What Buffett isn?t telling us?at least not loudly

Beyond Buy-and-Hold #21

Warren Buffett is one of my heroes. Valuation-Informed Indexing is a combination of the best ideas of John Bogle and Warren Buffett. I often describe why I think Valuation-Informed Indexing is so wonderful by exclaiming that John Bogle and Warren Buffett go together like chocolate and peanut butter!

Still, Buffett is human and all humans make mistakes. I am aware of one very big mistake that Buffett has made in his investing advice. If you come to understand Buffett?s mistake, you will also understand why the ?controversy? over Valuation-Informed Indexing that has raged on the internet for nine years now is phony and pointless and counter-productive and silly.

Please note that I put the word ?controversy? within quotation marks. Is there a question as to whether this stuff is controversial or not? I?ve been banned from every large investing board on the internet and from a number of blogs. I?ve had death threats directed at me. Thousands of people hate Rob Bennett with a burning passion because of what he has said about investing. That?s a controversy! It calls for an exclamation point, not quotation marks.

Except for the fact that —

The full truth is that there is no controversy.

Buy when everyone is selling; sell when everyone is buying

Warren Buffett is the most respected voice in investing alive today. One of his most favored bits of investing wisdom is his injunction to ?be greedy when others are fearful and be fearful when others are greedy. ?Does anything about the idea being expressed in those words sound familiar to you?

It sure should if you have read any of the earlier column entries. That?s Valuation-Informed Indexing! How is it that one goes about being ?fearful? when others are ?greedy? (that is, a times of high valuations)? By lowering one?s stock allocation! And how is it that one goes about being ?greedy? when others are ?fearful? (that is, at times of low valuation). By increasing one?s stock allocation!

Bogle believes that investors should be investing more heavily in stocks when prices are good than they do when prices are bad. If he were an indexer, he would be a Valuation-Informed Indexer! If the most respected investor in the world says this, it certainly cannot be ?controversial? for an internet nobody like Rob Bennett to repeat the insight.

Can it?

Well, it can, kinda, sorta.

Why valuations are the foundation of investing in stocks

Buffett goes about the task of delivering this message in a very different way from the way Rob Bennett goes about delivering it. Buffett says the words and then he moves on. He doesn?t explore the implications of the words. Buffett didn?t actually come out and tell people that they needed to be lowering their stock allocations in the late 1990s and by how much.

I play it different. I say that, since the risk of stocks is so much higher when prices are high (that?s the obvious reason why Buffett says that you should be fearful when others are greedy), there are things you should be doing to protect yourself from suffering big losses at such times. You should be looking to the historical data to see how much you need to lower your stock allocation to keep your risk profile roughly constant.

Buffett keeps it vague. Thus, it?s easy for people hearing his words to ignore what he says. By delivering the message in the way he does, Buffett avoids making people mad. I put the reality that valuations affect long-term returns in people?s faces. That?s why controversy follows me wherever I go.

Buffett has explained why he plays it the way he does. He has said that in his long experience teaching people about investing he has found that some people immediately ?get it? that valuations matter and but most never do. He mentions the point often because he knows that it is a point of great significance. But he doesn?t push because he has learned that pushing doesn?t do any good.

The consequences of ignoring stock valuations

Buffett is right that some people ?get it? immediately and that most have a hard time getting this one to click. His take on that one matches my experience. So I have some understanding why he came to the conclusion that the way to handle this one was to make the point frequently but not to be a pain about drilling down on it.

There are millions of people who are going to suffer failed retirements because they never ?got it? re valuations. There are hundreds of calculators that are going to need to be junked because their authors never ?got it? re valuations. We are in an economic crisis because most of us never ?got it? re valuations.

We all need to get it. Just about all of us are investing in stocks today. Our free market economy is not long going to remain a viable institution if a much larger number of us don?t soon begin to get it.

It?s going to be hard for the investment experts to help people understand this point. Buffett is right about that. But this is the job. People who do not understand valuations do not understand investing! This one is too important for us to take a pass on. We are going to need to figure out why so many people have a hard time having this one click and develop tools that help them do so. Buffett (and lots of others who know he is right) is going soft on this one. We all need to work this one harder.

Rob Bennett writes about safe investing. His bio is here.

2 Responses to What Buffett isn?t telling us?at least not loudly

  1. To your point about tools that help highlight the discrepancy between valuation and exposure, we have a tool called Alpha Theory (www.AlphaTheory.com). We force investors to externalize their research in the form of Upside and Downside valuation estimates, analyze them, adjust as prices change, and point out where their position sizing does not match their valuation estimates. Most investors try and do this in their head. Unfortunately, that’s not possible and creating discipline that makes you question valuation in every portfolio decision is critical.

  2. shhh! Quiet Rob. As you know, I agree with you on valuations being critical to long term performance. But if you keep telling and teaching people then the market could become efficient. Then I would not be able to take advantage of volatility caused by people selling at market lows (when stocks are cheap) and buying at market highs (when stocks are overvalued).
    shhh! Quiet Rob

Leave a reply