Valuation-Informed Indexing #275
by Rob Bennett
It’s a good idea to try to obtain the best value for your money when buying things.
That’s an obvious truth, right? That one generates no controversy whatsoever.
It’s a good idea to try to obtain the best value for your money when investing it.
How about that one?
That one is insanely controversial. If you don’t believe me, remind me sometime to show you the scars that I have all over my body as a result of my efforts to spread the word re that one far and wide.
Price matters. Valuations matter. Long-term timing always works. Price discipline is just as critical in the stock market as it is in every other market. There are lots of ways to sum up the Valuation-Informed Indexing message in a few words. Perhaps the most compelling way of all is just to note that Valuation-Informed Indexing is rooted in the premise that what works so well in the saving realm should also work well in the investing realm.
I often ask myself why it is that I became so strong a believer in the idea of considering valuations when setting my stock allocation when the vast majority of investors and even the vast majority of investing experts think it is a bad idea to “time the market” in this way. The biggest influence on my thinking was my experience of learning how much farther my money went when I searched for strong value propositions when spending it.
I was once a careless spender. At age 35, my net worth was the $5,000 I had in a checking account. Then I got religion. I lost a job that I loved and was forced to take one that I didn’t love as a means of putting food on the table. I hated the feeling of vulnerability that I experienced as a result of that job loss and vowed to make sure that I never experienced it again. I learned that by spending more carefully I could save a big portion of my paycheck and in not too long a time become far less dependent on a paycheck. I was amazed at how big a change in my enjoyment of life I was able to achieve by making this one change.
When it came time to invest the money I had saved, I naturally was drawn to apply the same principles that had worked so well in the spending area in the investing area. I wanted to stretch my investing dollars as far as I had learned to stretch my spending dollars. I wanted to seek out strong value propositions in the investing realm.
It was the Summer of 1996 when I faced a decision as to how much of my portfolio to direct to stocks. Most of the “experts” advised me to identify the stock allocation that was right for someone in my financial circumstances and pursuing my life goals and with my risk tolerance and stick to it. This advice didn’t sound quite right to me. Lots of smarrt people pushed it and so I assumed that I was probably the one in the wrong. But it sounded off somehow.
Then I learned about the research done by Nobel Prize-winning economist Robert Shiller. The people pushing the conventional Buy-and-Hold advice believed that stock prices fall in the pattern of a random walk. Shiller showed that that is not so, that valuations affect long-term returns in a highly predictable way. High prices lead to poor long-term returns. Low prices lead to strong long-term returns. By seeking out strong value propositions you can make your investing dollar go a lot further. Just as you would intuitively expect it to work! Just as it works with spending!
I’ve never looked back.
I’m now 19 years down the road and I’ve learned a lot by exploring the implications that follow from this powerful insight. But the same principle that got me on this path all those years ago continues to drive my explorations to this day. Many people worry that investing is hard to understand. But the key principle is not at all hard to understand for those of us who spend money on a daily basis — and that of course is all of us. We must, must, must aim to achieve value for our investing dollars. We must always practice price discipline when setting our stock allocations. We must always tune out the “experts” who recommend Buy-and-Hold strategies.
Why don’t the experts read Shilller and take his message to heart?
To some extent, it’s a money thing. It can take 10 years or even a bit longer for stock prices to right themselves. During that time, the market creates trillions in Pretend Money. Investors love it when people tell them that the Pretend Dollars are real. So, from a marketing perspective, Buy-and-Hold is the cat’s pajamas.
But it’s not just about money. The Buy-and-Holders believe what they say. They follow Buy-and-Hold strategies themselves. I listen carefully to what they say when they engage in debate with me and it is clear to me as the result of tens of thousands of conversations that this is so. We all have a Get Rich Quick urge within us and it influences our thinking. It is overly cynical to believe that the Buy-and-Holders give bad advice solely to turn a buck. They are flawed humans like all the rest of us (including me, to be sure — please understand when you read these words that I am biased in favor of Valuation-Informed Indexing because of the years of work effort that I have put into the project of developing and promoting the concept).
We fail to seek strong value propositions with our investing dollars for the same reasons we fail to seek strong value propositions with our spending dollars. You see a car that you cannot afford today and a voice in your head tells you to put the budget aside and buy it because life is hard and you deserve nice things. You worry about your retirement and you want to reduce the worry and you are drawn to the idea of treating those Pretend Dollars as real ones because doing so creates the illusion of moving you closer to your financial independence goals.
We are flawed creatures. But Shiller is popular, his book was a best-seller. We learn over time. We advance in our understanding of things. We’re not so bad.
Rob Bennett’s bio is here.