Valuation-Informed Indexing vs. Passive Investing – Which is Better?

This article was selected as one of the top articles in the June 6th, 2011 Best of Money Carnival at Free From Broke.

Well folks, it’s been on my research topics list since January of this year, but during the past several days, I’ve finally been able to perform the detailed comparative analysis the topic deserves.

What topic is this, you’re probably asking? The topic is Valuation-Informed Indexing (or Valuation-Informed Index Fund Investing – however you want to call it). This topic/investing strategy was first introduced to me by Rob Bennett when he guest posted on the subject over at Free From Broke and has been the topic of numerous online and offline discussions in the personal finance world.

Reading Rob’s post really got me interested in this form of investing, because it is sort of an attempt to put a more actively managed role on my current investing strategy of passive investing, but without all of the emotion that normally causes the performance of active investors to suffer. More specifically, I wanted to find out two things after first hearing about Valuation-Informed Indexing. These are described below:

  • Determine the exact method it uses to find out how unbiased and repeatable it is.
  • Perform a long term (approximately 20 years) performance comparison between Valuation-Informed Indexing and passive investing to determine which makes you more money.
    • In this analysis, I would also want to compare risk levels (standard deviations) and attempt to optimize the Valuation-Informed Indexing method. 

So, armed with nothing but a Toshiba laptop, a “why-not” attitude, and a smile, I set off in trying to find some answers to the aforementioned goals.

Note from Jacob: I really get a lot of enjoyment out of these types of post that require putting together a spreadsheet, inputing some interest rate formulas, and analyzing large amounts of historical data. Maybe it is the scientist in me that enjoys this!

What is Valuation-Informed Indexing (VII) and How is it Different from Passive Investing?

Truthfully, it was fairly difficult to figure out the exact method that defines Valuation-Informed Index Investing and makes it different from passive investing. This is most likely due to the fact that it doesn’t yet have a wide following, as opposed to passive investing where there are shelves full of books written on the subject!

However, through study of 1) Rob Bennett’s website about Valuation-Informed Indexing (in particular, his “How To” guide) and 2) Professor Wade Pfau’s preliminary research, I was able to piece together enough information to define the VII method and construct a study.

In a general sense, Valuation-Informed Indexing involves changing your asset allocation targets in response to fluctuations in market prices. What does this mean exactly? It means that you should have a higher equity asset allocation when the market is lower and a lower equity asset allocation when the market is high.

Now, this all sounds well and good. But, the real question is “How do we actually go about doing this in a way that doesn’t introduce investor sentiment and ineffective market timing tactics?” VII has an answer to this too!

A summary of the Valuation-Informed Indexing methodology is summarized below:

  • First, decide on your base asset allocation. For example, in my study, I used 60% equity / 40% fixed income securities.
  • Second, use PE10 data (Current price of S&P500 divided by average inflation-adjusted earnings over the past 10 years) published by Professor Robert Shiller at Yale to change your asset allocation targets based on market fluctuations.
    • When the PE10 goes above 20, switch to 30% equity / 70% fixed income.
    • When the PE10 goes below 12, switch to 90% equity / 10% fixed income.
    • When PE10 is between 12 and 20, use your base asset allocation (60% equity / 40% fixed income, for example).

Application of this strategy is supposed to deliver superior returns at much less risk (standard deviation of returns) than a fixed asset allocation with regular rebalancing (in other words, passive investing).

Existing Findings

The only other numerical studies comparing passive investing to Valuation-Informed Indexing were conducted by Professor Wade Pfau. His preliminary findings can be found here, and the definitive, complete report, can be found at this link.

Wade’s findings reveal that VII provides more wealth for 102 of the 110 rolling 30-year periods from 1870 to 1980. However, in recent years, it appears that the out performance of VII over passive investing is becoming less and less.

As someone in my mid-20’s, the time period I was most curious about was the most recent twenty year period. Additionally, I wanted to test this period because in order for me to be convinced to give up passive investing in favor of Valuation-Informed Investing, I would need to see demonstration of its superiority in a time frame that is more relevant to me.

Lastly, over any 20 year period, it would reason to believe that random, short term fluctuations in the market should be hidden by the correct, overall, long term behavior.

 

Study Methodology

So, now that I’ve explained a little bit about what Valuation-Informed Indexing is in general and what existing research has been done on the subject, we can now get in to the specific investigation that I conducted.

The details of how I set up my analysis are summarized below:

·      Investment Total – For simplicity, we will assume that our investment only consists of a one-time initial purchase of $10,000. Transaction fees, fund expense ratios, and taxes will not be considered in the scope of this analysis.

·        Time Period – January, 1990 to May, 2011.

·        Portfolios – There will be two competing types of portfolios – 1) a Valuation-Informed Indexing portfolio, and 2) a passive investing portfolio. Various parameters within each of the models will be changed in order to analyze performance.

o   The equity portion of the portfolio will consist of shares of an S&P500 index mutual fund. Historical performance data for the S&P500 was taken from Yahoo Finance at the following link – S&P 500 Historical Prices – January, 1990 – Present at monthly intervals.

o   The fixed-income portion of the portfolio will consist of low-risk 1 year Treasury Bills. Historical yield data for 1 year Treasury Bills was taken from FederalReserve.gov Government Fixed Income Investments historical prices.

o   Both of these resources have a handy “export in Excel format” feature to facilitate quick analysis in spreadsheet format.

·        Rebalancing – Rebalancing for the passive investing and VII portfolios will be done monthly (the same as what I do currently). This is different than Pfau’s analysis, which assumed annual rebalancing.

·        Asset allocation changes – The passive investing portfolio will remain at the same asset allocation targets for the duration of the study. However, the asset allocation targets for the Valuation-Informed Indexing portfolio will be adjusted based on the PE10 trigger levels discussed previously.

 

Study Results

The complete results/details of my comparison between VII and passive investing can be found at the following Google Docs Spreadsheet – Valuation-Informed Investing vs. Passive Investing. Rows 1696 and 1697 contain the total return and standard deviation (risk level) for each portfolio.

The table below shows a summary of the portfolio returns and standard deviations of the analysis. Three passive investing portfolios were compared to three different Valuation-Informed Indexing portfolios/strategies. It’s interesting to note that from 1990-2011, the PE10 never fell to the lower trigger point level of 12.

valuation informed indexing time value of money passive investing mutual funds investing individual stocks vs mutual funds index funds carnival of passive investing

As can be seen in the table, passive investing with monthly rebalancing resulted in total returns over the ~20 year time period of 239%, 267%, and 220%, for 60/40, 75/25, and 50/50, asset allocation splits, respectively.

For comparison, three different Valuation-Informed Indexing strategies/portfolios were employed, as described below:

Valuation-Informed Indexing Portfolio 1

  • When the PE10 goes above 20, switch to 30% equity / 70% fixed income.
  • When the PE10 goes below 12, switch to 90% equity / 10% fixed income.
  • When PE10 is between 12 and 20, use your base asset allocation (60% equity / 40% fixed income, for example).

 

Using this strategy, a total return over the time period analyzed was 185% (much less than the 60/40 asset allocation passive investing portfolio).

 

Valuation-Informed Indexing Portfolio 2

Because the total return obtained from Portfolio 1 failed to outperform the passive investing portfolios, I decided to attempt to refine the strategy (because I really do feel that there is potential for this form of investing! We just have to find it!).

Next, I proceeded to take the average PE10 from 1990-May 2011, and saw that the average PE10 was a whopping 25.68. Since this PE10 seems to be higher than we’ve seen historically, I figured that maybe by increasing the upper trigger to 25, a higher return would be seen.

Making this change, the strategy for Portfolio 2 becomes as follows:

  • When the PE10 goes above 25, switch to 30% equity / 70% fixed income.
  • When the PE10 goes below 12, switch to 90% equity / 10% fixed income.
  • When PE10 is between 12 and 20, use your base asset allocation (60% equity / 40% fixed income, for example).

Using this strategy resulted in a total return over the time period of 195% – higher than Portfolio 1, but still much lower than the passive portfolios.

 

Valuation-Informed Indexing Portfolio 3  

In a final effort to increase my returns using VII, I next tried to increase my equity exposure during “high PE10” times to 50% equity/50% fixed income (instead of 30/70 in Portfolio 1 and 2).

Making this adaptation, the strategy for Portfolio 3 becomes as follows:

  • When the PE10 goes above 20, switch to 50% equity / 50% fixed income.
  • When the PE10 goes below 12, switch to 90% equity / 10% fixed income.
  • When PE10 is between 12 and 20, use your base asset allocation (60% equity / 40% fixed income, for example).

Using this strategy resulted in a total return over the time period of 221% – higher than Portfolio 1 and 2, but still much lower than the passive portfolios, with the exception of the 50/50 asset allocation one.

Conclusion – Passive investing outperforms Valuation-Informed Indexing in the past 20 years, but VII displays much less risk. This is consistent with the normal risk/return correlation.   

So, what can we conclude from all of these results and confusing numbers? In my opinion, we can take away several key things.

1)     While Valuation-Informed Index Investing may have outperformed passive investing in most previous historical periods, evidence of it not performing as well in recent years is enough to keep me as a passive investor, at least until VII is refined.

a.      It’s interesting to note that by using the VII methodology, an investor would have been 30% equity / 70% fixed income from January 1995 until September 2008. The investor would have taken on less risk (in the subsequent market crash of 2008-2009) by owning fewer equity shares during this “high price” time. However, he or she also almost totally missed out on the 163% total return during the ~13 year time period.

2)     Valuation-Informed Index Investing has great potential because it greatly reduces the risk to investor returns.

a.      Even though VII failed to outperform passive investing in my analysis, it also provided much less risk, as evidenced by the sharp decrease in standard deviation of the portfolio value over time.

b.     For example, VII Portfolio 1 provides a slightly lower return of 185% over the time period analyzed (compared to the passive investing portfolios). However, the portfolio also has 34%, 55%, and 21% less risk (standard deviation of portfolio value) compared to the 60/40, 75/25, and 50/50 passive portfolios, respectively.

This ability of VII to deliver sufficient (but slightly lower) returns at less risk is what I think is the real power of Valuation-Informed Indexing. I feel that with some refinements, VII can become an effective investing strategy. However, I’m not quite ready to switch over just yet…Thanks for reading!

How about you all? Have you ever tried or heard of Valuation-Informed Index Investing? What are your thoughts about its efficacy? What improvements do you think need to be made? 

Share your experiences by commenting below!

Comments

  1. optionsdude says:

    I have never heard of VII but it sounds interesting. I assume that your passive investing model utilizes dollar cost averaging. One less well known method that you might enjoy is the value averaging model. It sounds different than VII and might be worth looking into and doing a comparison with your passive investing technique. I would be interested to see how that holds up in your spreadsheet. Shoot me an email or post it if you do a comparison or have any questions about value averaging.
    My recent post Updating My Silver Wheaton Trades From Last Week

  2. Rob Bennett says:

    Thank you so much for posting this, Jacob. It's a hugely positive, life-affirming step.

    There's one quibble I feel obligated to bring up. I would never advise a Valuation-Informed Indexer to invest in short-term Treasuries as his alternative to stocks. It takes a long time for PE10 levels to change dramatically. So a Valuation-Informed Indexer could be stuck with a low stock allocation for a long time. Short-term Treasuries are the poorest performing asset class out there. Why not put your non-stock money in TIPS or IBonds? TIPS and IBonds were paying 4 percent real at the top of the bubble. Short-term Treasuries were not paying anything close.

    I understand that there is not as much good data around for TIPS and IBonds and that the return changes all the time if you go that route and that complicates the analysis. Still, in the real world those following a VII strategy would NEVER invest in short-term Treasuries. I think some adjustment in the numbers is needed to reflect that reality.

    That's a small point in the grand scheme of things, however. You have written an intelligent and balanced and life-affirming report. No one has ever gone to this much trouble to try to advance knowledge on these questions. I am immensely grateful to you for that. And I believe that ALL passive investors (both Buy-and-Holders and Valuation-Informed Indexers) should be.

    I love these words:

    “This ability of VII to deliver sufficient (but slightly lower) returns at less risk is what I think is the real power of Valuation-Informed Indexing. I feel that with some refinements, VII can become an effective investing strategy. However, I’m not quite ready to switch over just yet.”

    You speak for many with those words, Jacob. It is my belief that in time everyone is going to make the switch. But that will never happen for so long as it is only Rob Bennett promoting these ideas. People need to do what you did here, test out different possibilities and think them over and gradually over time come to a reasoned conclusion as to the realities.

    You are playing this exactly right. If the ideas are strong, they will win you over in time. If the ideas have holes in them, those holes will become apparent to you in time. It's a mistake to make dramatic changes in your investing philosophy (“Stay the Course!” the Big Guy advises). Just think these things over and in time you will become more sure of the best direction in which to move.

    If there is someone reading these words who has the ability to bring this post to the attention of John Bogle, I think it would be a huge plus if he or she would let him know about it and would ask him if he would be willing to comment. Bogle said in an interview with Index Universe that he believes that Valuation-Informed Indexing can work. It would be a huge step forward if he would provide us with a more detailed statement of his thoughts about the concept.

    You done good, Jacob. Real, real, real, real, real good! The entire Passive Investing Community thanks you (and, yes, I think it is fair for me to speak on behalf of the entire Passive Investing Community when it comes to this particular topic — I've got the scars to show you that I've earned that right!).

    Rob
    My recent post ITNR 55 — Gold Leaves Me Cold

    • Hey Rob! Thanks for commenting. Sorry I am just now getting to responding.

      You make a good point about using TIPS or other bonds instead of using T-bills. In my own asset allocation, I use a mix of those as well and would recommend others to do so as well.

      However, I think that for the sake of comparison, as long as I used the same asset (in this case T-bills), we can still determine the long term trends that are present.
      My recent post Whats Your Biggest Financial Pet Peeve

  3. Rob Bennett says:

    Something else that probably needs to be noted hit me as soon as I hit the “Send” button.

    Your title is “Valuation-Informed Indexing vs. Passive Investing.” Are the two strategies in conflict? Or is VII a subset of Passive Investing?

    I think of VII as a subset of Passive Investing. My view is that the thing that VII is in conflict with is Buy-and-Hold. But the full truth here is that no one has ever defined these terms carefully.

    This point underlines the historical reality that is the source of all the confusion we have seen evidence itself in the first nine years of discussions of these questions. Buy-and-Hold was developed in the late 1960s/early 1970s. It was popularized by the publication of the popular (and excellent!) book A Random Walk Down Wall Street. Shiller did not publish his research showing that valuations affect long-term returns until 1981. So the Buy-and-Holders did not know all there was to know about stock investing at the time they developed their strategy.

    Valuation-Informed Indexing is a combination of the most powerful insights of Bogle and the most powerful insights of Shiller. It is not anti-Bogle. It is Bogle-plus. It is what Bogle would have urged had Shiller published his research 10 years earlier.

    VII would be impossible without indexing (passive investing). P/E10 does not predict long-term returns for stock pickers. The magic that I talk about in all of my articles only works for Passive Investors. So I view myself as the biggest proponent of Passive Investing alive on Planet Earth today. I also of course bill myself as the most severe critic of Buy-and-Hold alive on Planet Earth today (because I argue that failing to take valuations into consideration when setting your stock allocation turns stock investing into an intensely emotional endeavor).

    What is it that Passive Investors are passive about? If you only invest in indexes and if you disdain short-term timing (I do) but if you change your stock allocation once every 10 years or so in response to big valuation shifts, are you a Passive Investor or not? I don't think anyone knows the answer to that one today.

    Bogle has said that Valuation-Informed Indexing can work. That leads me to believe that I AM a Passive Investor. But I am banned from posting at the Bogleheads Forum. I think it is fair to say that that would cause many to conclude that I am NOT a Passive Investor.

    Everybody knows what I do. But no one can figure out whether that makes me a Passive Investor or not. The reason why is that at the time Passive Investing was developed no one knew that long-term timing always works (Shiller had not yet done his research). So no one had ever even looked at the question. People just threw both forms of timing in the same bucket and presumed that long-term timing is as dangerous as short-term timing.

    The next big step forward is forming a consensus in the Passive Investing Community that VII is a legitimate option, that in no way, shape or form is it anti-passive to engage in long-term (but not short-term) timing. Long-term timing is just doing what Bogle says, Staying the Course (because you need to change your stock allocation at times to keep your risk profile roughly constant).

    That's my take re the definitional question, in any event. I'd like to see others take that one up. Before we can become effective Passive Investors, we need to come to a clear understanding of what Passive Investing is.

    Rob
    My recent post ITNR 55 — Gold Leaves Me Cold

    • I agree Rob. It all depends on how the things are defined. In my mind, passive investing is investing that 1) does not involve individual stock selection (or investing in active mutual funds that do this) or 2) short term market timing.
      My recent post Whats Your Biggest Financial Pet Peeve

  4. I LOVE this debate. Kudos to Jacob and Rob. If everyone used Valuaton investing we would have an efficient market. It will never happen. I use my own variation of valuaton investing for the Arbor Asset Allocation Model Portfolio (AAAMP), staying between 25% and 75% net long equites 95% of the time. I don't have set allocations as you use in your study, because I don't particularly like indexing. My asset allocation takes into account individual stocks and ETFs and their individual valuation also. If I can find certain sectors or individual stocks that meet my criteria then I will invest in them within a variable band of overall asset allocation. I have been very successful with this strategy, so I'm a real believer in Valuation Investing!__

    • Hi Ken! Thanks for sharing about your strategy! I just looked at your website, and it looks interesting. How long have you been using the AAAMP?
      My recent post Whats Your Biggest Financial Pet Peeve

  5. Rob Bennett says:

    It will never happen.

    Ya gotta believe, Ken!

    Just remember — there was never an internet before. Things change, sometimes for the better.

    Thanks much for the kind words.

    Rob
    My recent post ITNR 55 — Gold Leaves Me Cold

  6. Wow, really nice article with really good research. I have never really looked all that deep into valuation investing, but as I build a longer term portfolio this stuff will be of great use. I also like how this is a fairly active strategy…keeps you involved in your money :)
    My recent post A No Frills Approach to Learn Option Trading Successfully Part 1

    • Thanks for reading TradeTechSports. Truthfully, for most people, the less active role you can have (through the use of low cost index funds), the better. However, the purpose of this approach is to be only slightly more active, but still acting in an intelligent way
      My recent post Debt Consolidation – The Pros and Cons

    • Thanks for reading TradeTechSports. Just remember not to become TOO involved in your money by selecting those individual stocks!
      My recent post Whats Your Biggest Financial Pet Peeve

  7. optionsdude says:

    I have never heard of VII but it sounds interesting. I assume that your passive investing model utilizes dollar cost averaging. One less well known method that you might enjoy is the value averaging model. It sounds different than VII and might be worth looking into and doing a comparison with your passive investing technique. I would be interested to see how that holds up in your spreadsheet. Shoot me an email or post it if you do a comparison or have any questions about value averaging.
    My recent post Updating My Silver Wheaton Trades From Last Week

    • Thanks for reading optionsdude! The analysis actually doesn't use dollar cost or value averaging. Rather, it just looks at the value movements of $10000 invested initially.

      I do agree with you though. Dollar Value Averaging is a better method. However, it's slightly more complicated to roll out and from my experience, isn't aligned with how most people have money available to invest.

      If you're needing to keep things simple, go with dollar cost averaging.
      My recent post Whats Your Biggest Financial Pet Peeve

  8. Rob Bennett says:

    The purpose of this approach is to be only slightly more active

    I agree with this comment. I am a big believer in Bogle's injunction to “Stay the Course!”

    Actually, I would argue that changing your allocation in response to big valuation swings is the less active approach.

    The question is, When you stay the course, what is it precisely that you are trying to keep constant? The Buy-and-Holders keep their stock allocations constant but thereby let their risk profiles get wildly out of whack. The Valuation-Informed Indexers make whatever adjustments in their stock allocations are needed to keep their risk profiles roughly constant.

    What the Buy-and-Holders do not get is that there is no way to keep your risk profile constant without being willing to change your stock allocation now and again. Stocks are at some valuations a low-risk asset class, at some valuations a moderate-risk asset class and at some valuations an insanely-high-risk asset class. So no one stock allocation can work for any one investor at all possible valuation levels.

    There's no need for frequent allocation shifts, however. Valuation levels usually remain at the same general level for 10 years or so. And Valuation-Informed Indexers disdain short-term timing (the same historical data that shows that long-term timing always works also shows that short-term timing never works). So Valuation-Informed Indexers only make rare allocation changes (probably fewer than most Buy-and-Holders, who become forced to make changes when their portfolios “unexpectedly” collapse).

    Rob
    My recent post Index Funds Don’t Work In Bear Markets

  9. Jacob, this is a very interesting approach and thanks for posting. I also explore the options beyond the passive “market” approach. I believe that there are 2 forces that can help improve on it: trend-following (or momentum) and value (mean reversion). Added together they form the market. It's another way to slice the markets. There is a huge body of studies on this topic, and CXO Advisory is the first place to look at. If value works on a stock level, then why should not it work on an asset class level?

    • Thanks for sharing finsovet! The potential problem I can see with adding in trend-following/momentum is that it's difficult to do that in a predictable way that avoids investor sentiment.
      My recent post Whats Your Biggest Financial Pet Peeve

  10. Carlyle says:

    It's important to recognize with Mr. Bennett's Valuation-Informed strategy equities equal the S&P 500 Index. Also, note the Wade Pfau study looked backwards at historical S&P 500 returns and found that switching among 30%, 60% and 90% S&P 500 based on PE10 yielded better returns than a passive buy-hold-rebalance approach. That begs the question of how VII would have performed had different equity (S&P 500) percentages been used than those in his study. Ex post facto we can easily discern the ideal equity percentage to hold; at the beginning of a 30-year period we can only guess.

    For someone contemplating trying out Mr. Bennett's strategy, the fact that passive investing has outperformed his VII strategy the past 20 years should give one pause. Especially since it assumes that one invests soley in the S&P 500 Index. The performance of more diversified buy-hold-rebalance strategies over the same time period strongly suggests the superiority of a maintaining a diversifed basket of equity asset classes versus investing soley in the S&P 500 Index.

    • Thanks for sharing Carlyle! Agreed. Investing in other types of index mutual funds above and beyond the S&P500 index (such as international funds or small cap value funds) would have increased returns.

      Also, in looking through Wade's study, it appeared to me that VII worked better as a whole before recent years. This was most likely due to the fact that the market's PE10 has been quite high the past 20 years, causing an investor following VII to be almost completely out of equities.

      My recent post Whats Your Biggest Financial Pet Peeve

  11. Carlyle says:

    Simba, a poster at Bogleheads.org, has compiled a list of 25 “Lazy Portfolios” showing risk and return for those portfolios for 1972-2010;

    http://www.bogleheads.org/forum/viewtopic.php?t=2

    It's an interactive Excel Spreadsheet so one my play with start dates, allocations and such. It's an excellent resource which shows the value of holding a diversified basket of equities and the value of “staying the course.”

    • Thanks for sharing that spreadsheet/resource! I definitely need to look around/get more involved with the Bogleheads forum. Seems like there are some great ideas floating around there!

      What different Vanguard index mutual funds do you currently invest in?
      My recent post Whats Your Biggest Financial Pet Peeve

      • Carlyle says:

        Hmmm, where do I start! I have a smallish Roth IRA invested in 3 Vanguard funds; Total Stk Mkt, Total International Stock Index and Inflation-Protected Bond [Scott Burns' Margarita Portfolio]; a smallish Traditional IRA in 2 funds; Short-Term Bond Index and Equity income; and a much larger rollover IRA invested in a 50:50 stock/bond ratio of Total Bond Mkt (VBTLX) and Inflation-Protected Bond (VAIPX), Int'l Value (VTRIX), Value (VVIAX), Index 500 (VFIAX), Mid-Cap (VIMAX), Mid-Cap Value (VMVIX), Small Cap Value (VISVX), REIT Index (VGSLX), International Value (VTRIX), Pacific Stock Index (VPADX), European Stock Index (VEUSX), FTSE All-World EX-US Small Cap (VFSVX) and Emerging Mkt (VEMAX). The rollover IRA was derived somewhat by looking at Simba's Spreadsheet but mainly from the portfolio backtests that TrevH posted at Bogleheads. I have no idea whether the stock:bond ratio or the particular funds I've selected will maximize my returns or minimize my risks over the long-term, I'm just shooting for good enough. You buy your ticket and you take your chances!

  12. Rob Bennett says:

    the fact that passive investing has outperformed his VII strategy the past 20 years should give one pause.

    It's an important fact to report, Calyle. I certainly agree with that much. But it's a matter of perspective as to what this fact means.

    On the three earlier times on which we went to insanely dangerous valuation levels, we ended up at valuation levels of one-half fair value after the crash/economic crisis that followed. That's a 65 percent price drop from where we stand today. Would you still say that Buy-and-Hold “worked” after it brought on the Second Great Depression?

    Buy-and-Holders and Valuation-Informed Indexers are in agreement that it is through study of the academic research and the historical return data that we learn how stock investing really works. The difference is that Valuation-Informed Indexers don't believe that we learned everything there is to know on the day Buy-and-Hold was announced to the world. Science doesn't stop for any man or woman. We have learned new things in recent decades and we should talk about those things and incorporate the findings that stand up to scrutiny into our thinking re how to invest in the future.

    I don't say that VII is the last word either. There will be new findings. We will improve VII over time.

    This is why I so much admire the spirit that Jacob showed in posting this article. Jacob is skeptical about VII. Good for him! Skepticism is healthy. We need skepticism. But he is not afraid to look at the facts and see what can be learned from them. I only wish that all of my Buy-and-Hold friends were so non-dogmatic.

    Dogmatism is the OPPOSITE of science. Science is a quest for truth, no matter where it leads. Buy-and-Hold started out as a quest for truth. I think it would be fair to say that it has lots its way in recent years.

    That's my sincere take, in any event. Many smart and good people think I have gone off the deep end. It's been known to happen!

    Super thread, Jacob!

    Rob
    My recent post ITNR 57 — It’s Hard to Make a Buck Offering Good Financial Advice

    • Well said Rob. I think it's important to think about next steps for VII.

      What further refinements can be made? I'd be interested in hearing any one's thoughts on this!
      My recent post Whats Your Biggest Financial Pet Peeve

  13. Rob Bennett says:

    We need to get lots more people discussing VII, Jacob. There's never going to be 100 percent agreement on any particular points and we should never wish that there would be. We learn from talking things over. So we just need to do all that we can to get as many discussions started as we can.

    You did a super job with this post. The fellow who writes the “Money & Such” blog wrote several super posts about it. Frank at “Bad Money Advice” wrote a fine post about it a little ways back. Pop Economics had a good post on it. We need more of this sort of thing throughout the Personal Finance Blogosphere — people writing comments both pro and con so that their readers can hear both sides and think things through for themselves.

    Getting the Bogleheads Forum opened up to discussions of it would be huge. I don't know how much of the history you know but there were hundreds of people participating in the discussions that we had there for nearly two years. Those people are smart and know the issues well. So we could achieve big advances there.

    I would like to get more feedback from John Bogle. Bogle said in an interview that he thinks Valuation-Informed Indexing can work. But his words fell a bit short of an endorsement, in my assessment. I would like a clearer and more in-depth discussion of what he sees as both the pros and cons. I have written him three e-mails but have not received a response. I suggested at one time that I make a presentation at one of the annual Bogleheads meetings and that we have Bogle respond to the points I make, either endorsing them or challenging them or looking at things from his own perspective or whatever.

    That would be the best way to proceed, in my view. Bogle obviously has huge influence on many posters at Bogleheads. If he were to signal that he favors further discussions, that would encourage lots of people who post there and who have good ideas to speak up. The problem we have now is there there is one individual who posts there who is viewed as a “leader” and who intimidates those who post in support of VII. If Bogle made clear that he will support those who post their honest views regardless of any intimidation tactics employed by this other individual, that would do the trick. Many, many people are willing and happy to help out. But there are limits to how much people are willing to put themselves through to do so.

    I would like to see the leaders in the Personal Finance Blogosphere speak out as well. Again, both supportive and critical comments are helpful. The message that needs to be sent is — There is nothing wrong with talking about these ideas, there will be no punishments of those who talk about these ideas or harassment of those who post supportive comments. Once people begin to get that message, things will just naturally move over time to a better and better place.

    The other thing that people interested in the VII concept can do is to read my three weekly columns, where I expand on the ideas each week. I address the technical issues most frequently in the “Valuation-Informed Indexing” column at the ” target=”_blank”>http://www.ValueWalk.com site. There's lots of exciting stuff that comes up in those columns (I don't think that should be taken as bragging as I obviously don't claim that I developed the VII concept by myself — there were hundreds of fine people, including many passionate supporters of Buy-and-Hold, who helped out in very important ways).

    If there is anyone reading these words who can think of anything else I can do, I hope they will contact me. Getting the word out on this has become my Life Project. So I obviously want to do anything and everything I can do. I am of course extremely grateful for all the help you have offered, Jacob. Your efforts have been heroic. I believe that they will be widely seen in days to come as having helped out many, many people in highly significant ways.

    Rob
    My recent post ITNR 57 — It’s Hard to Make a Buck Offering Good Financial Advice

  14. Carlyle says:

    “Would you still say that Buy-and-Hold “worked” after it brought on the Second Great Depression?”
    No, what I would say is that the notion that Buy-and-Hold had anything to do with the economic downturn is beyond ridiculous.

  15. Carlyle says:

    “Getting the Bogleheads Forum opened up to discussions of it would be huge.”
    Bogleheads is open to all types of discussions about personal financial topics, including Rob Bennett's “Valuation-Informed Indexing” strategy of using PE10 to time the S&P 500 Index. What is not permitted at Bogleheads are posts by Rob Bennett himself. Bogleheads.org is just one of many personal finance discussion boards and blogs which have “uninvited” Mr. Bennett. But banning one indvidual for reasons which are clear to those familiar with Rob Bennett can hardly be rationally construed as banning discussions of those topics near and dear to Rob's heart.

  16. I would say is that the notion that Buy-and-Hold had anything to do with the economic downturn is beyond ridiculous.

    You speak for many with these words, Carlyle. I wish that one of those who feel this way would try to articulate why he feels this way. That would give us something to work with.

    Stocks were overpriced by $12 trillion in January 2000. That's a matter of public record. Bogle says that stock prices always return to fair value. He says that is an “Iron Law” of stock investing. So we knew in 2000 that the U.S. economy was going to lose $12 trillion in spending power over the next 10 years or so. Are you able to imagine any way that losing $12 trillion in spending power would not bring on an economic crisis?

    The reason why I say that Buy-and-Hold caused the crisis is that it was Buy-and-Hold that caused the $12 trillion in overpricing. If investors knew that they needed to lower their stock allocations when prices got too high, there could never again be another out-of-control bull market. People would sell stocks and prices would go down when prices got out of hand. Take Buy-and-Hold out of the picture and stock market prices are self-regulating. It's Buy-and-Hold that tells people they do not need to sell. Do you see that?

    I believe you when you say that you find the idea ridiculous. But I think we could all advance the discussion if you could articulate why you believe this. Is there some reason why you think that the promotion of Buy-and-Hold strategies could not cause an economic crisis?

    My personal belief is that it may be that the reason is that you are emotionally attached to Buy-and-Hold. I don't say that to hurt your feelings. I say it because it is my sincere belief that that is what is driving your belief.

    Thanks for the back and forth in any event.

    Rob
    My recent post The Bogleheads Forum Discusses the Pros and Cons of Valuation-Informed Indexing

  17. Bogleheads.org is just one of many personal finance discussion boards and blogs which have “uninvited” Mr. Bennett.

    That's so.

    But why?

    I am the person who discovered the analytical errors in the Old School safe withdrawal rate studies.

    So the first post that I put to the Vanguard Diehards board was met with a hostile response. And then there were abusive posters who followed me to every thread in which I posted. Why? Is it a bad thing to let people know about errors that were made in retirement studies? It seems to me that it is a very, very good thing.

    There's no one today who says that the Old School studies are valid. Bernstein has said those studies get the numbers wrong. Scott Burns has said this. Wade Pfau has said this. The Economist Magazine has said this. Michael Kitces has said this.

    Shouldn't the fact that I am the person who discovered the errors in these studies be cause for the Bogleheads to send me a special invitation to their discussions? Why this strange reaction?

    It's because a finding that the Old School SWR studies got the numbers wrong raises doubts about the entire Buy-and-Hold project. The way that the site administrator there put it is that I am a “threat” to the board community there. The reality is that I am not a threat to the entire community. I am a threat only to the Buy-and-Holders. There were hundreds of community members there who loved my stuff and who told me so on numerous occasions.

    If you were confident in your investment strategies, you would not feel threatened by posters who post views consistent with Shiller's research, Carlyle. You make an effort to sound confident. But it's bravado you evidence, not true confidence.

    I say these things not to hurt your feelings or the feelings of any other Buy-and-Holder. I say them because we need to come to terms with these realities before we drive our entire economic system over a cliff.

    It reflects poorly on the Bogleheads that they have banned honest posting at their site. It goes against our society's deeply held social norms. We are going to need to work together to change this. We cannot even begin learning the realities of stock investing until we reach a point at which we all agree that all sides should have a chance to speak.

    Rob
    My recent post The Bogleheads Forum Discusses the Pros and Cons of Valuation-Informed Indexing

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