A Better and Less Risky Way to Invest in Stocks

Stocks provide great returns.  There’s really only one thing wrong with this investment classIt’s the risk!  Lots of middle-class people feel that they must invest in stocks to have any realistic hope of attaining a good retirement but live in fear of the stock crashes that can wipe out the accumulated savings of a lifetime in a few years.  If only there were a better way!

There is.

Valur informed investing can make stock investing less risky.Like all of the most powerful ideas, the new way of stock investing that I will describe here is rooted in something so simple that it will amaze you that you and thousands of others did not think of it before.  Please don’t let that sway you.  This checks out.  I’ve been studying the new approach (Valuation-Informed Indexing) for nine years and I have put it before tens of thousands of people, both experts in the field and regular people.  None has yet identified a significant flaw.

The idea is — to buy stocks in the way you buy everything else you buy.

Say that you were buying a car.  Or a camera.  Or a computer.  Or a comic book.  How would you go about it?

Most of us follow a two-step process.  First, we determine which car or camera or computer or comic book is the right one for us.  Then we check around to get a good price.  No reasonable person would question this procedure.  No reasonable person would say that we should buy the car or camera or computer or comic book at any price whatsoever.  Taking price into consideration is always a plus.  Right?

So why don’t we do that with stocks?

Stocks sell at all different sorts of prices.  Sometimes they sell at fair value.  Sometimes they sell at half of fair value.  Sometimes they sell at double fair value.

Do we buy more stocks when stocks are well priced and fewer stocks when stocks are poorly priced?  Most of us do not.  Most of us follow some form of a Buy-and-Hold strategy, a strategy in which we stick with the same stock allocation at all times.

Does that make sense?

It doesn’t.  Not according to the historical stock-return data going back as far as we have records.

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The historical data says that Buy-and-Hold is the one thing that never works.  The historical data says that it’s the way we go about buying everything we buy other than stocks that would work best when buying stocks too.  The historical data says that we should be going with a high stock allocation when stocks are priced well and with a low stock allocation when stocks are priced insanely high (as they have been for most of the time-period from 1996 forward).

Lots of studies have been done testing whether this is so.  All say the same thing.  All say that price matters when buying stocks, just as it does when buying anything else.  One of the best I’ve seen is a study recently done by Wade Pfau, an Associate Professor of Economics at the National Graduate Institute of Policy Studies in Tokyo, Japan.

Pfau compares the results for Valuation-Informed Indexing with the results for Buy-and-Hold for 110 rolling 30-year periods going back to 1870.  He finds that: “Valuation-Informed Indexing provides more wealth for 102 of the 110 rolling 30-year periods, while Buy-and-Hold did better in 8 of the periods.”  And the “more wealth” was in a good number of cases significantly more wealth.  Look at the chart at that link!

It’s not just that Valuation-Informed Indexing provides far higher returns.  The kicker is that it does so at dramatically less risk.  Do you know how many lasting stock crashes there are in the historical record?  Four.  Do you know how many caused significant losses for Valuation-Informed Indexers?  Zero.  Lasting stock crashes only take place starting from times of insanely high prices.  It is only Buy-and-Holders (investors who have been persuaded not to lower their stock allocations even when prices reach insanely high levels) who suffer serious losses during stock crashes.

Which means that they have less money to invest in stocks when prices are reasonable again!  Which explains why Valuation-Informed Indexers beat Buy-and-Holders even at times when stocks are not priced to crash!  Sometimes the best offense is a good defense.

I know your question.

If this is so great, why isn’t everyone already following this approach?

Let’s return for a moment to our discussion of cars and cameras and computers and comic books.  If you were in the car business and you had somehow persuaded millions of your customers that cars were worth buying at any price imaginable, would you want the word to get out that this was nonsense?

You wouldn’t.  You would want to keep the realities hushed up.  The academic research has been showing for 30 years now that valuations affect long-term returns.  The Stock-Selling Industry has continued spending hundreds of millions promoting Buy-and-Hold.  It’s a good deal for them.  Just not for you!

It’s not just me who says that.  If you don’t trust me on this one (after all, you hardly know me), would you trust the Wall Street JournalBrett Arends recently wrote in the Wall Street Journal that: “For years, the investment industry has tried to scare clients into staying fully invested in the stock market at all times, no matter how high stocks go…. It’s hooey…. They’re leaving out more than half the story.”

I just told you the other half of the story.  You don’t want to be going with the same stock allocation at all times.  You want to go with a far higher stock allocation when stocks are priced reasonably than you do when they are priced insanely high (as they have been for most of the time-period from 1996 forward).

But listen — The Stock-Selling Industry is not going to be any too pleased with me for my having spilled the beans regarding this one.  Could we try to keep this one just between you and me? I don’t want any of those fellows getting angry with me.  Those guys are multi-millionaires!

Rob Bennett created the first retirement calculator that contains an adjustment for the valuation level that applies on the day the retirement begins. His bio is here.

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Published or updated April 3, 2013.

Comments

  1. Rob,

    I have seen your stuff for years and you have even guest posted on my blog years ago, but I don’t get why the passion. You think you have the answer (and I am not even disagreeing with you), why fight everyone? Why not just keep the idea quiet and make your millions off investing?

  2. Thanks for your question, Evan. My sense is that I come at this from a different angle than many in the investing field.

    I am not an investing expert. I did not study investing in school. I have never managed a big fund. I have zero interest in doing so. I am a JOURNALIST. It’s all I ever wanted to be. Everything I do I do with the instincts of a journalist (not an investing expert) driving me.

    My history is that I lost a job I loved in 1991 and that caused me to study personal finance for the first time in my life. I learned from reading “Your Money or Your Life” that it is possible to achieve financial independence early in life and I made that my goal. Not so that I could sit at home and watch sitcoms. I wanted financial independence so that I could spend the rest of my life pursuing stories that I thought were important rather than having to follow the ones that my editors at the corporations that paid me thought were important.

    I handed in my resignation in August 2000. My wife is a stay-at-home mom and I have two young boys (ages 11 and 8). What would you be concerned about if you were thinking of handing in a resignation from a high-paying corporate job in such circumstances? Wouldn’t you want to be sure that your plan worked? I focused on that. By doing that, I learned things that most people (including most investing experts, incredibly enough!) do not know.

    I built a hugely successful Retire Early board at Motley Fool. It was the #1 board at the site and I mad thousands of friends there. One day I shared what I had learned about safe withdrawal rates (it is a retirement concept). Hundreds of my friends were thrilled to be learning things about investing that they had never heard before and told me so. Some others wanted the discussions shut down IMMEDIATELY,.

    Now presume that you were a journalist? What would be your response? Journalists are trained to recognize a big story. There’s nothing that says “Big Story Here!” like an effort to have a discussion in which hundreds of people want to participate shut down immediately. That proves beyond any reasonable doubt that you have tripped onto something of huge importance.

    That experience has been replicated dozens of times, Evan. I have been banned from 15 different boards and blogs for telling people about these ideas. Never once have I put forward an abusive post. I have had site administrators write me notes APOLOGIZING for banning me. That has happened multiple times. I have had experts in the field call me on the phone and tell me that they know that everything I say is so but that they dare not say it publicly themselves for fear that they will lose their jobs. I have had bloggers tell me that they have read everything I have written about investing and that they find “huge value” in it and then ban me from their blogs because it upsets their readers for me to post comments talking about the realities of stock investing.

    Do you see how odd this all is? It’s strange as strange can be. If you had journalism in your blood, you would want to get to the bottom of it. So I have just kept following the path to see where it led me.

    I’ll tell you something important that I learned. Buy-and-Hold caused the economic crisis. Because few of us lowered our stock allocations even when prices went to insanely dangerous levels, stocks came to be overvalued by $12 trillion. When prices reverted to the mean (they always do — even the Buy-and-Holders acknowledge this), we lost $12 trillion worth of spending power from our consumer economy. There’s your economic crisis!

    It’s not only me who says this. Shiller predicted the economic crisis. Arnott predicted it. Asness predicted it. Smithers predicted it. Everyone who understands the effect of valuations predicted it. That’s a huge story. This was an entirely optional economic crisis. If we had permitted middle-class people to hear about the alternative to Buy-and-Hold (Shiller has said that he has never shared all he knows about stock investing because he would be painted as “unprofessional” if he did), there never would have been an economic crisis.

    And the crisis would quickly come to an end if we could get the word out on this. People aren’t spending today because they are scared that their retirement accounts are so much lower than they thought they were going to be by this time. Valuation-Informed Indexing lets people retire five or ten years sooner than they can following Buy-and-Hold. So, if we could share this, our economic troubles go away. Another big story!

    It’s not only me who says this story cannot be told. Rob Arnott asked for a show of hands at a convention of investment researchers as to how many still believe in the Efficient Market Theory (the intellectual foundation for Buy-and-Hold). A tiny number of hands went up. Then he asked how many would be doing research when they got back to the office that was rooted in a belief in the Efficient Market Theory. Nearly every hand in the room went up. The researchers are just like the people at the discussion boards. They understand on one level of consciousness why Buy-and-Hold can never work. but they dare not say anything because there are so many people who have invested so much (both money and reputations) in it.

    This is the biggest story in the personal finance field in my lifetime. There is nothing else even close. What happened is that Buy-and-Hold was put together before we knew everything, and then when additional research came out showing how things really worked, the feeling was that it was too late, too much money had already been spent promoting Buy-and-Hold. But if Shiller is right, it’s not just that Buy-and-Hold is slightly flawed. If Shiller is right, Buy-and-Hold is the OPPOSITE of what works. If Shiller is right, Buy-and-Hold is the most dangerous strategy ever concocted by the human mind.

    There are millions of middle-class lives at stake here. If we can tell people the realities, we can enter the greatest period of economic growth ever seen (never before in history have we known as much about how to invest effectively as we know today). But if word does not get out, the odds are very high that we are on our way into the Second Great Depression. If stocks continue to perform in the future somewhat as they always have in the past, we are going to see another price drop of 65 percent from today’s levels. Many people cannot take a hit like that after the losses they have already suffered.

    I am well ahead today as a result of having followed VII for the past 14 years. But that is not my driver. The two drivers are: (1) this is the biggest story of my lifetime, bigger than Watergate, and as a journalist I cannot resist following it where it leads; and (2) I care about the friends I have made on all the boards and blogs and I have had hundreds of them express great gratitude that I was the first person with the courage to tell them the realities of stock investing. I feel that I owe it to those people and to all others like them (who obviously number in the many millions today) to share with them what they need to know to be able to secure their financial futures.

    Even the ones who have been hostile benefit if the word gets out. Some think that I am being mean to John Bogle by letting the word get out. I don’t see it that way at all. I love John Bogle. John Bogle taught me as much about this as anyone. There wouldn’t be any Valuation-Informed Indexing without John Bogle. When word gets out about this, he will be a bigger hero than he has ever been before.

    Do you think John Bogle woke up one morning with an evil plan to destroy the U.S. economy and the lives of millions of middle-class investors? I don’t. I think it would be insane to think that. I think the guy made a mistake, just as any of us could have made a mistake. I think that the guy’s friends should be trying to get him to acknowledge the mistake and move on to better things. I think of myself as John Bogle’s friend, so that is what I do.

    It’s about getting the story and about using what we learn by getting the story to help people achieve financial freedom many years sooner than has ever been possible in earlier days. What I don’t get is why EVERYONE isn’t all over this story! I don’t understand how any of my fellow bloggers are able to pass it up! It is the possibility of coming across this sort of thing that got me interested in doing this sort of work in the first place!

    There shouldn’t be any fights, by the way. This is 100 percent positive, with no possible downside., There is no downside to learning. Learning is all good. That’s why I love it so. That’s why I work so hard trying to help people learn. That’s why I directed my life to that purpose and that’s why I saved enough to be able to leave corporate employed at an early age and spend my remaining years helping people discover the jobs of achieving financial freedom early in life.

    Rob

    • I’m hearing you on a lot of fronts Rob (and I’ve seem where commenters will follow your work online just to dispute it), but is Buy and Hold really the cause of the economic crisis?

      I would think that cheap credit and over-inflated housing prices as well as mortgages that were thinly backed (and ARM’s), and the securities that were based on the mortgages were a big part of our recent crisis.

      Another aspect is the fact that we live in a culture of leverage where we’re encouraged to spend at all costs.

      Not so much over-valued stocks.

  3. but is Buy and Hold really the cause of the economic crisis?

    There are lots and lots of good and smart people who don’t think Buy-and-Hold is the primary cause, Craig. I’m in the minority. I am not the only one saying this. But I am certainly in the minority. I do personally believe it is the primary cause.

    I certainly don’t approve of the mortgages and the leverage and all that sort of thing. Those things were certainly contributing factors. The reason why I pin the primary blame on Buy-and-Hold is that the numbers re that one are so huge. Do you know where I got the $12 trillion figure for the debt we incurred in the bull market of the late 1990s? That’s from John Bogle. So there is no dispute over the numbers. The only question is — Is it really so that losing $12 trillion of spending power over 10 years or so could cause an economic crisis? My take is that the burden should be on those saying that they believe it is something other than Buy-and-Hold that is the primary cause.

    As for the culture that encourages overspending, the biggest aid that those trying to encourage us to overspend have is Buy-and-Hold thinking. Buy-and-Holders treat the numbers on their portfolio statements as valid. They are not valid. Everyone’s portfolio numbers were overstated by a factor of three in 2000 (that’s what it means to say that stocks are priced at three times their real value).

    If your statement said that you possessed $300,000 in accumulated wealth, you really possessed $100,000 of LASTING wealth. Do you not think that telling people that they possess $200,000 more of accumulated wealth than they do in fact possess causes them to feel more free to spend on cars and houses and vacations? It’s human nature. In fact, it is 100 percent reasonable. We would be crazy if we DIDN’T spend more after being told that we possess far more wealth. The only trouble here is that the $12 trillion was Pretend Money. Spend Pretend Money and you get yourself in a big heap of trouble somewhere down the road.

    The other reason why I believe that it is Buy-and-Hold that is the primary problem is because of the Social Taboo on discussing the dangers of Buy-and-Hold. As noted above, I come from a journalism background. So free speech is a big deal with me. I have never in my life seen any question of public policy significance re which so few people believe that our social norm of permitting free discussion should be followed. This amazes me on a daily basis.

    My knowledge of that Social Taboo (I am the world’s #1 expert re that one!) tells me that, in the event that Buy-and-Hold really is the problem, it is a problem that hardly anyone would notice. We can’t notice things we don’t talk about. We can’t notice things we turn our eyes away from. We have been turning our eyes away from the dangers of Buy-and-Hold for a long time. So we shouldn’t be even a tiny bit surprised that not everyone is pointing to Buy-and-Hold as the problem today. It is the very fact that we are unwilling to look at the downside of Buy-and-Hold that made it so popular in the first place.

    The ultimate question here is — How does a stock market ever become overvalued by $12 trillion in the first place? Fama said that it is a logical impossibility. Everything Fama said made perfect sense according to logic — he is a very smart fellow. But be obviously missed something. What did he miss? He missed the factor of human irrationality.

    If humans were entirely rational creatures, there would be no alcoholics. There would be no smokers. None of us would ever date people who are no good for us. But we all do these things all the time. Humans are NOT entirely rational creatures. We are a mix of reason and emotion and we often employ reason IN THE SERVICE of emotion (that’s not reasoning but rationalizing). Fama missed all that, but P/E10 (Shiller’s valuation metric) zeroes in on it.

    The P/E10 value is telling us the extent of human irrationality present in stock prices at any given time. It is like the warnings you might get from friends when they notice you are starting to drink too much. P/E10 tells us when we are getting a little too crazy and gives us a chance to take care of the problem before it gets out of hand. Buy-and-Hold turned off the warning system.

    With Buy-and-Hold, you pay no attention to P/E10 because it is of no practical significance. You’re never going to change your allocation anyway so why waste your time with such stuff? The trouble is — with your warning system turned off, how would you know when things had reached a point where the overvaluation had grown big enough to collapse the entire economic system? Once the warning system is turned off, there is no way to know until the collapse happens. And it becomes a painful thing to acknowledge at that point.

    I hope that everyone understands that I do not think the Buy-and-Holders are bad or dumb people. Shiller had not published his research when Buy-and-Hold was developed. Buy-and-Hold was state-of-the-art thinking at the time “A Random Walk Down Wall Street” was published and the people putting it forward were very excited with what they had come up with and wanted to help people by sharing it with them. There are many, many important advances present in the Buy-and-Hold Model (I should know, I stole about a dozen of them for inclusion in VII!).

    I want these people to obtain the respect and gratitude and affection that they merit for the important contributions they made. We don’t see that happen by continuing the cover-up. That makes things worse. The way out is to launch a national debate (starting on the internet and spreading from there) on the realities. Lots of good people have lots of good questions and all those questions need to be carefully examined. If VII cannot take the heat, then it falls and that’s a good thing, If VII triumphs, we all win — we all then have a better and less risky way to invest then than any people coming before us ever had.

    The Buy-and-Holders end up heroes either way. If Buy-and-Hold prevails in the debate, they are vindicated. If VII prevails, the Buy-and-Holders get credit for having put us on the track that led down the road to the development of Valuation-Informed Indexing. We never could have had VII without first having had Buy-and-Hold. All of the principles of VII except one (the idea that you don’t need to change your allocation in response to big valuation shifts) were taken from Buy-and-Hold.

    I don’t know everything, Craig. I’m some guy who figured out how to post stuff on the internet, nothing more and nothing less. We need THOUSANDS participating in the discussions, all coming from their unique perspectives and their unique sets of life circumstances. I can only tell you what Rob Bennett believes and that is never going to be enough to get us to where we all want to be because no one person can deliver the goods on something as big as this.

    I say that having the discussions is a win/win/win/win/win, with no possible downside for anyone and I make a sincere effort to help with any questions that are put to me in response to my suggestion that we permit (and outright encourage!) the discussions to go forward. After doing that, I leave it to the community to decide the question of when this all happens. My view is that the sooner it begins the better for every single one of us. But I fully appreciate that I only get one vote. And I accept that that is as it should be.

    Rob

  4. This is a great post! By simply employing target asset allocation %’s and rebalancing when you are +/- 5% off from the targets, it automatically forces you abide by this valuation-investing strategy.

  5. Thanks for stopping by and thanks for your kind words, Jacob.

    I’m not entirely sure that you are understanding how Valuation-Informed Indexing works (perhaps it is me who is not understanding your comment).

    This is not rebalancing as it is conventionally practiced. With rebalancing, you might determine that the proper stock allocation for someone with your risk tolerance is 60 percent stocks. Then, if prices went up steadily for a time, that might cause your stock allocation to rise to 70 percent without your having done anything to make that happen (stocks can become a higher percentage of your portfolio just because they are worth more). You would then sell enough stocks to get your allocation back to 60 percent. That’s standard Buy-and-Hold practice.

    Valuation-Informed Indexing calls for the investor to CHANGE his stock allocation, not to rebalance back to it. The changes come when stock valuations rise or fall dramatically. For example, your plan might be to go with 90 percent stocks when the P/E10 level (P/E10 is the price of the S&P over the average of its last ten years of earnings) is below 12, 60 percent stocks when the P/E10 level is from 12 to 21 and 30 percent stocks when the P/E10 level is above 21.

    You could still practice a form of rebalancing while practicing Valuation-Informed Indexing. Each year, you might engage in little sales or little buys to get your stock allocation back to the 30 percent level, the 60 percent level, or the 90 percent level. Rebalancing is the theoretically pure way to do this.

    There is an innovation here, though. The innovation is that you do not aim to return to the same stock allocation (60 percent) at all times. You aim at times of reasonable prices to be at 60 percent and at times of super-low prices to be at a higher allocation (90 percent) and at times of super-high prices to be at a lower allocation (30 percent).

    The goal is to take advantage of Buffett’s injunction to “be fearful when others are greedy and be greedy when others are fearful.” Buy-and-Holders remain at the same stock allocation at all times. Valuation-Informed Indexers believe that investors must change their allocations in response to big price swings to keep their risk profiles roughly constant. The root belief is that stocks offer lower return and more risk when priced high.

    Rob

  6. Wow, Rob … that is definitely an intriguing post. You have really strong opinions on the matter for sure! I don’t think I’ve ever seen someone post several comments on a blog that are actually longer than their original article!

    I didn’t make it through all the comments but I do agree with you that buy and hold can be dangerous and doesn’t make the most sense. It’s hard to get people actively involved in investing though so getting a lot of people to do anything more than buy and hold can be extremely difficult.

    What is your personal strategy for how to allocate your assets and when to exit the stock market completely?

  7. Wow, Rob … that is definitely an intriguing post.

    I like it that you used the word “intriguing,” Saving Mentor.

    I’ve spent nine years of my life studying these questions 10 hours per day for 7 days per week. I also had help from John Walter Russell, a guy who got interested when I put forward the first post at the Motley Fool site (that was on the morning of May 13, 2002). John worked it full time for eight years (his work, which is mostly statistical research we used to check and develop and refine the insights, is at the http://www.Early-Retirement-Planning-Insights.com site) until his death in October 2009. And I’ve had hundreds of community members at a large number of discussion boards helping me out. So I obviously cannot pass along all that I have learned to newcomers in one Guest Blog entry or one comment or whatever.

    That means that there is no way of avoiding the reality that there is going to be some skepticism about these ideas for some time to come. That’s healthy. People should be skeptical. I certainly did not believe all these things on the morning of May 13, 2002. I took it step by step. I learned one thing and that led to something else and it continued like that on and on (I am very much still in a learning mode today, by the way).

    So I don’t think it is realistic to expect to have too many see the post and say “I’m sold, Rob, where do I sign up?” But intrigued works. “Intrigued” means “not entirely convinced but open to hearing more.” That’s a great reaction, one of the best that I could hope for. So it makes me happy to hear you use that word.

    Rob

  8. It’s hard to get people actively involved in investing though so getting a lot of people to do anything more than buy and hold can be extremely difficult.

    Perhaps.

    It would be fair to say that I have walked an exceedingly rocky road for the nine years. However, I have a much more optimistic take than most who have watched this go down think I have any right to expect.

    I started putting together my Retire Early plan in the early 1990s. My guess is that you are a good bit younger than me. If you are, it would be impossible for you to imagine how little material there was on frugality in the early 1990s. There was nothing. I mean nothing. Maybe one or two books. No blogs, obviously. I have a tendency to want to study things I come to care about in depth so I was forced to read the one or two books that were out there over and over again in the hopes of finding new insights each time because there simply was nothing else. Interest in that one has exploded, no?

    My point is that things can change. And things can change quickly once conditions are right. I have faced huge resistance from Buy-and-Holders. That’s a fact. But you know what? There is an important sense in which the Buy-and-Holders are not really opposed. The Buy-and-Holders did not get things wrong intentionally. They are good people and they are smart people. They came up with lots of wonderful stuff. Once a few of the lead Buy-and-Holders come out in support of this, I think that all of the others are going to quickly fall in line. And then we are off to the races.

    The trouble I have selling this is that the implications are so huge. People sense that and they pull back. People don’t like big change. It is scary. This change is very, very, very big. You can’t possibly imagine how big if you haven’t spent nine years studying this. It’s only one thing — the only change is that valuations are considered when making investing decisions. But that changes absolutely everything in profound ways.

    I’ll give you one example. Here is a link to a column I wrote a week or two ago (I now write three weekly columns seeking to spread the word about Valuation-Informed Indexing):.

    http://www.valuewalk.com/bonds/ivaluationinformed-indexingi-25br-stocks-risky-bonds/

    The headline for that column is “Stocks Are Less RIsky Than Bonds.” Please let that sink in for a moment. It’s hard for even me to take in how big the implications of just that one change are. If that’s so (you can read the column and decide for yourself whether the argument holds up or not), we have changed the history of investing. People have believed that stocks are more risky than bonds for as far back as there have been stock markets.

    What could change that? What changed it is the research of Yale Economics Professor Robert Shiller. Shiller showed in research published in 1981 (the ideas were popularized somewhat through Shiller’s book “Irrational Exuberance”) that valuations affect long-term returns. To say that valuations affect long-term returns is to say that long-term returns are predictable. Something that affects something else tells us how that something else is going to behave. We now possess the ability to know in advance what our stock return is going to be (not with precision — but still).

    It’s impossible to overstate how big a development this is for middle-class people. Middle-class people today are required to invest in stocks to finance their retirements. But most middle-class people fear stocks. As you say, they don’t want to spend a lot of time learning about investing, it is boring and complicated to them, and so they don’t like the idea of having their money in something that can cause them to lose most of it. Guess what? They don’t have to anymore! Those days are over! The risk of stock investing is pretty much a thing of the past (not in practical terms just yet because we have not yet been able to get the word out, but the tools to make this happen are already all in place and available for free on the internet).

    Now, I know that you are not going to believe what I just said, SavingMentor. It is not a believable statement. But, if you check out my Bio and the comments made by over 80 experts and ordinary people who have examined these ideas in great depth and who have been persuaded by them, you will in time come to believe them. Or , if you don’t, someone else will. And the ideas will eventually go viral. I personally believe that this is inevitable.

    The key is that this is so simple and so rewarding both. It is just what middle-class investors need today. The only hold-up is that it is so big an advance that people cannot let it in just let. Over time, there are going to be more and more influential people helping me make the case and then I believe we will all be talking about it at every blog and at every discussion board on the internet.

    It has been hard to get people interested. That’s a stone cold fact. But that’s not because there are any people alive who don’t want to know what it takes to invest effectively. It is because this just sounds so off from what people have been hearing for years about how stock investing works. It sounds weird and this involves money and so people are naturally skeptical. Once we get over that threshold, I think interest is going to explode.

    But then I would, wouldn’t I?

    Rob

  9. What is your personal strategy for how to allocate your assets and when to exit the stock market completely?

    I personally went to a zero stock allocation in the Summer of 1996 and have been at zero ever since (most of my money is in TIPS and IBonds paying 3.5 percent real), SavingMentor. I don’t think it is a good idea for most people ever to go to zero (my circumstances are highly unusual). It’s generally better always to stay at a stock allocation of at least 20 percent.

    The reason is that we CANNOT predict the short-term. Stocks offered a horrible long-term value proposition in 1996 but returns were amazing in 1996, 1997, 1998, and 1999. Those going with a zero stock allocation took an emotional risk that they would become frustrated with “missing out” on those great short-term returns and would abandon the strategy just at the worst possible time for doing so. More measured valuation shifts are more emotionally balanced and thus more likely to generate good real-world results.

    The primary tool that I use to make allocation decisions is The Stock-Return Predictor, a calculator at my web site:

    http://www.passionsaving.com/stock-valuation.html

    To work the calculator, you need to enter a P/E10 value. P/E10 is the current price of the S&P Index over average of the last 10 years of earnings. Benjamin Graham (Warren Buffett’s mentor) created this valuation metric in the 1930s and Robert Shiller has used it successfully in his research. When you enter a P/E10 level, the calculator performs a regression analysis of the historical stock-return data to reveal the most likely annualized 10-year return for stocks.

    In 1982, the most likely annualized 10-year return was 15 percent real. In 2000, the most likely annualized 10-year return was a negative 1 percent real.

    What stock allocation makes sense in both sets of circumstances? There is none. That’s why Buy-and-Hold can never work for the long-term investor. When you choose one stock allocation to go with at all times, you insure that you will be going with a wildly wrong stock allocation at all times when stocks are either highly undervalued or highly overvaluation (Buy-and-Holders get it roughly right at times of moderate valuations). We are often at either low or high valuations and high or low valuations can remain in place for years (we were at insanely high valuations for the entire time-period from 1996 through 2008). So Buy-and-Holders are often going with wildly wrong allocations. Getting your stock allocation right is the key to investing success. So this is not a good thing.

    I compare the likely 10-year return for stocks with the certain return for the super-safe asset classes (Treasury Inflation-Protected Securitiies, IBonds, and CDs). My rule is that stocks need to pay a return at least two percentage points higher than what I can get with a super-safe asset class to make it worth it for me to take on the volatility of stocks). So if stock are paying 3 percent real and TIPS are paying 3 percent real, I go with TIPS. If stocks are paying 5 percent real and TIPS are paying 2 percent real, I go with stocks. If stocks are paying 4 percent real and TIPs are paying 2 percent real, I would call it a jump ball.

    In January 2000, the most likely 10-year return for stocks was a negative 1 percent real. TIPS were at that time paying 4 percent real. That’s a difference of 5 full percentage points of return every year for 10 years running. Do that math and it comes to an edge for the Valuation-Informed Indexer of 50 percent of the initial portfolio value. If you had $200,000 in your portfolio in 2000, you are today roughly $100,000 ahead of the Buy-and-Holders.

    Now — the thing that makes this really work is the next part.

    You have no doubt seen those tables that show the power of compounding returns, SavingMentor. The Valuation-Informed Indexer doesn’t just get the $100,000. He gets compounding returns on that $100,000 differential for as many years as he continues to invest. The differential can grow to very large amounts over time. I have run many 30-year tests in which the Valuation-Informed Indexer ends up with a portfolio more than double the size of the portfolio of a Buy-and-Holder who went with any of the possible stock-allocation percentages!

    There are two keys. The first is that sooner or later the Valuation-Informed Indexer is virtually certain to go ahead. It can take some time. It often doesn’t happen in a year or two or three or four. This is ONLY for long-term investors. But it is a rare returns sequence that doesn’t sooner or later put the Valuation-Informed Indexer ahead (the research linked to in the blog entry showed that VII beat Buy-and-Hold in 102 of 110 30-year periods and the Buy-and-Hold differential was small in the tiny number of cases in which it worked).

    Then, once he goes ahead, his edge grows larger and larger over time because of compounding,. It is usually impossible for the Buy-and-Holder to catch up. How could he? Remember, the Valuation-Informed Indexer is heavily invested in stocks when prices are low or moderate. And stocks never go well in the long term starting from times of high prices (the only time when Buy-and-Holder hold more stocks).

    None of the problems associated with short-term timing apply with this. For example, people often point out that timers need to guess right both as to when to lower their stock allocation and when to increase it again. There is no guessing with this! If stocks offer a better value proposition than TIPS, you go with stocks; if not, you go with TIPS. What is there to guess about? So you are virtually sure sooner or later to go ahead. And once you do, the magic of compounding returns does the rest.

    And there is no need to worry about acting quickly or any such nonsense. Stocks were well-priced for the entire time-period from 1975 through 1995. No allocation changes were required in that time. Stocks were poorly priced for the entire time-period from 1996 through today (with the exception of a few months in early 2009). Again, no changes required. Valuation-Informed Indexers only need to make roughly one allocation change every 8 or 10 years. But that one change permits them to retire five to ten years sooner than would be possible with Buy-and-Hold.

    The magic is that you are taking the price being charged for the thing you are buying into consideration before buying it. Those who have experienced the magic of paying attention to price on the spending side should get this immediately. I was drawn to this because I had seen what a difference in made to my life for me to start managing my money more effectively. This is taking the concept of money management and applying it to investing. Instead of buying lots of stocks both when they are priced well and when they are priced horribly, you only but lots of stocks when they are priced well. It should not really surprise anyone that that always makes a huge difference in the long run.

    Rob

    • Rob – Do you know of any mutual funds or ETF’s that use the value informed strategy? Is there an easy route that one could go to follow this without having to get their head around it (I mean basically for those novice investors that are hesitant to invest because they think it’s difficult)?

  10. Is there an easy route that one could go to follow this without having to get their head around it?

    You phrased this question amazingly well, Craig. You’ll see what I’m getting at after you read my answer. The short version is: “Yes, but it would be dangerous.”

    I don’t know of any mutual funds or ETFs that do the precise thing we are talking about here. There are Value funds. Any Value-oriented fund is following the driving principles. The trouble is that Value Investing is not for the typical middle-class person. Warren Buffett is the hero of Value Investing. You could invest in Bernskire Hathaway, Buffett’s fund. I don’t recommend this, however. And the great thing about Buffett is that he is honest enough not to recommend it either. Buffett obviously believes that his fund is a good fund. But he is a straight-shooting enough guy to let people know that it is not for everyone.

    Value Investing is what works. If we lived in a perfect world, I would tell everyone to become a Value Investor and to forget about Valuation-Informed Indexing. You will probably get superior returns with Value Investing. There’s only one problem. Value Investing is hard work. Only 1 in 10 of us is capable of doing what is needed and open to putting in the time. If you do Value Investing poorly, you’ll get killed. So for the typical middle-class investor, Value Investing is out.

    This is where Bogle enters the picture. Bogle is the first person to come forward with an approach that lets the typical middle-class person partake in the benefits of stock investing. Bogle was a pioneer. I could write a separate post listing the ten true breakthrough ideas in the Buy-and-Hold Model. No simple approach can be as good as Value Investing. But most of us don’t need something as good as Value Investing. We need a “good enough but very simple” approach. That’s what Buy-and-Hold was intended to be.

    VII is the combination of Value Investing (what works) and Buy-and-Hold (what is simple). The goal of the project is to for the first time in history provide typical middle-class people with a way to partake in the benefits of stock investing that actually works in the real world. The reason why this precise thing has not been available before is because all of the pieces needed to make it work were not available to us until recent years. The wonderful news that we should all be making an effort to let in is that now they are. It’s like the night the Beatles sang “She Loves You” on The Ed Sullivan Show. In retrospect, it’s hard to understand why no one did it sooner but the stuff needed to make it happen just hadn’t been in place before that night.

    The problem is that all the research had not yet been done at the time Bogle put together the Buy-and-Hold concept. Obviously, you cannot incorporate insights you don’t know about. So Buy-and-Hold as it was initially put forward is fatally flawed by its failure to account for the effects of valuations. Valuation-Informed Indexing could properly be referred to as The New Buy-and-Hold. It’s a fulfillment of the original concept made possible when Shiller did the research that hadn’t been available when Bogle got to work on the problem.

    There is not one possible VII strategy. There are many. I have a podcast where I describe nine possibilities and I am sure that people could come up with at least nine more if they put their minds to it. If simplicity is your goal (and that is indeed an important goal for many millions of people), it’s easy to come up with a VII strategy that is exceedingly simple.

    You need two asset classes. One would be a a Total Stock Index Fund (available at Vanguard). One would be Treasury Inflation-Protected Securities (these come with a government guaranty — they are the safest and easiest-to-understand asset class available today). The only other thing you need is a plan for when to make your allocation shifts. The most simple would be a cliff approach. You would go with a 70 percent stock allocation (30 percent TIPS) when the P/E10 level was 20 or below and with a 30 percent stock allocation (70 percent TIPS) when the P/E10 level was 21 and above.

    That’s very simple. You lose some of the benefits available to those following more sophisticated strategies by making it that simple, but it would still be a lot better than Buy-and-Hold (and far more simple than Value Investing), in my assessment. You would tap into the great benefits of long-term stock investing because you would usually have a 70 percent stock allocation (the P/E10 level does not frequently go above 20). You would always have at least 30 percent stocks. Your non-stock money would be super -safe (TIPS are safer than bonds because they are protected from the effects of inflation). And you would never have to worry about losing your money in a stock crash. We have never had a crash of any lasting significance starting from a P/E10 level of less than 24. If you were at a 30 percent stock allocation when we had a 50 percent price drop, you would see only a 15 percent loss in your portfolio value. That’s not devastating.

    I think that’s what you are looking for, Craig. There’s one problem, though, and it is a big one.

    The thing that Buy-and-Hold failed to address was valuations. IT IS NOT AN ACCIDENT THAT THIS HAPPENED TO BE THE THING THAT WAS MISSED. Valuations scare us — we all have something within us that makes us want to turn away from the subject. To understand why, you need to understand why it is that stocks become overvalued or undervalued. Overvaluation and undervaluation are never the product of a rational process. They are 100 percent emotional phenomena. When we talk about valuations, we are talking about human emotions. Looking at how human emotions affect stock prices (and thus our retirement accounts) scares us to death.

    We all engage in projects that have an emotional content to them all the time. We read novels. We date. We sing songs. We raise children. We root for our favorite sports teams. So we are all perfectly capable of grasping the importance of emotions. When it comes to investing, though, we want nothing to do with it. Investing involves money. So we adopt a super-serious attitude when talking about it. Write about investing and you had better be sure you always get your numbers right and that you come across as authoritative and sober and that you know lots of big words and lots of strange words (alpha and beta and all this sort of thing).

    We are fooling ourselves, okay? We are putting on an act. We are scared little boys and girls and we are pretending that these charts and tables will protect us from the Boogyman. I am NOT saying that the statistical analyses do not have value. They have great value. I am saying that we too often use them as a shield protecting us from the scary monster under the bed that is the single biggest influence on investing results and that 90 percent of the people recognized as experts in this field are not capable of dealing with — human emotion.

    Investing knowledge today is unbalanced. We are super-strong on the numbers side. We’ve got that stuff down. But we are zeros on the emotions side. And unfortunately, emotions affect the numbers. So, while we are proud of all our great statistical proofs of this and that and the other thing, all the numbers we use to understand investing are wrong because we refuse to look at the emotional aspects of the project. All of the numbers-related analyses we use in investing today are giving us a FALSE CONFIDENCE in misleading findings. The analyses are fantastic. But they cannot prove truly helpful until we let it in that emotions matter here and adjust them to reflect that critically important REALITY. “Reality Matters” is one of my catch phrases. You cannot ignore the #1 reality of stock investing (emotions/valuations) and still get it right.

    I bring all that up because I worry about your words “without having to get their head around it,” Craig. In terms of implementation, we can make this amazingly simple by doing it as described above. But it will not work for those who do not get their heads around at least the basics. The VII mindset is a different mindset from the Buy-and-Hold mindset. For this to work, you need to change mindsets. That is absolutely essential.

    They are discussing Wade Pfau’s research at the Bogleheads Forum this week. One fellow made a point that is perfectly reasonable from the perspective of someone with the Buy-and-Hold mindset but not from the perspective of someone with a VII mindset. He noted that those following VII should have been increasing their stock allocations in March 2009, when the P/E10 level dropped to 12 (that’s a bit below fair value). But he noted that people were super-concerned about what was going on in the economy at the time. What knucklehead would want to increase his stock allocation when the economy was going down the toilet?

    A VII knucklehead would! The reason why Buy-and-Holders view economic trouble as a bad sign is that Buy-and-Holders believe that it is economic developments that cause stock price changes. Valuation-Informed Indexers do not believe this. We believe that price changes are caused by shifts in investor emotion (the shifts can be set off by economic changes, to be sure, but the driver is emotion shifts — the same economic development will have a very different effect on stock prices if it takes place at a time of high valuations rather than a time of low valuations). We view economic developments that cause stocks to be available at better prices as a good thing from an investing standpoint. We were every bit as much worried about the economy in 2000 as we were in 2009 because we knew in 2000 that the valuation levels that had come to apply were going to cause an economic catastrophe. We were not shocked by the economic crisis because our understanding of the effect of bull markets on the economy told us that a crash was coming years before it hit.

    The point I am leading up to is that, while the implementation of VII can be made very simple, it will not work unless you have in place some means of helping you develop and strengthen an understanding of the effect of emotions/valuations on stock prices and on the general economy. This is essential. If you work through all the principles one time and understand them, you are probably fine. If this were to become popular enough that it was being discussed at all the web sites and blogs, you would be fine. If those things were not so, you would need to be part of some discussion-board community where people were regularly discussing how this works and responding to events going on in the world from a VII perspective. You need to have the thoughts generated by your new mindset reinforced or you will get pulled into the extremist bull/bear stuff sooner or later.

    Here’s a way to think about it. Do you know how there are blogs that are from the political left and blogs that are from the political right? And something happens in the world and the two sets of blogs respond to the event in such different ways that you can hardly believe that they are talking about the same fact pattern? That’s how it is with investing but with one big difference. With investing, one of two extremes applies universally for a certain number of years and then the other of the two extremes applies universally for a certain number of years. For 10 or 20 years, we have access only to extreme pro-stock reports and then for the next 10 or 20 years we have access only to extreme anti-stock reports (in the early 1980s, Business Week ran a cover story titled “The Death of Equities?”).

    The ultimate aim of the VII concept is to integrate our bull and bear insights into one model for understanding stock investing that works AT ALL TIMES. The idea is to avoid extremism in both directions. The goal is to create a truly human (not bull, not bear — human) model for understanding how stock investing works. We all learn about the world from picking up on what we are exposed to. Until VII becomes dominant, we are every day being exposed to the extremist stuff. And that will undermine your confidence in the balanced approach unless you put in effect some sort of plan for dealing with it. You either need to put in the effort one time to learn the principles yourself or you need to connect with a community that will help you make sense of all the stuff being pushed down your throat that is contrary to an emotionally balanced take.

    The implementation can be made very simple indeed. But it won’t work unless you take care of the emotional side of things. If (when!) this takes the world by storm, that will be easy. Until then, the investor taking this path needs to be willing to put in a little extra effort. I believe that it pays off big time with the peace of mind it offers in the long run.

    Rob

    • Rob, I should have you writing follow up articles rather than the informative books you are writing in the comments!

      Interesting that you mention emotions. I met Tom Gardner of the Motley Fool not long ago and he says getting around your emotions is one of the big obstacles in investing (or at least he said something similar to that). He also mentioned that one of the great things that makes Buffett great (and Buffett says this too) is being able to control his emotions.

  11. Rob, I should have you writing follow up articles rather than the informative books you are writing in the comments!

    Now you’ve done it, Craig! Putting forward words like that with me in the room is like placing catnip before a crazy cat!

    If there is ever a time when you feel that it would be a good thing for the community that congregates here for me to address another aspect of this, please just let me know and I will do the best job that I am capable of doing. The goal of course should be to proceed at whatever pace best meets the needs of your readers.

    I met Tom Gardner of the Motley Fool not long ago and he says getting around your emotions is one of the big obstacles in investing

    I think of Tom as a friend. My years at Motley Fool (I built their Retire Early board, which was in that day the most successful board at the site) were some of the happiest days of my life. I had some great times there and made many good friends there, some of whom I think about from time to time to this day.

    Tom wrote one of the blurbs that appear on the back of my book on saving (Passion Saving: The Path to Plentiful Free Time and Soul-Satisfying Work). He said: “The elegant simplicty of his ideas warms the heart and startles the brain.” I am not allowed to say that he’s right but I think it is okay if I say that those words provide a concise statement of what some find appealing in my work (the particular combination of brain and heart that I couldn’t help aiming for if I tried because my personality type (INFJ) is just set up that way).

    one of the things that makes Buffett great (and Buffett says this too) is being able to control his emotions.

    Precisely so. People think Buffett is smart. He is that, of course. But there are many, many very smart people in this field. What makes Buffett so special is that he is both very smart and very emotionally balanced. That’s a rare combination. The reason is that the human personality is set up in such a way that the things that make one smart tend to distance one from one’s emotions and the things that makes one emotionally aware tend to make one discount the importance of smarts. It is unusual for one person to excel in both areas.

    My strength is on the emotional side (I am a disaster with numbers and both of my brothers did better in school than I did). In ordinary circumstances, I would have zero to do with personal finance (I didn’t save a penny for the first 35 years of my life) and less than zero to do with investing (the numbers-focused side of personal finance). The freak occurrence was that I lost a job I loved and became determined to learn about financial independence and when I saw what it could do to help people fulfill their life potential I was able to appreciate money topics in a way that few who are strong in the emotions department are able to appreciate them.

    In short, I am a genetic mutation! I was put on Planet Earth to help personal finance (and investing in particular) evolve in a new direction. I am joking, of course, but only kinda, sorta.

    Anyway, I thank you again for giving me a chance to spill a few words here. All of the questions were great. I enjoyed myself immensely and I was forced to think hard to be responsive to the questions asked. I have hopes that perhaps one or two or three picked up some new ideas that they may ponder for a time and perhaps someday put to a good and constructive and life-affirming purpose.

    Yes, that sounds grand but this is a grand communications medium. You do something important here, Craig, and I wish you and your entire community (including all the Buy-and-Holders in it, who I think of as friends as much as I do those interested in VII) the best of luck in all your future endeavors!

    Rob

  12. I agree! Follow up posts are definitely in order! I am truly intrigued by this approach. As an index investor and supporter, I know understand how this is different from the normal rigid asset allocation targets that I currently employ.

    I need to comb through all of the fine details of your method here, as it may have merit.

    The things I am worried about though is that

    1) if your asset allocation is based on a 10 year average P/E ratio, won’t short term (say within one month) variations not be reflected?

    Currently, I try to rebalance my tax sheltered accounts once every month or two. Wouldn’t your asset allocation still be stuck at say 60% stocks when a large decrease in the market should make you up your exposure to say 70%?

    and 2) I also worry that the asset allocations associated with a respective 10 year P/E average ratio might introduce too much “market timing” element in to your investing approach.

    Are there established standards that associate a specific P/E average ratio with a related asset allocation? How much data is their to support the performance of these allocations.

    I imagine that some of those questions would be answered on your site, but those are the things I am thinking at the moment!

  13. I agree! Follow up posts are definitely in order! I am truly intrigued by this approach. As an index investor and supporter, I know understand how this is different from the normal rigid asset allocation targets that I currently employ.

    I need to comb through all of the fine details of your method here, as it may have merit.

    The things I am worried about though is that

    1) if your asset allocation is based on a 10 year average P/E ratio, won’t short term (say within one month) variations not be reflected?

    Currently, I try to rebalance my tax sheltered accounts once every month or two. Wouldn’t your asset allocation still be stuck at say 60% stocks when a large decrease in the market should make you up your exposure to say 70%?

    and 2) I also worry that the asset allocations associated with a respective 10 year P/E average ratio might introduce too much “market timing” element in to your investing approach.

    Are there established standards that associate a specific P/E average ratio with a related asset allocation? How much data is their to support the performance of these allocations.

    I imagine that some of those questions would be answered on your site, but those are the things I am thinking at the moment!

  14. Sorry for posting the double comment….There was something screwy going on with my computer yesterday loading the site.

  15. I agree! Follow up posts are definitely in order!

    You are causing me to feel more happiness that I am able to bear, Jacob! I’ll be in touch about putting together a Guest Blog Entry at your site.

    As an index investor and supporter, I now understand how this is different from the normal rigid asset allocation targets that I currently employ.

    I have learned that it takes awhile for this to click with people. It’s not that there is anything complicated about it. VII is simplicity itself! The trouble is that the VII head is a totally different head from the Buy-and-Hold head. It is rooted in an entirely different understanding of how stock investing works. If none of us had ever heard of Buy-and-Hold, I believe that we all would today follow VII strategies. But we have become so accustomed to thinking that the world is flat that it has become difficult to even imagine the possibilities that follow from accepting that it is really round.

    if your asset allocation is based on a 10 year average P/E ratio, won’t short term (say within one month) variations not be reflected?

    It’s only the “E” part that is a 10-year average, Jacob. The “P” part is just the current “P.” So that contains everything.

    The reason why you need to take an average of 10 years of earnings is that otherwise economic ups and downs throw everything off. Say that the economy is going gangbusters. The “E” is going to be artificially high and make the P/E number lower than it should be to give you an accurate sense of whether stocks are overpriced or not. The reverse is so when we are in a recession. You want to be comparing the price with the earnings that apply on average.

    I try to rebalance my tax sheltered accounts once every month or two. Wouldn’t your asset allocation still be stuck at say 60% stocks when a large decrease in the market should make you up your exposure to say 70%?

    The “P” would be changing, as explained above.

    I also worry that the asset allocations associated with a respective 10 year P/E average ratio might introduce too much “market timing” element in to your investing approach.

    This is market timing! No apologies offered! People need to get over this idea that there is something bad about market timing. There is no way to take price into consideration without engaging in market timing. And to fail to take price into consideration is investor suicide. So timing is absolutely required for those hoping to have a realistic chance of long-term investing success. (It obviously makes sense to only in engage in the form of market timing that always works (long-term timing) and to avoid the form that never works (short-term timing).

    We need to distinguish between the two types of market timing (short-term and long-term). Short-term really does not work. The Buy-and-Holders are right about that and learning this was a huge advance. We all owe them for that one.

    It does not follow that long-term timing is not required. This is the thing that always throws people. Every study that looks at short-term timing shows that it never works. Every study that looks at long-term timing shows that it always works. We need to come to a good understanding of WHY that is. When we get that, I believe that all of the pieces click into place.

    The REASON why short-term timing doesn’t work is that it is investor emotions that determine stock prices in the short-term. Emotions are irrational. So there is no way to predict them. So short-term timing cannot work.

    In the long-term it is the economic realities that determine stock prices. So what always happens in the long term is that the gap between fair value and the crazy short-term price is closed. So it is easy to know where stock prices are headed in the long term (not precisely but in a general sense). That’s why long-term timing always works. Once you know which way stock prices are headed, you just adjust your stock allocation to reflect that knowledge and you are set.

    When stocks are priced at one-half fair value, you can be sure that they will be rising big time over the next 10 years or so. When stocks are priced at three times fair value, you can be sure that they will be falling hard over the next 10 years. And this is what always happens. There is not one exception in the historical record, nor is it possible to imagine how there ever could be one. This is as close to a sure thing as you are every going to get in the field of investing.

    Are there established standards that associate a specific P/E average ratio with a related asset allocation?

    I have a calculator at my site (“The Stock-Return Predictor”) that identifies the range of possible returns for each P/E10 level and that reveals the rough probabilities of each point on that spectrum of possibilities turning up. There is always some random element because emotions always play a role in the short term. So we can never say precisely what your return is going to be. But we can tell you when the probabilities are on your side and when they are against you.

    How much data is there to support the performance of these allocations.

    Th entire historical record (going back to 1870) supports this. I cite research by Wade Pfau in the blog entry. He found that VII beat Buy-and-Hold in 102 of 110 of the 30-year time-periods now in the historical record. I will be posting a column at the http://www.ValueWalk.com site next Tuesday that will show why Pfau’s research greatly understates the edge that the investor obtains by following a valuation-informed strategy.

    This is all good. It is not even possible to imagine a downside. Can you imagine anyone saying that there is a downside to considering price before buying a car? Why should anyone think it would be different with stocks?

    I imagine that some of those questions would be answered on your site, but those are the things I am thinking at the moment!

    There’s tons of materials at the site. But I am also happy to work through any questions that anyone has at any place they care to put them forward. It is my job to bring people to a better understanding of this. Once it really clicks, you will see why that is so important, Jacob.

    The implications here are HUGE. We are talking about something equivalent to the harnessing of electric power to light our homes. I know that’s hard to believe but I can assure you that I am shooting straight re this. When this fully clicks, you are going to be blown away with what we have come up with (hundreds of my fellow community members have helped me with this). No one is ever going to go back to Buy-and-Hold once converting to Valuation-Informed Indexing. It greatly increases your return while also greatly reducing your risk. It doesn’t get any better than that. That’s investor heaven!

    Rob

  16. Thanks for all the answers to each of my questions Rob! I’d love to have you do a guest post at some time on my site. Just shoot me an email via the contact page on my blog. One thing though – I don’t want to take away blog posts that you would do here at Free From Broke (as long as you let me know the url so I can read them when they go live!).

    I think what I’ll most likely do is do my homework on this, set up some simulations to test it out, then give it a try with a relatively small amount of money to get started. Thanks!

  17. That all sounds super, Jacob.

    I have something in mind for your site that I’ll aim to get to you by the close of business tomorrow (100 percent fresh material, of course). There is never going to be any trouble generating enough material re this subject. I write three weekly columns on it and I have enough column themes on my list to get me through at least another year or two. If there are any bloggers out there who would like to see a Guest Blog re any aspect of the question, please just get word to me and I will zip something back to you in a few days. It is my Life Project to spread the word re this far and wide on the internet.

    Doing your homework is of course precisely the right way to proceed, Jacob. There’s one big caveat, however. You must understand that it can take as long as 10 years for this to start paying off. It’s not fair to expect good results in a year or two. It is not designed to produce good short-term results and it often does not.

    I have a calculator at my site that permits users to run as many tests as they like. It is called “The Investor’s Scenario Surfer”:

    http://www.passionsaving.com/portfolio-allocation.html

    The Surfer generates an unlimited number of essentially random 30-year returns sequences. I say “essentially” because the returns sequences are not entirely random — filters are applied to insure that the sequences generated are true to the general outlines of the 30-year return sequences we have seen in the historical record So the return sequences are both random and realistic.

    The calculator reports the 30 years of results one year at a time. Each year it tells you how your portfolio value has changed and also tells you the new P/E10 value. It also lists the portfolio values for investors following rebalancing strategies of 20 percent, 50 percent and 80 percent for comparison purposes.

    Each year you have the option of sticking with your old stock allocation or choosing a new one. At the end of the 30-year test, you get to see whether you beat Buy-and-Hold, by how much. and, most importantly, what particular allocation choices it was that sent you ahead or behind.

    My experience is that VII beats Buy-and-Hold in about 90 percent of the tests. 80 percent rebalancing usually finishes in second place, 50 percent rebalancing in third place, and 20 percent rebalancing in fourth place. There have been occasions when at the end of 30 years the VII portfolio has been more than two times the size of any of the rebalancing strategies. That’s not the norm but it does happen. When rebalancing beats VII, it is usually by a small amount.

    Rob

  18. Thanks so much for letting me know about the tool Rob! I’ll definitely check it out.

  19. Ed @ Trading Strategy says:

    Rob, I’m not saying that I agree with you 100%, but I someway do. Personally, I’ve been selecting stocks the same way I’ve been selecting certain item of collection. I make sure to study the value of what I buy, just like everything else (this is where I agree with you Rob).
    With that said, to go back to what Graig has mentioned, I don’t think “Buy and Hold” is the reason why we haven’t gone through the worst crisis in history.
    This current crisis if far more than buy and hold. As Rbo has mentioned, “The implications here are HUGE.”

    Well, Rob I have one question for you:
    What are your thoughts on the coming months of even the next 2 years, considering the current market conditions, the elections that are coming soon, and the situation in Europe? How do all of these factors affect your game plan?

  20. Thanks for your thoughtful comment, Ed.

    None of those factors affect my game plan. I am a critic of Buy-and-Hold but I also believe that the Buy-and-Holders are right about many important points. I believe strongly in Bogle’s advice to focus on the long term and to stay the course. So I try not to permit temporary ups and downs throw me too much off the path that I think makes the most sense over time.

    I believe that we have dark days ahead. Not so much because of elections or because of things happening in Europe. I see dark days because stocks are still insanely overvalued even after 11 years of poor returns. If stocks perform over the next few years anything at all as they have in the wake of all prior runaway bull markets, we will see a 65 percent price drop from where we are today. I think there’s a good chance that that will put us in the Second Great Depression. Truly scary stuff.

    But you know what? We’ll get out of it. And we’ll live better on the other side than ever would have been possible had we NOT gone into the Second Great Depression.

    Why? Because going into the Second Great Depression is going to shake people up. People are going to open their minds to new investing ideas. And when you incorporate Shiller’s insights with Bogle’s insights, you have the best investing strategy the world has ever seen. We are blessed to have available to us research about how to invest effectively that has not been available to any group of investors who ever lived before. Once we gain the ability to talk about the new ideas, we are all going to be able to retire many years sooner than we ever thought possible and our economy is going to be going gangbusters.

    Do you know who we will be thanking? The Buy-and-Holders. Because they laid the foundation that made all this possible. And because they will be helping spread the word once they come to see what a big deal this is and how it is all just a logical follow-up to the fine foundation they laid a good number of years ago.

    The next few years are going to be rough going. But it’s always darkest before the dawn. I am seeing an amazing dawn not too many years down the road. I’ve been looking forward to this Learning Together phase of our discussions for a long time and my sense is that it is no longer all that far off in the future.

    I wish you the best of luck in all your future endeavors!

    Rob

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