Valuation-Informed Indexing #198
by Rob Bennett
I am not an investing expert.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
I am a journalist.
I fell into the Valuation-Informed Indexing back in May 2002 and found it irresistible. It has been my life ever since.
There are 14 reasons why.
1) The story is big.
This is a bigger story than Watergate. If Shiller is right and Fama is wrong, it was the heavy promotion of Buy-and-Hold that caused the economic crisis. Plus, there are millions of middle-class investors who are going to suffer failed retirements in days to come and the government is going to need somehow to find money to bail them out (it wasn’t their fault if they followed the conventional advice, which was known to be in error for three decades but was promoted heavily all the same). That’s news.
2) The story affects everyone.
Everyone who hopes to be able to retire someday needs to know how to invest effectively. This affects Democrats and Republicans, young and old, women and men, black and white. This is a story that pulls everyone together.
3) The story has drama to it.
We have been ignoring Shiller’s insights for over three decades now. But we don’t have unlimited time to fool around. There will be another stock crash if we don’t come to our senses. So there is a clock ticking in the background.
4) The story is simple.
The core idea here is easy for average people to grasp: We need to consider price when buying stocks, just as we do when buying anything else.
5) The story is also complex in its way.
If the story were only simple, there would be nowhere to go with it. The Valuation-Informed Indexing story is simple in its essence. But there is an aspect of it that is complex indeed. Why don’t the experts get it and why don’t ordinary investors ignore what the experts say and act in their self-interest? Both the experts and the ordinary investors are suffering from cognitive dissonance. We desperately want to believe that the pretend gains of bull markets are real and so we refuse to heed the decades of research showing otherwise. This is about the quirks of those goofy humans.
6) The story is positive.
We now know what we need to know to reduce the risk of stock investing by 70 percent. That’s amazing and uplifting stuff.
7) The story has economic and political implications.
This is not just about people’s stock portfolios. If we come to a better understanding of how stock investing works, we can reduce the odds of seeing future economic crises (it is the loss of consumer spending power that results when markets crash that has served as the primary cause of the four economic crises we have seen since 1870). Economic crises cause political unrest. So stabilizing the stock market stabilizes our democracy.
8) There are lots of angles to be explored.
The error in the old way of understanding how stock investing works is so fundamental that we need to rewrite all the old textbooks. It will be decades before we have fully explored all the far-reaching implications that arise from Shiller’s research.
9) The story is credible.
Buy-and-Hold is of course backed by many experts. But so is Valuation-Informed Indexing. Shiller has won a Nobel prize. These ideas seem out there. But how far out there can they be when they are rooted in the research of a Yale Economic professor who has won a Nobel prize?
10) The story encourages optimism for the future.
We all want to believe that the lives of our children will be better than our own. This story is life-affirming because it shows that humankind advances in knowledge over time.
11) The story has an edifying theoretical side.
Learning how human psychology affects stock returns requires consideration of scores of fascinating puzzles. The emotional side of the investing project is probably more than half of what needs to be known. So we are solving scores of intellectual riddles quickly. For example, Shiller’s insights enlighten our thinking on the so-called equity risk premium and on how to reduce volatility in stock prices and on the cause of bull markets and bear markets.
12) The story has an important practical side too.
While lots of people enjoy solving theoretical puzzles, lots of other people do not get excited by academic debates. Lots of people get more worked up over advances with practical implications. That’s this story! What could be more practical than figuring out how to generate accurate retirement-planning numbers?
13) There’s a big internet aspect to the story.
I couldn’t have done the work have done over the past 12 years without the internet. It was through interactions on the internet that I learned how millions of middle-class investors use Buy-and-Hold strategies and why they are in some cases reluctant to embrace Valuation-Informed Indexing strategies. I met John Walter Russell and Wade Pfau through the internet and both helped me produce amazing research that advanced the ball in important ways. It was also through the internet that I was able to contact leading figures in the field and run ideas past them and benefit from their feedback by revising the key principles of the Valuation-Informed Indexing concept.
14) The story shows the merit of our system of checks and balances.
The big problem with Buy-and-Hold was not the mistakes that were made. We all make mistakes in all fields of human endeavor. The problem was the opposition that developed to correction of the mistakes and the failure of our system of checks and balances to overcome that opposition for three decades. Journalists should have been tougher in their questioning of Buy-and-Hold advocates. We should have seen more investing analysts trying to distinguish themselves by taking the anti-Buy-and-Hold line. It shouldn’t have taken an economic crisis to cause challenges to the old ideas to get off the ground. If we learn this lesson as a result of the financial losses we have endured, it may be that the experience will somewhere down the line prove to have been a positive one.
Rob Bennett has recorded a podcast titled Liberals Both Love and Hate Rational Investing, and It’s the Same With Conservatives. His bio is here.