Valuation-Informed Indexing #193
by Rob Bennett
I have been making the case for Valuation-Informed Indexing (the model for understanding how stock investing works rooted in the research of Yale Economics Professor Robert Shiller) for 12 years now. It’s been an exciting adventure but one that has taken me down a rocky road. Thousands of middle-class investors (and a good number of big names too) have told me that Valuation-Informed Indexing is the first investing strategy that they have heard of that truly make sense. But a good number of others have responded with — um — less enthusiasm.
I was a Buy-and-Holder myself on the morning of May 13, 2002, when I put forward my famous post to a Motley Fool discussion board pointing out the errors in the Old School safe-withdrawal-rate studies. I still am a fierce advocate of the core idea of the Buy-and-Hold project, the idea of rooting one’s investing strategy in the findings of the peer-reviewed academic research in this field. It was the intensely emotional reaction that I saw among Buy-and-Holders who learned of the errors in those studies and yet refused to acknowledge what they had learned that persuaded me that Buy-and-Hold was not for me. Buy-and-Hold makes investors MORE emotional, not less so.
That’s not what research-based strategies should do. I became convinced 12 years ago that Buy-and-Hold is not a truly research-based strategy, that Shiller’s 1981 finding that valuations affect long-term returns shows that the foundation stone of Buy-and-Hold (that timing is not required or might not even be a good idea) is flawed at a fundamental level and must be reformed to deliver on its promise. I have devoted those 12 years to developing the Valuation-Informed Indexing concept so that it can become what John Bogle intended Buy-and-Hold to be back in his pioneering days.
I have a slider at the top of every page of my web site at which I present quotations made by those who have found value in my work. I have collected over 200 such comments.
But I noticed at some point in the journey that it is often people outside of the investing field who have the most cogent observations to make. I included in the “People Are Talking” slider quotes from Tolstory, Machiavelli, Ghandi and Joan of Arc that make essential points that I have never seen any investment-related figure make as effectively.
“There is nothing more doubtful of success than a new system. The initiator has the enmity of all who profit by preservation of the old institution and merely lukewarm defenders in those who gain by the new one.’
That’s Machiavelli. The guy nailed it! How did he know precisely why it was going to be so hard to make the transition from Buy-and-Hold to Valuation-Informed Indexing centuries before either model was conceived? That’s smart stuff!
If Valuation-Informed Indexing represented a small improvement on Buy-and-Hold, all of the ideas that move under this banner would have been adopted a long time ago. The trouble is that the advance is a huge one. Reduce the risk of stock investing by 10 percent and the world beats a path to your door. Reduce the risk of stock investing by 70 percent and you make lots of people who have built careers promoting the inferior model feel defensive and embarrassed and resentful and hostile.
“First they ignore you, then they ridicule you, then they fight you, then you win.”
That’s Ghandi. I turn to this one for inspiration. I certainly have been ignored. I certainly have been ridiculed. I certainly have been fought. Ghandi seems to think that there’s a chance that somewhere down the road I will win. His insight was to see that you can lose every battle and still win the war. If the Buy-and-Holders were engaging in spirited debate, I wouldn’t put too much stock in what Ghandi said. My guess is that he too experienced the feeling of losing lots of battles because of some factor other than a lacking of strength on the merits. The merits of the case really do matter in time. I hope.
“I am not afraid. I was born to do this.”
That’s Joan of Arc. I turn to these words for comfort when I am being intimidated. I do think I was born to do this. I am not an investing expert. Paradoxically, it takes a non-expert to do this job. The experts have ties to the experts who promote Buy-and-Hold and were educated in schools that teach Buy-and-Hold and have advised clients who today follow Buy-and-Hold strategies and who will be upset to learn that it doesn’t work. This has to be done by an outsider. And it took courage a lot more than it took brains to hang in there when the fires were raging.
“Difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them. But the simplest thing cannot be made clear to the most intelligent man if he believes he knows already what is laid before him.”
That’s Tolstoy. If Shiller had published his research showing that valuations affect long-term returns in 1971 rather than in 1981, we all would be Valuation-Informed Indexers today. The idea that timing isn’t required had become so embedded in people’s brains by 1981 that it has taken three decades even to get people to take a fresh look at the question. It amazes people when I point out that there has never been a single piece of research showing that long-term timing doesn’t work. People assume that conventional wisdom must be rooted in something important. The reality is that conventional wisdom can become widely accepted just because there are gaps in our knowledge that make us uncomfortable and because we turn to half-baked ideas to fill those gaps.
At that point, the old story applies. It’s not what you don’t know that hurts you, it’s the stuff you know for certain that just ain’t so.”
That’s Mark Twain.