Valuation-Informed Indexing #330
by Rob Bennett
John Bogle learned that Buy-and-Hold doesn’t work in 1981. That’s when Robert Shiller published his “revolutionary” (Shiller’s word) research showing that valuations affect long-term returns. If that’s so, stock investing risk is not static but variable and investors must be willing to adjust their stock allocations in response to big valuation shifts to have any hope of keeping their risk profiles roughly constant.
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It’s not quite true that Bogle “learned” all that, of course. Shilled’s research really was “revolutionary.” That means that it changed everything, that it played with people’s heads. Bogle had a big emotional investment in Buy-and-Hold. He fell victim to cognitive dissonance. In an objective sense, he understood that Shiller’s research discredited the premise on which the Buy-and-Hold strategy was built (that the market is efficient). But that knowledge did not “click” for him. He went on believing in Buy-and-Hold despite what he “knew.” I think it would be fair to say that Bogle did not know what he “knew” at all.
Bogle ignored Shiller’s research. Buy-and-Hold is the same today as it was in the days before the research was published. And of course millions of good and smart people believe to this day that it is a good strategy, even that it is a research-backed strategy, a proven strategy.
All of the research published in the 35 years since has confirmed Shiller’s findings. The mountain of evidence that investors must practice price discipline when buying stocks grows ever larger, causing the cognitive dissonance of those who advocate and follow the Buy-and-Hold strategy to grow ever stronger.
It was easy to rationalize not incorporating Shiller’s findings into one’s investing strategy in 1981; stock prices were at rock-bottom prices — the thinking no doubt was that this was a “no harm/no foul” situation. The potential harm grew larger as prices rose throughout the 1990s. But then so did the embarrassment that would result from suddenly coming clean. It is a lot easier to own up to a mistake within a few weeks of when it is discovered than it is to do so several decades down the line. The price crash and economic crisis of 2008 of course made it more imperative than ever that the Buy-and-Holders come clean while also making their psychological need to avoid doing so all the more pressing at the same time.
It’s been 35 years now. Everyone who works in this field understands on some level of consciousness that the most important question before investors today is the question of how much they should adjust their stock allocations in response to valuation shifts. And yet very few address themselves to this question in a serious way. Discussing the implications of Shiller’s findings has become socially taboo. Holding open debate on these critically important matters opens too big a can of worms. Doing so might help us avoid future economic crises. But how do we explain to ourselves our failure to not take advantage of what we learned in 1981 to avoid the last one?
The best time for Bogle to act was in 1981. But I really do believe that he fell victim to cognitive dissonance at the time. Shiller’s research really did turn everything that we once thought we knew about how stock investing works on its head. Humans are not able to process fundamental and far-reaching changes in their understanding of matters important to them in a flash. It shouldn’t have taken us 35 years to launch a national debate. But I can see how it might have taken one year or two years or three years or perhaps five years.
Could Bogle have handled things differently?
I think so. I think that there are two approaches that he might have taken that would have taken us down a more life-affirming path.
One, he could have objected strongly to Shiller’s findings. He could have argued that they just didn’t make sense and that other researchers should have stepped in to show the Yale economics professor the error of his ways. I believe that that effort would have failed. But it would have forced us as a society to resolve the conflict between Shiller’s research (which supports the Valuation-Informed Indexing Model) and Fama’s research (which supports the Buy-and-Hold Model). We need to see these two ways of thinking about how stock investing works fight it out in the marketplace of ideas to see one of them prevail in a legitimate and permanent way. That battle was delayed by Bogle’s soft opposition (I have never heard Bogle directly criticize Shiller’s research although he obviously has not thought it of sufficient merit to influence his investing strategy).
Two, he could have adopted a more cautious approach to advocacy of Buy-and-Hold. For so long as Bogle truly believes that Buy-and-Hold works (it is my belief that this remains true today), he is obligated to share that belief with investors. But there is nothing that stops him from noting each time he offers a Buy-and-Hold take on a strategic question that there is another school of thought rooted in Shiller’s research that leads those who believe in it to very different conclusions. Lots of people would have learned about Valuation-Informed Indexing over the past three decades had Bogle followed that approach and those people would have engaged in insight-producing explorations that by now might have persuaded even Bogle of the merit of the new model.
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