Valuation-Informed Indexing #327

by Rob Bennett

I am a big believer in the idea of using historical return data to guide one’s investing strategies. I became e a convert to the idea by reading Jack Bogle’s books. So I find it frustrating when people write me down as anti-Bogle when I speak out in opposition to Buy-and-Hold. I am a critic of Buy-and-Hold not because I have doubts about the merit of the idea of using the historical return data as a guide but because I have come over time to believe that Bogle in particular and the Buy-and-Holders in general got off the historical return data train in 1981, when Robert Shiller published his “revolutionary” (Shiller’s word) research showing that valuations affect long-term returns and that, thus, it is impossible that a strategy that does not call for the exercise of price discipline could ever work well for even a single long-term investor.

A few days before the election Nate Silver published an article that I believe does a good job of showing why the Buy-and-Holders came to betray what was once their core belief, the belief that it is the 145 years of historical return data available to us today that is the best guide to how stocks will perform in the future. Silver was of course not in a direct sense writing about investing strategies; he was writing about making use of public opinion polls to predict election results. But the general argument he advanced very much applies in the investing context and he did a fine job of pointing out the need for prudence in making use of statistical analysis to learn more about how the world around us works.

In the months leading up to the election, there were three schools of thought as to what the opinion polls were telling us. The dominant school of thought was that Hillary Clinton was so far ahead that it was a virtual impossibility that Donald Trump could catch up to her. A second school of thought argued either that the polls were “rigged” or gravely flawed and that Trump was going to win. Silver described a third perspective — the polls were accurate but imperfect predictors and the full reality was that Trump stood about a one in three chance of winning the election.

Silver’s take was rooted in two realities: (1) three-point polling errors are common; (2) there was an unusually high number of undecided voters going into the election and that increases the chances for seeing a polling mis-prediction. Silver did not ignore the polls; his take was that Clinton had a two in three chance of winning because the vast majority of polls favored her. But he took notice of the limitations of polls, that there are some things that polls cannot measure; for example, some voters make up their minds on the day of the election and it is thus impossible for polls taken before the day of the election to predict effectively how they will vote.

Many Trump supporters dismissed polling altogether; not knowing what the polls said permitted them the luxury of giving in to their pro-Trump bias and concluding that he was certain to win. Many Clinton supporters pointed to the pro-Clinton polls as scientific evidence but failed to consider the limitations of the science, thereby permitting themselves a certainty as to the outcome that they pretended was rooted in what the polls showed but in reality was not. It shows respect for the science of polling to note its limitations. Truly scientific explorations demand an intellectual discipline that leads to more uncertainty, not less.

I believe that investors must be willing to adjust their stock allocations in response to big swings in stock valuations to have any hope whatsoever of keeping their risk profiles roughly constant. I believe that this belief is rooted in science, that the last 35 years of peer-reviewed research in this field support it. But I am not without my doubts that we have figured it all out as of today. I view it as a healthy thing that there are lots of good and smart people around willing to make the case for Buy-and-Hold. Valuation-Informed Indexers cannot learn about the holes in their arguments by talking to other converts. We need to hear our views challenged to sharpen our thinking over time.

My biggest beef with Buy-and-Hold is that so few Buy-and-Holders respect the science that underlies their beliefs enough to challenge it. I have been banned at many discussion boards and blogs because abusive Buy-and-Holders know that I will challenge their beliefs and engage in trolling behavior aimed at getting me removed from “their” boards and blogs. These “Goons” are not really the problem. The far bigger problem is the large groups of “Normals” who permit the Goons to do their dirty work. It is a rare Buy-and-Holder who is confident enough in his beliefs to insist that abusive posters follow the published rules of the sites at which they post so that the Buy-and-Hold Model can survive intellectual challenges put to it on the merits of the case.

Buy-and-Hold used to be rooted in science. Since 1981, that is no longer so. Buy-and-Hold remains dominant today because there are so many people making so much money in the careers they built advocating Buy-and-Hold that all challenges to the concept are viewed as turf battles. I love what Buy-and-Hold used to be. I love the idea of rooting investing strategies in science. Buy-and-Hold has in the past three decades become the opposite of what it once aimed to be.

The Buy-and-Holders of today are too certain of their beliefs. They no longer are interested in seeing the holes in their arguments uncovered. They have permitted career considerations to weaken their appreciation of the need for a continuing uncertainty in all scientific endeavors.

Rob’s bio is here.