Everyone Is Biased About Stock Investing Strategies Because Everyone Employs One

Everyone Is Biased About Stock Investing Strategies Because Everyone Employs One
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Valuation-Informed Indexing #405

By Rob Bennett

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Say that Valuation-Informed Indexing is garbage. Say that Shiller is wrong. Say that valuations really do not affect long-term returns, that the market is efficient. Say that Buy-and-Hold is the ideal strategy.

If all of those things turn out to be so, I am going to look pretty darn foolish, aren’t I? I have devoted the last 16 years of my life to developing the strategy. I have been banned from numerous discussion boards and blogs and thereby separated from my friends. I followed the strategy in management of my own portfolio. If the strategy is a foolish one, I will have lost a lot of money as a result.

I am biased in what I say about how stock investing works.  Very, very, very, very, very biased. You need to know that. Every word that I write about the subject of stock investing is drenched in bias. I do my best not to let my biases influence what I say. But of course it is impossible for me to be entirely successful in my efforts in that regard. My biases are so dear to my heart that I don’t see them doing their dirty work when they influence what I write. It is inevitable that there are times when my biases undermine my work despite my efforts to avoid having that happen.

Here’s the thing.

It’s not just me.

We are all biased when it comes to this subject.

We all invest our money to provide for our retirement. Once we do that, we become emotionally invested in the strategy we employ. We start out using it because we think it is a good strategy. But few of us are able to do as much research as we would like before we decide on a strategy. We lead busy lives. We cannot afford to put off investing until we figure it out. To fail to invest our money is to make a decision to choose the worst way to invest. So we go with what looks best at a particular moment in time, going on the limited amount of knowledge that we have been able to acquire about the subject of stock investing up to that moment of time.

We are aware of our lack of knowledge when we make the decision as to which investing strategy to employ. To ease our minds, we tell ourselves that we will no doubt learn more about the subject as time passes and that we can always change strategies if we see a need to do so. But the odds are stacked against us actually pulling that one off. Our bias grows stronger with each dollar that we invest pursuant to the strategy we follow. We might not have been too concerned about getting things right when we invested our first dollar. When hundreds of thousands of dollars have been added to the pile, it’s not easy to acknowledge that that initial choice was made in error.

Have you had the experience of doing the research involved in buying a car and then deciding on a model and purchasing that car and then seeing that car on the road everywhere you drive? Our minds are hit with lots of information bits during the course of a day. We see lots of cars and we do not possess the mental capacity to take note of each one we see. But once we develop an interest in a particular model, we see that model each time it crosses our path. The car was always there before our eyes. But it might as well have not been until we focused on it enough for it to be something that we noticed when it appeared.

It works that way with investing strategies. Stock prices fell hard in late 2008 and early 2009. Lots of people who generally do not pay much attention to stocks became highly interested in the subject at that time. They were worried that their retirement savings was going to be greatly diminished. They heard Buy-and-Holders advise them not to worry because money lost in price drops is always restored in not too long a time. Then they saw that happen. That made a big impression. Lots of those people became confirmed Buy-and-Holders as a result of that experience.

The pro-Buy-and-Hold story really did play out. Perhaps those people were right to be convinced by what they saw. But they saw only the scenario that they were watching for, not every scenario that has taken place in the market since its earliest days. I believe that they would gain a better understanding of how the market really works if they looked at all the scenarios, if they adhered to the disciplines that are required when peer-reviewed research is developed. I believe that, if they looked at all the scenarios, they would conclude that the Buy-and-Holders are wrong, that sometimes losses are recovered in a short time and sometimes they are not and that it is the valuation level that applies in a particular case  that determine which it is. I believe that those people were looking for a particular model of car and saw it not because that is the only kind of car to see but because they had trained their eye to watch for that kind of car. I believe that they were looking at events with a biased perspective.

I believe that we all do that. Without intending to. Our minds are structured in such a way that there is always a risk that bias will influence what they perceive. And stock investing is a subject re which the bias problem is particularly strong because it is so important to get it right and yet most of the people who need to make decisions about stock investing do not possess expertise in the subject. The more important it is to get something right, the more likely we are to let our biases get the better of us. When something is important we don’t want to be wrong. And so we tune out information that might cause us to question beliefs on which we have a lot riding.

Rob’s bio is here.

Updated on

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. Rob,

    There have been countless discussions at your board and elsewhere in which we have compared returns on an assortment of buy, hold and rebalance portfolios (such as the Simba list) that have trounced your returns. Your continued lying does not help your situation. Further, we can all go back and look at your retirement plan when you left your job and see how that did not work out as planned. You are wasting your time with revisionist history.

  2. Buy-and-Hold has been performing poorly for 18 years running. From January 2000 forward, the annualized return has been 3.2 percent real. That means that millions of Americans are short of where they need to be for retirement. They were counting on returns of something in the neighborhood of 6.5 percent real (the long-term average return for 150 years now). So we are all paying a huge price for the out-of-control bull market of the late 1990s. When we push prices up so far above what the economic realities permit, we are borrowing returns from future years. It hurts to have to pay back the debt.

    I have my money in TIPS and IBonds paying 3.5 percent real. So I beat the stock return from 2000 forward by a tiny bit. But I of course did so by taking on only a fraction of the risk. So I think it would be fair to say that I am a good bit ahead of the Buy-and-Holders from 2000 forward.

    The Buy-and-Holders are a good bit ahead of me counting from 1996, when prices first reached dangerous levels. But stocks are today priced for a 50 percent crash. On the day after prices drop that much, I will be far ahead counting from 1996 forward as well. So the real question here is — When stock prices travel to levels of extreme overvaluation, are additional gains the product of economic developments (in which case they would be true and lasting gains) or at they the product of irrational exuberance (in which case they would be non-real and only temporary gains). I believe that those gains are the product of irrational exuberance.

    This is really the only difference between Buy-and-Holders and Valuation-Informed Indexers. Buy-and-Holders count all gains as real, even gains attained at times of extreme overvaluation. Valuation-Informed Indexers do not. We believe that those gains are the product of irrational exuberance. It seems to me that it is an issue of huge national importance to figure out whether it is Fama or Shiller who is right re this one. If Shiller is right, we will be seeing millions of failed retirements in days to come because millions of people planned their retirements in reliance on Buy-and-Hold retirement studies and calculators which are rooted in a belief that even gains attained at times of overvaluation are real and lasting gains. We will also be seeing a deepening of the economic crisis in the event that Shiller is right because a 50 percent price crash will cause trillions of dollars of consumer buying power to disappear from the economy.

    This is the $64,000 question. Is Shiller right re this one or is Fama right re this one. It is my strongly held view that a national debate should be raging re this question on every discussion board and blog on the internet. The answer to the question affects the future of each and every one of us. I think Shiller is right. I find his case very persuasive. Of course, I acknowledge that 90 percent of the population is today inclined to believe that those gains are real. Shiller and I are very much in the minority.

    My best and warmest wishes to you, Sammy.


  3. The way we remove bias is looking at outcomes. With your VII strategy, you decided to pull out of stocks over 20 years ago. We can look back on your posts (which you have tried to revise) and see that you had lower returns versus the commonly used buy, hold and rebalance portfolios (such as those described on Simba’s list). Since you can no longer deny your failure, your most recent attempts at trying to soften the critics is that you think you did better from a “risk adjusted” basis. as any person grounded in statistics can tell you, you do not risk adjust historical returns as those are actual returns…….but as you admit, you are not really a “numbers” guy.

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