The Effect That Valuations Have on LT Returns Is Consistent Across Range of Valuation Levels

The Effect That Valuations Have on LT Returns Is Consistent Across Range of Valuation Levels
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Valuation-Informed Indexing #341

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By Rob Bennett

Shiller didn’t show that valuations affect long-term returns when valuations are in bubble territory. He showed that valuations ALWAYS affect long-term returns. Valuations matter when prices are low. Valuations matter when prices are moderate. Valuations matter when prices are high. Valuations ALWAYS matter.

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Investors need to accept a paradigm change to appreciate this point. Most of us think of valuations as a special case. The ordinary thing is to be highly invested in stocks. Occasionally valuations reach such high levels that it might make sense to lower one’s stock allocation a bit. The valuations question, for most of us, is a matter of determining whether now is one of those rare times and a matter of determining how much of an allocation shift is appropriate.

That’s the wrong way to think about things. The valuation level for stocks is the price of stocks. Price is something that needs to be taken into consideration in every possible strategic determination. You need to consider the effect of valuations when determining your safe withdrawal rate. It doesn’t matter whether valuations are low, moderate or high when you do this. You simply cannot get the numbers right without taking the valuation level that applies on the day the retirement begins into consideration. And of course it is not possible to do effective financial planning without getting the numbers right.

Or say that you just want to know how well you are doing financially. The size of your stock portfolio is a big part of the answer to that question. But holding a $100,000 stock portfolio at a time when the P/E10 level is 8 is not the same thing as holding a $100,000 stock portfolio at a time when the P/E10 level is 32. The former portfolio obviously holds four times the value. The investor who holds a $100,000 stock portfolio at a time when the P/E10 value is 8 is in much better shape.
Or say that you want to know how the economy will be doing in coming years because you are starting a business or because you expect to be leaving the career you are in and are concerned whether opportunities will be widely available or not a few years into the future. If stocks are priced at rock-bottom prices, it is almost certain that valuations will be moving upward over the next five or ten years. When valuations remain constant, the return on stocks is 6.5 percent real. So the return is greater than that at times when valuations are rising. When returns are strong, millions of people have more money to spend and the economy expands. So knowing the P/E10  level that applies at a particular point in time and possessing an understanding of the far-reaching implications of Shiler’s “revolutionary” (his word) research findings tells you more about the future economic picture than do most of the conventional economic indicators.

Valuations affect every aspect of the stock investing experience. Too often discussions of valuations are rooted in a presumption that the purpose is to guess when valuations are going to turn and to profit from the guessing game. That the one thing that Shiiller’s research findings do not help the investor to do; short-term price changes are highly unpredictable. The power of Shiller’s finding that valuations affect long-term returns is that it illuminates every question faced by investors other than the silly guessing-game one that garners so much attention.

Say that you were thinking of buying a car. You obviously would ask the dealer for the price. You don’t do that for a single purpose. Knowing the price serves multiple purposes. It tells you whether you can afford the car or not. It also informs you how you may need to adjust your desires to identify the car that is right for you; by comparing the prices of two cars, you can see how much one feature y
ou like adds to the overall cost and assess whether that feature is worth the cost associated with it. Knowing the price attached to a used car with a specified number of miles on it signals how new of a car you can afford. Knowing the price of a car advances your car purchase project in many ways and the same is true with knowing the valuation level for stocks — identifying the P/E10 level tells you all sorts of things that you need to know to make an intelligent investment decision.

Knowing the valuation level for stocks matters every bit as much when valuations are low as it does when valuations are sky high. People hesitate to buy stocks when prices are low. Low prices usually appear as the result of crashes that scare most investors out of the market. But they steady the nerves of those who understand the message being conveyed by the low prices. When the P/E10 level is at rock-bottom lows, the potential for loss on a stock investment is very small and the potential for large long-term gains is high. The risk/reward ratio favors the investor to an extent that it does not at times of moderate or high prices. You don’t want to follow valuation trends just to know when to jump out of stocks but to know when to increase your stock allocation as well.

Valuations always affect long-term returns. Always. Valuations matter when prices are low, moderate and high. Valuations always matter. Valuations are not something you should be tuning into only when prices are off the charts on the high side. Think about valuations all the time and it will become a habit to do so and taking valuations into consideration at times of high prices will be part of a holistic practice and will no longer be the panicky practice that it is for too many of today’s investors.

Rob’s bio is here.



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Rob Bennett’s A Rich Life blog aims to put the “personal” back into “personal finance” - he focuses on the role played by emotion in saving and investing decisions. Rob developed the Passion Saving approach to money management; Passion Savers save not to finance their old-age retirements but to enjoy more freedom and opportunity in their 20s, 30s, 40s, and 50s - because they pursue saving goals over which they feel a more intense personal concern, they are more motivated to save effectively. He also developed the Valuation-Informed Indexing investing strategy, a strategy that combines the most powerful insights of Vanguard Founder John Bogle and Yale Professsor Robert Shiller in a simple approach offering higher returns at greatly diminished risk. Tom Gardner, co-founder of the Motley Fool web site, said of Rob’s work: “The elegant simplicty of his ideas warms the heart and startles the brain.”
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  1. Over at your website, we see you continue on with the blame game as follows:

    “The only reason why I am not a multi-millionaire today is that this is such a huge advance that we are having a hard time as a society making the transition. ”

    Rob, it is not the fault of society that you are not a multi-millionaire. It is your fault. You quit your job at the age of 43 when you should have continued working. You also made the decision to pull out of the stock market.

    You could have been a millionaire, like many of us, if you kept working and built your savings and investing in a well diversified portfolio. Instead, you made stupid choices.

  2. Wade already addressed what you said. This is all part of your imaginary world. You made it all up and we have the proof.

    The imaginary “Buy and Hold” boogeymen did wipe out your portfolio. We can see by your own statements that you were the cause. You quit working at 43, with only $400k in savings, while still supporting a family. You also chose to exit the stock market and watched from the sidelines while other investors were successful with their diversified portfolios. Stop looking to blame others for your failures.

  3. Rob,

    Stop trying to blame everyone else for your failures. You decided to stop working a an early age and with only $400k in savings. You decided to get out of the stock market and subsequently missed out on a big bull market. You decided to misbehave on board after board, getting yourself kicked off. You did all this too yourself. No one else did this. It is all on you.

  4. Wade loves Valuation-Informed Indexing. He told me so on dozens of occasions. He was so excited to learn about it and to dream about how he could help millions of people explaining to them how stock investing really works.

    Until you Goons threatened to destroy his career if he followed through on that dream.

    I believe strongly that you never would have made those threats if you felt confident about your own strategy — Buy-and-Hold. If you felt confident, you could go with a live-and-let-live philosophy.

    Following Buy-and-Hold strategies doesn’t just wipe out our portfolios. It eats away at our souls. It is important to get the numbers right. To get the numbers right, we need to adjust for the effect of valuations. Buy-and-Holders never adjust so much as one penny for the effect of valuations. Buy-and-Hold is not the answer. Buy-and-Hold is the problem.

    That’s Rob Bennett’s sincere belief, in any event. I think that Buy-and-Hold is truly dangerous stuff.


  5. Please think about what the word “overvalued” means, Sammy. It means “mispriced.” If your stock portfolio is mispriced, then what you say here is so — that wrong number that you are telling yourself is the amount of your life savings is a make-believe number. It’s not just me who is telling you that. Every time you read an article that cites today’s valuation level — the stock market is today priced at two times its fair value — the person saying that is in an indirect way telling you that you need to divide your portfolio value by two to know the amount that you actually have put aside to provide for your old age.

    The only thing that I do that is different is that I say it in a direct way. I don’t dance around the topic and put forward all sorts of happy talk. I tell people “if you have barely enough to retire going by how stocks are priced today, you are going to only have half of what you need once prices return to reasonable levels, as they always do.” People HATE when I do that. You are one of those people. You hate me with a burning hate because I have been stating these obvious truths in your presence for 15 years now2.

    But am I the bad buy or is it the people who are putting forward Buy-and-Hold happy talk who are the bad guys? I believe in planning. You cannot plan effectively if you don’t even get the numbers roughly right. So I believe very strongly that you need to be taking stock valuations into consideration when you develop your investing strategies. Without doing what you need to do to get the numbers right, you are shooting in the dark.

    The rarely spoken truth here is that you are not really angry at me. You are angry at yourself. You know on one level of consciousness that you should have been taking valuations into consideration all along. You talked yourself into not doing so because like all humans you possess a Get Rich Quick urge that entices you to ignore common sense and live in a fantasy land and because the vast majority of people who work in this field have noticed that there’s a lot more short-term money to be made encouraging people to live in fantasylands than there is in telling people what the last 36 years of peer-reviewed research shows us.

    I am not your enemy, Sammy. Your Get Rich Quick urge is your enemy. Buy-and-Hold is your enemy. You won’t have these feelings of hate toward anyone once you bring your investing beliefs into accord with your common sense. There’s a powerful feeling of peace and confidence that comes with doing that. You are living in a fantasyland today and it doesn’t feel good. But you can give that up and start feeling better about your financial future anytime you want.

    That’s my sincere take re these matters in any event, my good friend.


  6. Rob,

    We have seen you post the same stuff over and over again. When are you going to get new material?

    Why don’t I help you out. We saw some new material this last week by someone who left a comment on your board. This person shared an email from Wade Pfau regarding some of your unsupported claims. I think the last paragraph summed it up well when Wade said the following:

    “Rob lives in an imaginary world of death threats and threatened
    academic researchers and so on, as you would discover if you waste
    time reading what he writes. Just thought I’d let you know, straight
    from the horse’s mouth.

    Best wishes, Wade”

  7. Everything you posted above is something you have repeated hundreds of times. Don’t you think you should come up with new material?

    Tell you what, Rob. I am willing to help you out with that. For readers of your website, we were able to get some new insights on the lies you have made about Wade Pfau. Here is an email received by one of your readers that was sent by Wade:

    Long Time Hoco-Researcher says
    April 28, 2017 at 1:10 pm
    Liar. Here’s an old email to me in which Wade explains your hoax about his “academic career being threatened by anonymous internet posters” to an unfortunate fellow who bit on your 30k email jihad you waged against him in an effort to impugn his integrity and besmirch his good name. The only person who threatened Wade was Rob “hocus” Bennett.

    “Dear Vivek,

    I understand that Rob Bennett has sucked you into his drama. I’m Wade
    Pfau, the academic researcher who has allegedly been threatened. In
    writing about your tweet at his blog today, Rob even wrote, “(A number
    of Buy-and-Holders threatened to send defamatory e-mails to Wade’s
    employer in an effort to get him fired from his job for the “crime” of
    having published research showing the dangers of Buy-and-Hold
    investing strategies and several big names in the field [including
    Vanguard Founder John Bogle] failed to take action against those
    advancing the threats, thereby implicitly encouraging them [I have
    sent Bogle four e-mails asking for his help with the matter])”

    I can assure you that this is all part of Rob’s vast mythology in
    which he seeks to make himself into a super hero fighting the evils of
    Wall Street. It isn’t true. Rob magnified a very minor situation by
    10,000x. The entire story he developed is based on the one minor
    comment found here at the start of this discussion board thread:

    “I hope this doesn’t ruin that guy’s chances for tenure.”

    That’s it. He imagined all of the subsequent details.

    At any rate, I did indeed publish the studies which Rob claims I am
    afraid to publish. There is no issue. The main study is this one:

    Rob lives in an imaginary world of death threats and threatened
    academic researchers and so on, as you would discover if you waste
    time reading what he writes. Just thought I’d let you know, straight
    from the horse’s mouth.

    Best wishes, Wade”

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