by Rob Bennett
The purpose of this column is to promote Valuation-Informed Indexing, a model for understanding how stock investing works which is rooted in a rejection of the core premise of the Buy-and-Hold model, the idea that it is not necessary to time the market to achieve long-term investing success. If you don’t time the market, you stay at the same stock allocation at all times, regardless of the price at which stocks are available for sale. That obviously makes no sense. That obviously cannot work.
So it would be fair to say that I give a ringing endorsement to those who say that Buy-and-Hold is dead.
Hedge fund managers go about finding investment ideas in a variety of different ways. Some target stocks with low multiples, while others look for growth names, and still others combine growth and value when looking for ideas. Some active fund managers use themes to look for ideas, and Owen Fitzpatrick of Aristotle Atlantic Partners is Read More
— And no.
It is certainly fair to say that in one sense Valuation-Informed Indexing constitutes a rejection of Buy-and-Hold. Buy-and-Hold is a research-based approach and a numbers-based approach. Valuation-Informed Indexing is also a research-based approach and a numbers-based approach. But when you incorporate the effect of valuations into your research, the numbers that your studies generate are very, very different numbers. The VII guidance on retirement planning is very, very different from the Buy-and-Hold guidance on retirement planning. The VII guidance on risk management is very, very different from the Buy-and-Hold guidance on risk management. The VII guidance on asset allocation is very, very different from the Buy-and-Hold guidance on asset allocation.
So the two models really are very, very different. The way I see it is that Valuation-Informed Indexing aims to offer rational guidance. In contrast, Buy-and-Hold aims to rationalIZE guidance that appeals to investor emotions.
Buy-and-Holders don’t like it when I say that. But I really do think this is a fair way of describing the primary distinction between the two models. I once asked Scott Burns, financial columnist for the Dallas Morning News, why the analytical errors in the Buy-and-Hold retirement studies, which I reported on in a post to a Motley Fool discussion board put forward on the morning of May 13, 2002, had not been widely reported. Burns suggested that just about everyone in the field understands that the Old School safe withdrawal rate studies don’t contain an adjustment for the valuation level that applies on the day the retirement begins. So why don’t they warn their clients and readers about the dangers of these studies? According to Burns, it’s because the accurate safe withdrawal rate numbers are “information most people don’t want to hear.”
I can testify on Scott’s behalf re that one. I’ve been reporting on the accurate numbers at discussion boards and blogs for nine years now and my experience is that the accurate numbers are information that lots of people very, very, very, very, very, very, very much do not want to hear.
We hate knowing the realities of stock investing. Hate it, hate it, hate it, hate it, hate it. That’s the premise of the VII model. Investors are emotional. The purpose of investment research is to rein in investor emotions. It is essential to incorporate valuation adjustments into all calculations. It is critical to report the numbers people use to develop their investing strategies accurately.
Am I suggesting that the Buy-and-Holders don’t want to get it right?
Yes and no.
The people who developed Buy-and-Hold wanted to get it right. Just as all investors since the beginning of time have wanted to get it right. Just as all humans who become alcoholics want to get it right. And all humans who develop gambling addictions want to get it right. And all humans who mess up in their relationships with the people they love want to get it right.
The Buy-and-Holders want to get it right. They just —
They are humans. Perhaps you are one too. If so, perhaps you are familiar with how the humans have been behaving in every field of human endeavor other than investing since the beginning of time. So perhaps you can manage some understanding of how they happened to drop the ball in the investing realm as well.
There’s another side to the story.
We’ve been messing up in investing since the first stock market opened for business. The Buy-and-Holders made it worse by providing us all these “scientific” justifications for messing up worse than we have ever messed up before. But that’s not all the Buy-and-Holders did. The Buy-and-Holders did something else that I believe is going to prove a powerful force for making it far less likely that we will mess up so badly in the future.
The Buy-and-Holders established the idea in people’s minds that investing advice should be numbers-based and research-supported. They got all the numbers wrong and their mistakes have caused great human misery. But the process they followed — testing investing claims by examining what the historical stock-return data says — is going to prove to be the most important advance in the history of this field of study, in my assessment.
There is really only one difference between Buy-and-Hold and Valuation-Informed Indexing. Buy-and-Hold was developed before Shiller published his research showing that valuations affect long-tern returns. So Buy-and-Hold does not require valuations adjustments. Valuation-Informed Indexing was developed after Shilller’s research showed this. So all Valuation-Informed Indexing studies contain valuation adjustments.
That one change changes everything. A numbers-based model that gets all the numbers wrong is a dangerous model. A numbers-based model that gets all the numbers wrong encourages investors to do wrong things over and over and over again.
But a numbers-based model that gets the numbers right is a life-affirming model. A numbers-based model that gets the numbers right helps investors rein in their self-destructive emotions and come to terms with them.
Do we not owe the Buy-and-Holders our respect and admiration and gratitude for spending so much life energy promoting the idea that effective investing guidance must be numbers-based and research-supported? It sure seems to me that we do.
Valuation-Informed Indexing is in one sense a rejection of Buy-and-Hold. In another sense VII represents the realization of the original vision of the Buy-and-Holders. VII is what Buy-and-Hold would have been going back to the first day had only Shiller’s research been available to the people who developed Buy-and-Hold at the time they were developing it. Valuation-Informed Indexing is the new Buy-and-Hold.
Buy-and-Hold is dead!
Long Live Buy-and-Hold!
According to Rob Bennett’s bear market analysis, we are headed into the Second Great Depression unless we soon pull together and get to work on informing millions of middle-class investors of the realities of stock investing. His bio is here.