Shiller Showed That Valuations Matter, the Return Predictor Shows How Much They Matter

Valuation-Informed Indexing #299

by Rob Bennett

“The P/E10 tool could drastically change how the entire investment industry operates and measures risk.”

That’s a comment sent to me by my friend Larry Evans after he spent two months of his life reading every article at my web site and thinking though the implications that follow from the points made in them. Larry was not a friend on his first visit to the site. He was a polite skeptic. He found the core idea of the Valuation-Informed Indexing concept absurd.

He observed in a comment posed to the discussion thread for a blog entry that it appeared that I was advocating a form of market timing (I do indeed advocate long-term timing — price discipline — but not short-term timing). I told him that that was indeed the case. He said that that could not possibly work; every expert he had ever heard has said otherwise. I said that many smart and good people shared his point of view but that I did not. He offered to spend two months reading every article at the site if I would agree in advance to post an article he would write saying what he thought of the Valuation-Informed Indexing concept after studying it in depth. I said that that sounded good to me.

After two months. Larry called me and we talked for several hours about the good that this new investing model (rooted in Robert Shiller’s research) could do for the world. The following day he sent me an e-mail containing the words quoted above. Larry put Valuation-Informed Indexing concept to the test and a skeptic became a believer. It happened the same way with me (I was once an enthusiastic Buy-and-Holder). And with John Walter Russell. And with Wade Pfau. And with scores of others.

I would like to see it happen with millions of others. But that hasn’t happened yet by a long shot. So I often ask myself what it is that people need to hear to bring them around. I believe that the answer is — they need to work the numbers. The research-backed finding that exercising price discipline when buying stocks can reduce risk by 70 percent is a highly counter-intuitive reality. People find it impossible to believe until they see the numbers for themselves.

The purpose of The Stock-Return Predictor is to put those numbers before people in a clear and easy-to-understand format.

The investor enters a valuation level that he would like to examine and the calculator performs a regression analysis of the 145 years of historical return data available to us today to reveal the most likely annualized 10-year return on a stock purchase. Enter the super-low valuation level that applied in 1982 and you learn that the likely annualized 10-year return on stocks is 15 percent real. Enter the super-high valuation level that applied in 2000 and you learn that the likely annualized 10-year return on stocks is a negative 1 percent real. It does not make sense to maintain the same stock allocation at all times. Stocks at some prices offer a powerful value proposition and stocks at other prices offer a terrible value proposition.

It’s just like with anything else that can be purchased with money!

It’s the opposite of what the Buy-and-Holders say. Timing always works. And it is always required for those seeking to keep their risk profile roughly stable (stocks are obviously a more risky proposition when the likely long-term return is a negative number than when it is a double-digit positive number).

The Stock-Return Predictor tells you the price tag attached to the stocks you buy. None of us would consider buying anything other than stocks without first looking at the price that applies. But we do it all the time with stocks. We once didn’t know that long-term timing is always required or even that it always works. We heard that short-term timing doesn’t work and just assumed that the same was so re long-term timing. We developed a habit of buying stocks without taking price into consideration and thereby greatly diminished our long-term return while greatly increasing the risk we took on earning it.

The Stock-Return Predictor puts an end to all that for those who take its powerfully liberating message — price matters when buying stocks as much as it does when buying anything else — to heart. Engaging in the form of market timing that always works is something that you want to be certain to do, not something that you want to avoid doing. The claim that market timing is dangerous is itself dangerous (even though unintentionally so, to be sure).

It’s a simple tool. But it changes the stock investing experience in a fundamental and profound way. We have long believed that stocks are an inherently risky asset class. The Return Predictor tells us that, when stocks are priced as they were in 1982 (a P/E10 value of 8), there’s a 95 percent chance that the annualized 10-year return will 8.5 percent real or higher. All possible outcomes are mouth-wateringly good. What’s the risk in that? To be sure, there’s still a great variance in the possibilities. There’s a 5 percent chance that the annualized return will be greater than 20.5 percent real. That’s much better. But the usual understanding of what the word “risk” signifies does not apply when there is virtually zero chance that the outcome will be poor.

I was not surprised to see the calculator report that it is better to buy stocks when they are low-priced than when they are high-priced. But I was shocked to learn that the expected 60-year return is not much different regardless of the valuation level that applies at the time of purchase. But I’ve learned to accept what the data is telling me and that I need to alter my preconceptions rather than ignore the data when the two do not fit together well. After a good bit of further study and lots of discussion, I came to see why that’s so. Stock prices follow a predictable long-term pattern of about 20 years of rising valuations followed by about 15 years of falling prices. Go far enough out and the good years cancel out the bad years to an extent sufficient to make the average long-term return (6.5 percent real) the one that applies.

That’s close to what the Buy-and-Holders say. But not close enough. It is the first ten years of a retirement that have the biggest effect on whether a retirement plan succeeds or fails. Once a retirement plan fails, it’s game over — the return that theoretically would have applied 60 years out just doesn’t matter. The Stock-Return Predictor supplies the investor with the numbers he needs to plan effectively in the real world — the 10-year numbers, the 30-year numbers and the 60-year numbers. Knowing that the average long-term return is outstanding really is important, just as the Buy-and-Holders often observe. But it is not the only thing that is important. Not by a long shot.

Rob Bennett’s bio is here.

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  • Sammy Soda

    Still waiting Rob. I have complete documented financial records, so there is no question as to the numbers or returns. Let’s go.

  • Sammy Soda

    We are waiting, Rob. Let’s start the debate. No intimidation. No hiding. Let’s just focus on the numbers and facts.

  • Sammy Soda


    You are not standing on anything. You are just evading. This is very simple. We will each post our numbers, holdings and strategy and then we and everyone else can then debate. Simple enough?

    Let’s go to a forum in which neither of us can delete or edit what the other person posts.

    I am ready to go. It is time to put up or shut up.

  • http://arichlife.passionsaving.com RobBennett

    My response above stands, Sammy.

    What numbers are right and what numbers are wrong depends on whether it is Shiller or Fama who really deserves the Nobel prize they were both given. One of the two got things terribly wrong and hurt a lot of people by doing so (unintentionally — but still).

    I tell people all the time that I could be wrong, that I have been wrong before and that, if it were happening again, I would in all likelihood be the last to know.

    Have you ever heard Jack Bogle say something like that?

    Given Shiller’s Nobel Prize, I believe that Bogle should be putting forward that statement in every speech he gives and in every article he writes. If Shiller’s research is legitimate, Buy-and-Hold is dangerous.

    It works the other way too. If Fama’s research is legitimate, Valuation-Informed Indexing is dangerous. The difference is that I say that all the time and I have never once heard Bogle say it. I think we all should be working together to urge Bogle to start saying that.


  • Sammy Soda


    The only person I see reporting numbers wrong is you. You like to tell people that their net worth a will drop 65% yet you have no clue as to what they hold.

    Secondly, you have never allowed me or anyone else to post any numbers on your website as you delete them. You never allow the debate to ever start.

    So, as I have proposed many times, how about we both post our numbers, returns and strategies and let the results speak for themselves.

  • http://arichlife.passionsaving.com RobBennett

    Please read my post above, Sammy.

    Comparing number is helpful only if you report your numbers accurately. When you report your numbers, do you adjust for valuations or do you not?

    If you do not (never once in my thousands of interactions with you have I seen you do this), then all your numbers are wrong (presuming that Shiller’s research is valid, as I believe).

    Reporting numbers inaccurately helps no one.

    We need to launch a national debate re these matters. We all need to know whether it is Shiller that is right or Fama that is right. This is a big deal. We can’t duck this one.


  • Sammy Soda


    Before you ask me or anyone to change what they are doing, you should first compare results. You have no idea as to my investments and how I implement my strategy.

    Now, let’s stop the games and long-winded diatribes. Shall we compare numbers?

  • http://arichlife.passionsaving.com RobBennett

    I’m happy to discuss real-world results, Sammy, but only if you are willing to make valuation adjustments to your portfolio numbers. The error at the core of the Buy-and-Hold strategy is the claim that valuations don’t matter. If they do matter, everything the Buy-and-Holders say is wrong.

    Buy-and-Hold is a numbers-based approach. To show how dangerous it is, we have to report the numbers accurately and compare the accurate numbers to the Buy-and-Hold numbers. The Buy-and-Holders get upset when we do this. Because there’s just no comparison. If valuations really do matter, as Shiller showed and as I believe, then Buy-and-Hold is INSANELY dangerous.

    The point of this column entry is that everyone acknowledges that valuations matter but few are willing to QUANTIFY the effect. That’s what the Stock Predictor does. It doesn’t just make a vague statement that valuations matter. It works the numbers. It shows HOW MUCH valuations matter. When you look at the numbers, it’s pretty darn amazing how big the effect is.

    The idea that valuations don’t matter at all (the Efficient Market Theory) is wrong (in my view!) but at least it is logically consistent. The idea that valuations matter a little is flat-out at odds with all of the historical data available to us. If you truly believe that valuations matter, you should be willing to examine the data to determine HOW MUCH they matter. Anyone who takes a serious look at the data is going to walk away frightened about what Buy-and-Hold is doing to us as a nation.

    You take comfort in your portfolio numbers. But are they real? That’s the question on the table. Shiller showed that valuations affect long-term returns. If that’s so, the portfolio numbers that we all use to plan our financial futures are not real. There are the nominal numbers that most of us use for planning and there are the valuation-adjusted numbers, the numbers you get when you consider the level of investor emotion that permitted inflated numbers to prevail for a time.

    I mean no personal offense but it is my contention (based on 35 years of peer-revirewed research) that you are living in a dream world. We have discussed this stuff thousands of times and every single time you refuse to adjust your portfolio numbers for the overvaluation that applied at the time the discussion was being held. It’s easy to beat a competing strategy when you use phony numbers. Use numbers consistent with what the last 35 years of peer-reviewed research shows about how stock investing really works and your portfolio results will go from looking decent next to mine to looking very poor indeed.

    The short version of all this is that any suggestion to compare portfolio results of Buy-and-Holders and Valuation-Informed Indexers BEGS THE CORE QUESTION of whether valuations matter or not. If you adjust for valuations, you get a result that favors Valuation-Informed Indexing. If you fail to adjust for valuations, you get a result that favors Buy-and-Hold. So you end up right back at the starting point of needing to determine whether valuations matter or not. That’s the only question that really matters.

    That’s why I make such a point of noting that Shiller’s 1981 findings “revolutionized” the field. Everything we once thought we knew about how stock investing works is wrong if Shiller is right. We all should be talking about this. We should have launched a national debate re these questions 35 years ago, in my view.

    Please take good care.


  • Sammy Soda

    Yes, Rob. The first step in effective investing is saving enough money to invest. You keep repeating that retirements are failing due to using the wrong numbers, yet we all know it is primarily due to insufficient savings.

    There is nothing intimidating in anything I post and you know it. Intimidation is best characterized by threats and we all see how you threaten people with prison threats.

    I prefer to discuss facts. I prefer to compare results. I wish you would do the same. My suggestion is for you and I to discuss and compare our investing strategies and their results so that readers can compare. Are you ready to have this adult conversation?

  • http://arichlife.passionsaving.com RobBennett

    The purpose of an investing column is to help people learn how to invest more effectively, Sammy. That should be the focus.

    Intimidation tactics hurt us all. I have seen the tactics that you employ to “defend” Buy-and-Hold destroy many discussion boards and blogs. I OPPOSE those tactics.

    I am 100 percent sincere about wishing you all the best that this life has to offer a person.


  • Sammy Soda

    It was a question, Rob. How about a response.

  • http://arichlife.passionsaving.com RobBennett

    Thanks for taking time out of your day to share your thoughts with us, Sammy.

    I naturally wish you all the best that this life has to offer a person.

    Hang in there, old friend.


  • Sammy Soda

    Yet, having this fancy tool at your disposal, you still ended up with a failed retirement.

    Your failure (lack of sufficient savings) is the same reason for most retirement failures. Don’t you believe that the focus should be on this issue?