Valuation-Informed Indexing #276
by Rob Bennett
There’s been a lot of talk lately about Donald Trump’s claim that he saw thousands of Muslims in New Jersey celebrating the terrorist attacks of September 2001. Trump critics have asserted that there is no documentation of such attacks and have suggested that Trump is dishonest to say such a thing. Trump supporters have asserted that there is documentation that a smaller number of people celebrated the attacks and that thus Trump is more right than wrong re the facts of his claim and on top of that is showing courage to advance it given the reaction it inspires among his critics.
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
You would not think that a claim of this nature would inspire controversy. The 911 attacks were the subject of saturation news coverage. Either such celebrations took place or they did not. It’s not hard to see how there would be differences of opinion as to how to deal with the terrorism problem. But the question of whether or not there were thousands of Muslims celebrating the attacks in the United States is a simple factual matter. Is it possible that there could be a dramatic divergence of opinion re the basic facts of the matter?
The full reality is even more shocking that that. The full reality is that this sort of thing is common. Humans do not process information in the manner in which computers do. We don’t process information bits that are entered into our brains, subject them to some sort of reasoning process and then spit out logical conclusions. All of our thinking on all of the issues that we think about pass through an emotional filter. Facts do influence us. But to a large extent we believe what we want to believe. Those of us who want to believe one thing respond to a fact in one way and those of us who want to believe the opposite respond in a very different way.
There is documentation of a small number of Muslims celebrating the 911 attacks. That settles the question for Trump critics. He said that there were thousands celebrating. The documentation does not support the claim. Trump was wrong. End of story.
But the Trump supporters don’t see it that way. They see documentation that supports the core claim being made. There were indeed celebrations. So Trump’s critics were wrong to suggest that he was being dishonest. Who cares whether Trump got the number precisely correct or not?
It works this way when we process knowledge about how investing works too. I know because I have been on both sides of the most important issue — whether Buy-and-Hold is the ideal strategy or is the most dangerous Get Rich Quick scheme ever concocted by the human mind. I was once a proud Buy-and-Holder. I am today the most severe critic of the strategy alive on Planet Earth. The basic facts have not changed. How is it that I have been able to employ those basic facts to arrive at such dramatically different conclusions?
I became a Buy-and-Holder in the Spring of 1996. I had been engaged in a study of investing for several years and had been drawn in that direction because I liked the fact that Buy-and-Holders frequently cite peer-reviewed research as support for their beliefs about how stock investing works. It annoyed me that there are “experts” in this field coming down on every possible side of every issue. It seems to me that true experts should be able to agree at least on the basics of a field under study; otherwise their expertise doesn’t amount to much.
By rooting their beliefs in peer-reviewed research, the Buy-and-Holders disciplined their thinking in a way that the other “experts” did not. They weren’t telling me what sounded good in a marketing pitch. They were telling me what the historical return data reveals about the subject. I wanted investing advice that was real and objective, advice that would stand the test of time. The Buy-and-Holders provided that.
Or at least so I thought for a time.
I lost confidence in the Buy-and-Hold project on the evening of August 27, 2002. I had posted at a discussion board about the errors in the Old School safe-withdrawal-rate studies and the post had generated a good bit of controversy. Lots of my fellow community members viewed the discussion that followed as the most important discussion ever held at that board. Another group wanted to shut me up through any means possible. That night the group that wanted to shut me up resorted to the use of death threats aimed at me and my family. So much for the objectivity of peer-reviewed research! This development made clear to me that the primary appeal of Buy-and-Hold is emotional. The Buy-and-Holders tell us what we want to hear about stock investing and we believe it despite what the historical return data reveals because we want to believe.
I’m not talking about others. I’m talking about all the humans. I’m talking about me.
I believe that we should all use peer-reviewed research as the primary guide to formation of our investing strategies. Since 1981, the peer-reviewed research has shown that the key to successful long-term stock investing is to always take valuations into account when setting our stock allocations, a practice that the Buy-and-Holders disdain as a form of the dreaded “market timing.” And yet I believed in Buy-and-Hold! For six years! How was such a thing possible?
I rationalized, just as both the Trump critics and the Trump supporters rationalize today.
I knew that the safe withdrawal rate studies did not contain adjustments for the valuation level that applies on the day the retirement begins. I told myself that it didn’t matter because valuations probably don’t make that big a difference (I was of course careful not to check whether this is actually so or not). Or I told myself that at least the Buy-and-Hold retirement studies were better than most non-Buy-and-Hold retirement studies (that was so but they of course would have been even better yet if valuation adjustments were added). Or I told myself that the people promoting Buy-and-Hold were smarter than me (true) and must have known about aspects of the question that I wasn’t aware of (this one turned out not to be true once I got around to investigating the matter).
The Trump critics would understand better why Trump has won the support of a good number of voters if they could drop their biases and look at things from the other side of the table. And the Trump supporters would be more skeptical of the man’s appeal if they could drop their biases and appreciate where the Trump critics are coming from. And the pre-2002 me could have learned a lot about investing by reining in his enthusiasm for the Buy-and-Hold strategy and asking hard questions about the parts of the strategy that don’t add up.
Could the post-2002 me learn even more about investing by reining in his enthusiasm for the Valuation-Informed Indexing strategy and asking hard questions about the parts of that strategy that don’t add up?
He probably could.
But he probably won’t.
He’s one of those darn flawed humans.
Rob Bennett’s bio is here.