Valuation-Informed Indexing #308
by Rob Bennett
For much of the past decade, Crispin Odey has been waiting for inflation to rear its ugly head. The fund manager has been positioned to take advantage of rising prices in his flagship hedge fund, the Odey European Fund, and has been trying to warn his investors about the risks of inflation through his annual Read More
This is my third column commenting on a recent article published in the Wall Street Journal by Wade Pfau (What Is the Sustainable Spending Rate for Retirees in 2016?). The first column raised doubts as to whether Wade did the right thing by incorporating adjustments not only for valuations (which I of course see as a huge advance) but also for interest rates. The second column argued that, while it is fine to report what Wade calls the “sustainable spending rate,” it is also important to report the safe withdrawal rate, which is the number of far greater practical value to most investors.
My third observation on the article was inspired by a comment on it offered by a fellow who posts under the screen-name “Scott Turnquist.” Scott writes: “I would like to see the formulation for a 70/30 or even an 80/20 Stock/Bond split. I find that the 50/50 split that goes back to last century is not adequate for today’s portfolio growth needs.”
That’s a fair comment, in my view.
I started writing about safe withdrawal rates in May 2002. At that time, it was common practice among Buy-and-Holders to assume that smart retirees would employ a portfolio allocation of 80 percent or so. The conventional wisdom of the day was that stocks had been proven to be the far superior investment choice and so retirees would be leaving lots of money on the table by going with stock allocations too much less than that.
To be fair, not all Buy-and-Holders took this position. But the voices of the ones who did often drowned out the voices of those who did not. Those of us who held reservations about the idea of going with high stock allocations at times of insanely dangerous valuation levels often censored ourselves. We shared our thinking in limited, tentative ways. But we knew that stating our views in too clear a manner would make us unpopular and so we walked on eggshells when making this painfully basic and important and accurate and responsible point.
It’s a different story today. Stocks have been performing poorly for nearly 17 years now. Today, the Buy-and-Holders know that saying that stocks are always the far superior asset class does not go over nearly as well as it did in 2002. So they state things differently. They suggest that perhaps 50 percent stocks is a better allocation fort most retirees or even for most investors. Occasionally you will see a Buy-and-Holder advocate a stock allocation even lower than that, something I can never recall seeing in the days of wildly inflated prices.
It’s all perfectly natural, isn’t it? Isn’t this just what you would expect to see? When the Yankees are winning pennants every year, people tend to see them as a powerhouse and tend to imagine them always remaining a powerhouse. When they are having a hard time of it, people tend to see them as “finished” not just for now but for always. We humans jump on bandwagons. We are inclined to see trends playing out in the present day as extending into infinity.
However, there’s a problem when we give in to these inclinations in the investing realm.
Investing is a long-term game. We begin investing in our 20s to finance retirements that will begin in our 60s and extend into our 80s. It doesn’t matter much how our portfolios will perform for five years. What matters is how they will perform for 30 years or even for 60 years. We need investing advisors who will tell us how things work over long stretches of time and who are not too influenced by what is popular in the one particular stretch of time in which they are speaking.
Those investing advisors need to make a living!
When stocks are priced insanely high, everybody is drawn to the idea of over-investing in stocks and when stocks are priced insanely low, everybody is drawn to the idea of under-investing in stocks. The marketing realities are the opposite of the research-based investing realities. The experts like to pretend that there is research supporting the Buy-and-Hold strategy because that is what sells but the research tells a very different story to those who look at it to learn what works from other than a marketing perspective.
I think we should be telling investors ALL the numbers. We should tell them how their retirements will proceed if they go with an 80 percent stock allocation and how they will proceed if they go with a 50 percent stock allocation and let them decide which path to take.
This approach too has drawbacks from a marketing standpoint. I talked to a fellow at a party once who had checked out my web site and who told me that I would be a lot more successful if I would put less effort into explaining to investors why Valuation-Informed Indexing is superior to Buy-and-Hold and would instead just get quickly to the bottom line. “Tell me what to do with my money!” he implored me. “I don’t want to think about it. I want you to do the thinking. I come to investing sites to be spared the chore of thinking this stuff through for myself.”
I believe that this fellow was speaking for many people. People want to be told what to do, not why it works.
There’s only one problem. What works won’t work unless the investor understands on a deep level why it works.
Any investing strategy you choose is going to perform well in some time-periods and poorly in some time-periods. Buy-and-Hold was aces through the 1980s and 1990s and has performed poorly from 2000 forward. Valuation-Informed Indexing was aces in the 1980s and from 1990 through 1995 and then was a disaster from 1996 through 1999 and then has performed reasonably well but not incredibly well for the past 17 years.
We need to present to investors as many options as possible and encourage them to explore how each of the various options performs over a number of different time-periods. This approach adds complexity to the analysis. Simplicity is a plus and I would not sacrifice it without good reason. I believe that the added complexity that I am recommending here produces benefits that more than justify the expenditure of added mental energies. Investors who examine numerous possibilities before making their investing decisions are prepared for whatever comes and thereby are able to stick with their choices for the long term. That’s the key to success in stock investing.
Rob Bennett’s bio is here.