Valuation-Informed Indexing #387
By Rob Bennett
I don’t claim to be a stock investing expert. But in the early 1990s, when I began the explorations that over time led to development of the Valuations-Informed Indexing concept, I knew a lot less about the subject than I know today. My first big step forward was on the day when I became frustrated that it is all just too confusing. Lots of people call themselves “experts.” Lots of the advice they offer differs on important points from the advice offered by other “expeerts.” How is the typical middle-class investor to make sense of all the noise being directed at him?
The Buy-and-Holders said that the answer is to root your investing beliefs in peer-reviewed research. That made sense to me. Research is objective. It is not just some fellow’s opinion. It is not the product of an agenda. It is not generated by a marketing department. Research doesn’t tell you what you want to hear, it tells you what is. I decided on the day that I heard that argument that I would be investing my retirement money pursuant to what the research says.
It’s been a wild ride!
I still believe that investors should root their strategies in what the research says. I have come over time to view stock investing as a highly emotional endeavor. The risk of stock investing is that the investor can get caught up in his emotions and lose the ability to think clearly about what is in his best interest. Following research-based strategies makes all the sense in the world.
Except for the fact that —
The same Get Rich Quick emotions from which investors are turning to research for protection influence their decisions as to which research to follow!
There really is a broad body of research supporting the Buy-and-Hold strategy. I make the point that Robert Shiller has been awarded a Nobel prize as one of my primary arguments in favor of Valuation-Informed Indexing. But Eugene Fama was awarded a Nobel prize on the same day that Shiller was awarded his and of course Fama’s research says completely different things about how stock investing works (Fama’s research says that the market is efficient, suggests that is is economic developments that cause stock price changes and posits that stock investing risk is static while Shiller’s research says that valuations affect long-term returns, suggests that it is shifts in investor emotion that cause stock price changes and posits that stock investing risk varies with changes in valuation levels). There are two schools of academic thought as to how stock investing works and each investor puts his retirement in peril when he chooses to follow the path suggested by one school over the path suggested by the other.
How is he to make the choice?
Should he research the question? Is there research to tell us what research is best?
Or should he listen to his gut? Should investors who are convinced that research is the answer to the confusion of the investing advice realm make emotional choices as to which body of research is the right one? Deciding that following a research-based strategy is the answer doesn’t really settle the question of what investing choices to make when there is a wealth of peer-reviewed research pointing in two very different directions.
What makes it worse is that research solidifies opinions.
If the question of which investing strategies are best were a purely academic one, we would listen in as the academics made their cases pro and con both models for understanding the market and would elect one as our own choice only after hearing the full case for both sides. That’s not possible in the real world. From 1965 until 1981, the research supporting Buy-and-Hold was available and the research supporting Valuation-Informed Indexing was not. Millions of investors had money to invest and had to make a decision after only hearing the case for one of the two strategies. Once those investors became Buy-and-Holders, they became emotionally invested in the strategy and to a considerable extent closed their minds to the case for Valuation-Informed Indexing.
And of course those investors have seen results in the years since that have confirmed the biases that they are not even aware they possess. Buy-and-Hold performed amazingly well from 1982 through 2000. A Valuation-Informed Indexer would say that Buy-and-Hold performed well from 1982 through 1996 because stock prices were shockingly low at the start of that time-period and did not become dangerously high until the end of it. But all the Buy-and-Holder sees is that the strategy worked and from his perspective that’s all that matters. A Valuation-Informed Indexer would say that stocks offered a poor long-term value proposition from 1996 through 1999 but all that the Buy-and-Holder sees is that returns in those years were even better. Could it be that those returns were the product of investor emotion sent into overdrive? This seems obvious to the Valuation-Informed Indexer but is a thought that does not even seem plausible to the Buy-and-Holder. Our decision to adopt one research-based strategy as our own influences our every assessment of it from that day forward!
I still believe that following research-based strategies is the solution to the stock investing puzzle. Twenty-some years down the road I have come to appreciate that the research-based road is a far more hazardous one that I imagined it could be on the day when I took to it.
Rob’s bio is here.