.com/2011/05/valuation-informed-indexing-vs-passive.html

Jacob sent a link to me and Wade and Wade copied me on his reply to Jacob.

Wade said: “VII tends to work as long as there is mean reversion in PE10, which there usually is.  The unprecedented run-up of PE10 in the 1990s makes it hard for VII to compete then.  I think there is not much else that can be done about that.  But I don’t think this means that VII has permanently stopped working. Trying to find a specific strategy for VII to have worked in this 1990-2011 period sounds too much like data mining.  Though in other time periods, it hardly matters which strategy you choose as it is hard to find a period in which VII does not work.”

He also linked to a discussion at the Bogleheads Forum that he said he thought might be of interest to us:

http://www.bogleheads.org/forum/viewtopic.php?t=75585&postdays=0&postorder=asc&start=0

In the Bogleheads discussion, a poster using the name “Fred Flintstone” said that Wade’s research showing the superiority of Valuation-Informed Indexing over Buy-and-Hold “refutes a central tenet of the Boglehead investing philosophy. It’s a big deal.”

Academic Researcher Wade Pfau: “Valuation-Informed Indexing Always Provides More Returns for Often Less Risk”

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Yesterday’s blog entry reported on an e-mail that I sent to Academic Researcher Wade Pfau on March 1, 2011. He sent his response later that day.

Wade said that he shared my view that using 30-year rolling time-periods to make the case for Valuation-Informed Indexing was “compelling” and that “I’m definitely going to be using tables like the one I showed at Bogleheads with all the risk measures.” He explained that: “My idea is to show many different tables with results over the whole period for returns and risks.  Valuation-Informed Indexing always provides more returns for often less risk.” Wade’s e-mail continued: “I also want to read more about the “information ratio” measure, as I think it may be the most important of all the measures in that table. But I need to better explain its full power.”

He stated: ” I will pick some of the cases where VII did least well and show the 30-year rolling periods for those.  This is to help avoid data mining.  But the fact will remain that no matter what I try, VII will still perform better in 85-95% of cases for 30 years, and the times that it does worse are those in which buy and hold was doing its best in history (which is always right around the peak of the bubble in 2000), and so VII is not more risky.  I have a new figure for showing this as well. And a nice figure showing the outperformance percentages across rolling periods of lengths between 1 and 40 years.  I think it is all quite persuasive.”

Academic Researcher Wade Pfau: “Two Papers by FIsher and Statman Are Still All I Can Find That Provide Evidence Against Long-Term Market Timing”

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Yesterday’s blog entry reported on an e-mail that I sent to academic researcher Wade Pfau on January 17, 2011. Wade responded on January 20, 2011.

He described a thread that he started at the Bogleheads Forum:

http://www.bogleheads.org/forum/viewtopic.php?t=67093

He said that it was not his intent to start a debate on the merits of Valuation-Informed Indexing since he hadn’t yet finished his research paper. However, he wanted to know if anyone was aware of studies concluding that Valuation-Informed Indexing does not work. He explained that: “Once I finish my study, I would like to refer to the concept as Valuation-Informed Indexing, but I called it long-term market timing in this post since I really was trying to avoid controversy and just uncover more background reading materials.” He reported that: “Two papers by Fisher and Statman are still all I can find that provide evidence against long-term market timing.”

“I Definitely Need to Cite [You] as the Founder of Valuation-Informed Indexing…. Shiller Pointed Out the Predictive Power of P/E10 But Never Discussed How to Incorporate It Into Asset Allocation.”

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Yesterday’s blog reported on an e-mail that I sent to academic research Wade Pfau on January 16, 2011. Wade responded later the same day. He endorsed John Walter Russell’s characterization of a paper purporting to show that long-term timing does not work as testing “idiot switching.” He said: ” ‘Idiot switching.’  That is great, and describes exactly what the Fisher and Statman paper does.  You and John have a great knack for coining new terms.  I think VII is a much better term than any alternatives I’ve come across.” He added that he did not think it would be appropriate to use the term “idiot switching” in an academic paper.

Wade also reported that “as always, I will be reading all your links.” He said: “I definitely need to cite some of your work as the founder of VII, as I have not found anyone else who can lay claim to that.  Shiller pointed out the predictive power of PE10 but never discussed how to incorporate it into asset allocation, as far as I know.”

 

Academic Researcher Wade Pfau: “As You Say in Your Podcast, Valuation-Informed Indexing Should Beat Buy-and-Hold About 90 Percent of the Time, and I Am Getting Results That Support This”

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I received an e-mail from academic researcher Wade Pfau with the title “Valuation-Informed Indexing” on January 16 2011. Wade told me that he had listened two times to the RobCast in which I outline nine possible Valuation-Informed-Indexing portfolio allocation strategies and characterized it as “excellent.” He said: “I wrote up the programs to test your VII strategies against buy-and-hold, and I must say that the results look very promising…. I am quite excited about the findings so far.  As you say in the podcast, VII should beat buy and hold about 90 percent of the time, and I am getting results that support this for various strategies.”

Wade wrote that he had only been able to find one paper in the literature “which tests something even remotely close to Valuation-Informed Indexing.” This was a paper by Kenneth L. Fisher and Meir Statman titled “Market Timing in Regressions and Reality.” Here is a link:

http://ww.scu.edu/business/finance/research/upload/mkt-timing-in-regression-and-reality-2.pdf

Wade said that he would be criticizing the paper in one of his own forthcoming research papers.

He concluded by saying: ” I hope to have a finished paper in a month or so.  I think I may need to ask you a few questions before finishing, but I still have to work my way through all the materials you already sent me.”

Wade Pfau: “If Valuation-Informed Indexing Consistently Outperforms Fixed and Lifecycle Strategies, Then the Proof Is In the Pudding. Given How Well Valuations Help to Explain Withdrawal Rates, I Think There Is a Lot of Potential for This Topic”

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Yesterday’s blog entry reported on an e-mail that I sent to academic researcher Wade Pfau on December 19, 2010. Wade sent his response the following day.

Wade said: “‘I’m excited about this, as depending on what you have already done, I think I can design a study using the Shiller data to provide historical simulations of VII strategies against fixed buy-and-hold strategies and also lifecycle strategies (declining allocation to stocks as one ages).  If VII consistently outperforms fixed and lifecycle strategies, then the proof is in the pudding so to speak.  Given how well valuations help to explain withdrawal rates, I think there is a lot of potential for this topic.”

He added that Monte Carlo simulations do not work in this area because “the assumptions built into their design will mean that valuations do not matter by definition.” He argued that this type of study can only be done with historical data and speculated that using Monte Carlo simulations may have thrown some researchers off the right track.

Wade also suggested that different types of investors might want to follow different allocation-change rules. “There are lots of possibilities,” he said.

My response is set forth below.

Wade:

All that sounds super.

You may want to take a look at the analysis/graphics set forth at this link:

http://www.financialwebring.org/forum/viewtopic.php?t=106998

This examination of how Valuation-Informed Indexing has performed historically was done by Norbert Schenkler, a part-time financial planner and co-owner of the Financial WebRing Forum. He is a long-time abusive poster at numerous boards but it appears to me that he was playing it straight in preparation of this analysis.

He says: “The evidence is pretty incontrovertible. Valuation-Informed Indexing is…everywhere superior to Buy-and-Hold over ten-year periods.” The one exception he finds is the late 1990s. But that is no longer an exception since the crash
(the analysis was prepared pre-crash).

John and I prepared a calculator called “The Investor’s Scenario Surfer” that permits a Monte Carlo testing of possible 30-year return sequences so that investors can compare how they would have done with VII vs. how they would have done with 80 percent reebalancing, 50 percent rebalancing and 20 percent rebalancing:

http://www.passionsaving.com/portfolio-allocation.html

The Monto Carlo used here is a bit different from what is usually used in that it contains filters that cause the results to show a valuations effect (going-forward returns are higher starting from low-valuation starting points).

I am not advocating either Monte Carlo or actual historical data. Some view the actual data as more real. But some others argue that 140 years of data is not enough to draw definitive conclusions. I personally like the filtered Monte Carlo approach. But it makes sense only for those who already buy into the idea that valuations affect long-term returns, so I think it could be argued that in a sense it begs the question. My aim here is just to let you know about what I know that has already been done so that you can review if before choosing your own path.

My experience with the Surfer is that VII produces the best 30-year results in about 90 percent of the return sequences generated. 80 percent rebalancing almost always places second, 50 percent almost always places third, and 20 percent rebalancing almost always places last.

There’s a pattern that applies in most runs that explains why VII usually ends up ahead. It sometimes takes only a few years for VII to go ahead and it sometimes takes many years. But this almost always happens at some point in a 30-year cycle (in every 30-year cycle in the real world, we have had one occasion when valuations were dangerous). Once VII goes ahead, it becomes impossible for 80 percent rebalancing to catch up because VII and Buy-and-Hold both call for high stock allocations at moderate and low valuations. And the compounding effect causes VII to go farther and farther ahead over time.

The thing that make the difference as to whether VII wins by a little or a lot is how early in the 30-year cycle it goes ahead. The dynamic here is that it is virtually a lock that sometime within a 30-year period valuations are going to become a big factor. And one big win due to valuations makes a huge difference at the end of 30 years after compounding is taken into effect. The numbers are counter-intuitive (as is always the case with compounding) and very impressive.

I STRONGLY agree with your point that there is more than one possible VII approach. This one is a little bit of a pet peeve of mine. People often ask me “What is the best allocation at today’s P/E10 level?” There is no one answer. Asking that question is like asking John Bogle “What is the one stock allocation that everyone should go with?” VII is different than Buy-and-Hold in that it posits that an investor must not go with the same allocation at all times. But it does not posit that
valuations are the only factor. So the investor still needs to take his financial goals, his age, and his risk tolerance into consideration.

RobCast #137 is titled “Nine VII Portfolio Allocation Strategies”:

http://www.passionsaving.com/personal-finance-podcasts-page-eighteen.html

Sorry to dump even more material on you. Please just look at what you think might be of use when you get a chance to do so. You will learn that expressing even limited interest in any of this stuff when I am in the room can be dangerous!

Rob

What’s the Best Age At Which to Experience a Stock Crash? and Seven Other Guest Blog Entries

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Set forth below are links to eight Guest Blog Entries I’ve written on the Valuation-Informed Indexing investing strategy:

1) What’s the Best Age at Which to Experience a Stock Crash?, at Barbara Friedberg Personal Finance;

2) A Better and Safer Way to Invest in Stocks, at the Foolish Blogging Network;

3) Playing Dominion vs. Playing the Market, at Free From Broke;

4) Stocks Are Not Risky for Those Willing to Tune Out the Wall Street Mumbo Jumbo; at Everyday Tips and Thoughts;

5) The Biggest Unknown Risk of Stock Investing, at Invest It Wisely;

6) The CAPE: How to Beat Stocks with a 50/50 Portfolio, at Invest It Wisely (I did not write this one. I was excited to see someone else writing about the VII concept);

7) Does the Trend Matter, at Advisor Perspectives (Again, I did not write this one. Again, it is exciting to see the ideas we began exploring ten years ago beginning to spread through the financial planning community);

8 ) Timing the Market Using Stock Valuations, at Mint.com (This is a nice survey of my work and the work of Wade Pfau and Michael Kitces);