By Rob Bennett
Valuation-Informed Indexing offers long-term investors both higher returns and less risk than what they can expect while following a Buy-and-Hold strategy. It sounds good, of course. The trouble is — It sounds too good.
Many investors are skeptical of Valuation-Informed Indexing on grounds that it sounds too good to be true. Higher returns and lower risk both? If there really were a way to pull that off, everyone would be doing it. No?
I think that?s right. Eventually, everyone will be doing it.
For now, though, you need to dig to learn what works in stock investing. Most of the people generally viewed as experts in this field very, very, very much do not want average investors to learn what works.
There are nine reasons:
1 ) The Experts Themselves Don?t Possess a Clear Understanding of the Realities. Every expert I have spoken to accepts that valuations affect long-term returns. But I have not yet spoken to one who fully appreciates all the implications that follow. Valuation-Informed Indexing is something new. Those who learn about this idea today are getting in on the ground floor;
2 ) The Shift From Buy-and-Hold to Valuation-Informed Indexing Is a Big One. Buy-and-Hold was rooted in breakthrough insights. The experts are properly proud of their association with the good that was done through promotion of the now discredited model and feel disloyal to point out that it has been discredited. My sense is that it is going to take another stock crash before a large percentage of experts will be willing to give up on Buy-and-Hold;
3 ) Investing Is a Conservative Field. When you are telling people what to do with their money, you need to exercise caution. Buy-and-Hold seems like the more conservative strategy because it has been around so much longer. Experts in this field are reluctant to stick their necks out by promoting new ideas, no matter how exciting;
4 ) There?s a Fear of Lawsuits. The mistakes made by the Buy-and-Holders were not deliberate. The reality is that our understanding of how stock investing works is today primitive and that the Buy-and-Holders advanced the ball in many important ways. Still, mistakes were made and those mistakes are likely going to cause millions of people to suffer failed retirements. Can those who promoted Buy-and-Hold be held financially liable? No one knows the answer to this question. Many would prefer that the question not even be brought to the table. So there is little enthusiasm among experts for seeing the failings of Buy-and-Hold publicly examined;
5 ) The Flaws in the Buy-and-Hold Model Have Been Public Knowledge for a Long Time. We learned that valuations affect long-term returns in 1981. The ideal time for the experts to have begun backing away from Buy-and-Hold would have been soon thereafter. But in practical terms there was little danger associated with following a Buy-and-Hold strategy until the mid-1990s (valuations were extremely low in the early 1980s). So the easy path for an industry that had already spent millions promoting Buy-and-Hold was to rationalize continued promotion efforts. Now that so much time has passed, and now that Buy-and-Hold has brought on an economic crisis, the decision to hold off letting investors know looks bad;
6 ) The Mistakes Made by the Buy-and-Holders Were Basic Mistakes. The reason why we have been told that there is no need to change our stock allocations when prices rise to insanely dangerous levels is that Buy-and-Hold is rooted in a belief that stocks can never be insanely overvalued. Anyone who has been paying even a little bit of attention has known for a long time now that this belief is seriously wide of the mark. It?s embarrassing for the experts to acknowledge that the mistakes they have made are such obvious ones;
7 ) Acknowledging Mistakes Is Not Viewed As Good Marketing in This Field. No one understands investing well today. But investors want their ?experts? to know it all. So most of those who put themselves forward as experts act as if they possess more confidence in their ideas than they do in fact possess. To say ?oopsie!? after promoting Buy-and-Hold for 30 years would help us put this failed idea behind us. But the experts giving thought to doing this worry about what it would mean re their personal career prospects;
8 ) Many Investors Become Angry When Told That Buy-and-Hold Does Not Work. Many investors are living in denial today. Many experts view it as their job to tell their clients what they want to hear rather than what they need to hear; and
9 ) Both Experts and Ordinary Investors Are Today Suffering from Cognitive Dissonance. We humans do not ?know? all the things we ?know.? We accept some information bits, we reject others. The huge bull market persuaded many of us of the merits of Buy-and-Hold and the intellectual case against it is something that many of us are finding it a struggle to acknowledge.
We need to have a national debate on the Big Fail of Buy-and-Hold and of the need to move to acceptance of the Valuation-Informed Indexing model. Some of these issues are so big that they can only be addressed on a society-wide basis.
Rob Bennett created the first retirement calculator that contains a valuation adjustment. His bio is here.