Valuation-Informed Indexing #266

by Rob Bennett

I brush every day and I floss every day. But I don’t use a water pic although I probably should given gum problems that dentists have been warning me about for a good number of years now. And I definitely don’t go in for check-ups as often as I should. Once I miss one, I begin to suspect that I am going to hear bad news when I finally go in and that causes me to go into denial. And then time passes. And then I feel guilty when I finally go in.

I was sitting there getting my teeth cleaned and feeling guilty about how long I had put it off when it hit me — “This is just like investing!”

It’s all emotion. There have been a lot of advances in dentistry in recent decades. There is a lot of technology that can be put to use to help us keep our teeth in good repair longer than was possible for our parents. But our dentists get frustrated because a lot of us don’t listen to the simple instructions they give us that could save us so much discomfort down the line if we would just take them to heart. Why don’t we listen?

It’s for the same reasons we don’t maintain a long-term focus when making investing choices. We know we should. The research is clear. We all want to invest well (and keep our teeth in good repair). We fall into bad habits easily and find it hard to develop good ones. We procrastinate. We become guilty about it and go into denial about it to avoid the feelings of guilty. We indulge in fantasies that things will somehow work out okay for us even if we don’t take the actions that our intellects tell us we must take for things to really work out okay.

I believe that the next round of advances for the humans are going to be advances in the emotional realm. The industrial revolution increased productivity by making it possible for each hour of labor to generate more value. Then the information revolution let us leverage our brains in the way that the industrial revolution let us leverage our brawn. It’s our mistakes in the emotional realm that are doing the most to hold us back today. We don’t possess a strong understanding today of cognitive psychology. But we are making steady progress. We are on the verge of achieving breakthroughs.

I didn’t think that I was picking up an investing guide when I took the book Predictably Irrational on a plane trip. The word “investing” does not even appear in the index. But I was only about 20 pages in when I realized that one of the insights being presented had relevance in the investing field. And then I was hit with another. And another. By the time I reached the last page, I had scribbled in my notebook 20 ideas for investing columns based on the material presented in this non-investing book. That’s how fertile a field this is. Authors who are not even trying to come up with investing insights end up doing so just because there is such a wealth of potential to be developed in this area and a good bit of it has application in the investing field as well as in others

I saw a short article in the magazine Mental Floss the other day that asked the question “Do Great Minds Think Alike?” The article concluded that they do. It stated: “Just consider the phenomenon of ‘multiple discovery.’ Calculus, the polio vaccine, logarithms, the theory of evolution, the Higgs Boson model, lightbulbs, the jet engine — each leap was made simultaneously by more than one researcher…. As people try to fix particular problems, they use a cultural knowledge that has accumulated over time, which makes certain discoveries inevitable.”

I use the term “Valuation-Informed Indexing” to refer to the model for understanding how stock investing works that is rooted in the research of Yale Economics Professor Robert Shiller. Shiller holds back from saying too much about the practical implications of his research (because the Buy-and-Holders become hostile when those practical implications are pointed out) and I wanted to explore the questions that Shiller ignored and so I had to come up with a term to refer to the model. Rob Arnott examines the same questions but refers to the model he explores as “Fundamental Indexing.” Dan Ariely, the author of Predictably Irrational, doesn’t even think of himself as someone who has anything to say about investing. Yet I would argue that the investing insights that can be picked up by reading his book are as important as any of those that can be mined by consulting with the big-name “experts” in this field.

Lots of people are working the same fields. They are making progress. They are helping us. Some studied investing in school, some didn’t. It doesn’t matter. We know all about the numbers stuff that has been the focus of study in this field for many years. We need to know more about how those darn humans who put the numbers stuff to use in the practical realm and about how they operate not in theory but in reality. This is the future of dentistry and investing analysis too. It is the next frontier.

Rob Bennett’s bio is here.