Can Two Schools of Thought on How Stock Investing Works Co-Exist?

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Valuation-Informed Indexing #346

by Rob Bennett

The safe withdrawal rate is always 4 percent. Unless it is a number that varies from 1.6 percent to 9.0 percent depending on the valuation level that applies on the day the retirement begins.

Stocks can be expected to provide a long-term return of 6.5 percent real. Unless valuations are currently so high that the likely long-term return is a negative number or so low that the likely long-term return is 15 percent real.

Stocks are always the best asset class. Except at times at which valuations are as high as they have been for the past 20 years.

Market timing never works. Except it always works for investors who follow a valuations-based market timing strategy who are willing to wait 10 years to see good results.

It’s confusing to have two schools of thought as to how stock investing works.

Still, the reality today is that there really are two schools of thought based on research compelling enough to have its author awarded a Nobel prize. Eugene Fama showed in 1965 that the market is efficient and thereby provided the impetus for development of the Buy-and-Hold strategy. Robert Shiller showed in 1981 that valuations affect long-term returns and thereby provided the impetus for development of the Valuation-Informed Indexing strategy. Both men were awarded Nobel prizes in 2013.

Can this marriage be saved?

I like Buy-and-Holders. They are smart and they have contributed hundreds of powerful insights to the literature. They are passionate about investing but try to avoid emotionalism. They support the idea of rooting one’s investing decisions in what the peer-reviewed research says. What’s not to like?

A good number of Buy-and-Holders don’t like me even a tiny bit. I am banned at over 20 investing discussion boards and blogs. Site owners who love my work have told me that they felt no choice but to ban me because things I said upset their readers and their readers threatened to abandon their sites unless they took action.

I think the marriage can be saved. We need to see a major figure on the Buy-and-Hold side (John Bogle is the person best suited to play the role) to make a public statement explaining why Buy-and-Holders have not been able to get along with Valuation-Informed Indexers in the past and why they must begin doing so in the future.

Shiller is always friendly to those who hold investing views different than his own. His family vacationed several times with the family of Jeremy Siegel and all got along just fine. When I see Shiller speak in public about his differences with the Buy-and-Holders, the word that comes to mind to describe his manner is “affable.” He doesn’t take this stuff personally. He cares deeply about the subject matter. But he possesses the humility and sense of humor needed to disagree with the Buy-and-Holders without being disagreeable to them.

Many Buy-and-Holders are like Shiller in this respect. The trouble on the Buy-and-Hold side is that it has long been the dominant school of thought. That means that the responsibility they feel to get it right weighs more heavily. If Shiller discovered an error he made some years back, he would be embarrassed. But that’s as far as it would go. Shilled’s writings have influenced the investing choices of perhaps 10 percent of the population. And even in those cases his influence was not total. Investors who follow Shiller’s ideas in almost all cases know the case for Buy-and-Hold and in many cases employ some principles of the Buy-and-Hold strategy in their own choices. So any mistakes that have been made by Shiller will likely prove to be something less than catastrophic in their impact on investors.

The same cannot be said with mistakes made on the Buy-and-Hold side. The negative reality associated with believing in the dominant strategy is that your ideas influence millions in an all-encompassing way. Buy-and-Holders do NOT necessarily know about Valuation-Informed Indexing.

I can offer personal testimony re this one. When I discovered the errors in the Buy-and-Hold retirement studies (no valuation adjustment!), I continued to believe in the overall strategy for several months. Why? I had never heard of any research-based alternative . I assumed that it was only the retirement studies that were flawed and that the strategy as a whole was still good. It is embarrassing today to acknowledge this. But this is how the human minds works — we continue to hold confidence in a paradigm until the cognitive dissonance associated with doing so becomes so strong that we can no longer ignore it and are forced to look for new ways of thinking.

The Buy-and-Holders could have been teaching error for many years and not have even been challenged re their contradictions because most of us assumed that, if there really were something wrong with the strategy, someone else would have long ago discovered it and spoke up about it. In fact, that’s just what I think has happened. As time has gone on, the errors have harmed more and more people. And that reality has made it harder for those who should be calling the errors out to do so. The Buy-and-Holders did not start out seeking to hurt investors. None of us want to be the one hurting their feelings by saying that they have done so.

It’s not possible that both schools of thought are legitimate in an ultimate sense. They are rooted in opposite premises and they generate opposite strategic conclusions. But as a society we cannot make a switch from Buy-and-Hold to Valuation-Informed Indexing with the flip of a switch. We need to have a transition time-period in which both schools of thought are viewed as at least somewhat legitimate so that they can be compared and contrasted.

For that to happen, we all need to adopt the manner exemplified by Robert Shiller. We need to argue our viewpoints with forcefulness. We learn most quickly when our views are challenged and when other views are presented effectively. But we need at all times to evidence warmth and friendship to those on the other side of the table. We learn best together. We all want the same thing — to invest effectively. We need to see some big-name Buy-and-Holders step forward and ask for more positive interactions between the advocates for the two schools of thought.

Rob’s bio is here.

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