Valuation-Informed Indexing #146
by Rob Bennett
I never stop talking about valuations. It would be fair to say that every word I have ever written about stock investing (and I have written many hundreds of thousands of words on the topic over the past 11 years) relates in one way or another to the valuations issue. Valuations, valuations, valuations. Some say that I am obsessed with this topic.
In his first-quarter letter to investors of Greenlight Capital, David Einhorn lashed out at regulators. He claimed that the market is "fractured and possibly in the process of breaking completely." Q1 2021 hedge fund letters, conferences and more Einhorn claimed that many market participants and policymakers have effectively succeeded in "defunding the regulators." He pointed Read More
People who know me say that I evidence a moderate take on just about every other issue that comes before me in life. What is it about the valuations topic that drives me so darn bonkers?
My view is that it is not me who is obsessed. It is all the people who pay insufficient attention to valuations who are obsessed. It just doesn’t seem that way because they don’t evidence their obsession by talking about the issue all the time. They evidence their obsession by not talking about it. They show how much the valuations question is on their minds by steadfastly refusing to acknowledge its importance.
A recent Financial Planning Association survey makes my point.
This survey was brought to my attention by a friend of mine who was using it to persuade me that things are getting better. The survey shows that one-third of retirement planners believe that the valuation level that applies on the day a retirement begins should be taken into consideration in the planning of that retirement. In my typically obsessive way, I don’t take this as good news. I take it as very bad news.
One third believe that valuations should be taken into consideration. That means that two thirds believe that valuations need NOT be taken into consideration. Huh? How does that make even a tiny bit of sense?
Are there people who believe that valuations don’t matter? I have not met anyone willing to take this position in a public debate of the question. But to read that two-thirds of financial planners believe that it is acceptable not to give valuations any consideration at all when putting together a retirement plan tells me that there certainly are people who for all practical purposes believe that valuations don’t matter. If they mattered, you would take them into consideration when putting together a retirement plan.
So we all say that we believe that valuations matter. But for a good number of us, such statements are polite reassurances that we understand the obvious realities. We don’t really believe that valuations matter. We pretend to believe it. When it comes to taking actions based on that belief, we take things the other way.
We are confused.
I don’t see how anyone can object to this conclusion.
Most of us pretend that investing analysis is at least in part rooted in scientific principles. Is it really? Scientific findings are developed through a building-block process. First, you reach consensus on the fundamentals. Then different groups reach farther, often going in different directions while never questioning the settled thought on the basics.
The question of whether valuations matter or not is the most fundamental investing question there could be. If we get that one wrong, we get it all wrong. But at least one third of us and perhaps two thirds of us have gotten it wrong, according to this survey.
The fact that there is even a little bit of controversy on so basic a question should scare everyone who makes a living in this field or who has made investment decisions based on what people who make a living in this field say about the subject. At least one third of the professionals in this field and perhaps two thirds of the professionals in this field don’t have the slightest idea what they are talking about.
That follows, does it not?
The New School safe withdrawal rate studies show that the safe withdrawal rate is 9 percent when valuations are where they were in 1982 and 1.6 percent when valuations are where they were in 2000. For a retiree with a starting-point portfolio value of $1 million, a 9 percent withdrawal rate permits $90,000 of living expenses in each year of retirement. A 1.6 withdrawal rate permits living expenses of $16,000. That’s a big difference in living standards. It sure would be nice to know whether valuations matter or not before advising a client how to structure his retirement plan.
But we don’t.
You might be tempted to say that the one-third KNOWS that valuations matter and the two-thirds KNOWs that valuations don’t matter. I don’t think that’s quite right, however. I BELIEVE that valuations matter with more conviction that anyone else alive on Planet Earth today. But I don’t think it is quite right to say that I “know” this. Not for so long as two-thirds of the professional in the field know otherwise. For me to have complete confidence in my strongly held belief, I would have to hear more of the experts in the field agreeing with me. We’re not there today.
Why aren’t we there?
Can’t we study and debate this question until we resolve it?
We are afraid to do so.
We are afraid that we will find out that two-thirds of today’s retirement planners have been doing it wrong for a long time now.
Rob Bennett has recorded a podcast titled “The Case Against Valuation-Informed Indexing.” His bio is here.