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What Bogle Says About Valuation-Informed Indexing

I am a critic of Buy-and-Hold and an advocate of Valuation-Informed Indexing. The one difference between the two strategies is that Buy-and-Holders say that it is not necessary to time the market while Valuation-Informed Indexers believe it is imperative to change your stock allocation in response to big valuation shifts so as to keep your risk profile roughly constant over time. I wrote two earlier guest blogs here describing the practicalities of Valuation-Informed Indexing.

The purpose of this post is to describe and comment on Vanguard Founder John Bogle’s views on Valuation-Informed Indexing. Bogle is widely recognized as the primary advocate of Buy-and-Hold alive on Planet Earth today, as I am the primary advocate of Valuation-Informed Indexing. The surprising truth is that, despite common misperceptions, the two of us are not all that far apart in our investing views!

Here are Bogle’s words on Valuation-Informed Indexing: “Big moves out of stocks should not be done at all. Tactical asset allocation — I should say strategic asset allocation rather than tactical — can be done at very rare times, so rare and so difficult to observe, maybe six times in an investor’s lifetime, three times when the market is stupidly high and three times when stupidly low.”

“Big moves should not be done at all.”

This is the one comment that suggests hostility on Bogle’s part towards Valuation-Informed Indexing. The most likely annualized 10-year return for stocks when they are selling at the prices that applied in 1982 is 15 percent real. In 2000, the number was a negative 1 percent. That justifies a big allocation change, perhaps from a 90 percent allocation in 1982 to a 30 percent allocation in 2000. A change from a 90 percent allocation to a 30 percent allocation is a big change and Bogle is here rejecting that possibility out of hand.

Still, I believe that his other words suggest an openness to the concept. I believe that, if Bogle developed a deeper understanding of how Valuation-Informed Indexing really works, he would be less dismissive.

For example, the ordinary procedure would be to go from a 90 percent allocation to a 60 percent allocation at one point and then only years later go to 30 percent stocks. In that event, there would never be an allocation shift of more than 30 percentage points made at a single time. Is a 30 percent allocation shift too big in Bogle’s eyes? Perhaps. But perhaps not.

“I should say strategic asset allocation rather than tactical.”

It made me very happy to hear Bogle say these words. I have had discussions about VII with many experts in the field. Even those who are supportive often refer to the allocation shifts that must be made as being “tactical” in nature. No! There is nothing “tactical” about getting your stock allocation percentage right. There is no decision that an investor makes that is more important than his choice of a stock allocation. The allocation shifts made by Valuation-Informed Indexers are strategic in nature.

“Maybe six times in an investor’s lifetime, three times when the market is stupidly high and three times when stupidly low.”

This statement gets it precisely correct. Some have the misperception that Valuation-Informed Indexers need to check P/E10 values daily or make allocation changes monthly. Nothing could be further from the truth. As Bogle says, allocation shifts should be made about once every 10 years on average.

“Can be done at very rare times”

I don’t entirely agree with Bogle’s characterization that a change made six times in an investor’s lifetime is a “very rare” change.

I don’t agree even a tiny bit with any hint of a suggestion that may be heard in these words that it is not of critical importance to make the infrequent allocation shifts (Where Bogle uses the word “can,” I would use the word “must”). The academic research shows that those six changes will permit the investor to obtain far higher returns at greatly diminished risk, delivering enough benefits in the typical case to permit the investor to retire five to ten years earlier than his Buy-and-Hold counterpart. That’s no small thing.

“So difficult to observe”

This language points to the course of Bogle’s confusion about this strategy, in my assessment. The suggestion is that investors will not know when they need to make the allocation shifts. But there is nothing even a tiny bit difficult involved in knowing when an allocation shift is needed.

The historical data shows that stocks are virtually a risk-free asset class when selling at fair value or less and are insanely dangerous when selling at two times fair value. Is there anyone who is not capable of understanding why he or she should be going with a lower stock allocation when the asset class is insanely dangerous than when it is virtually risk-free?

The other possibility is that Bogle is pointing here to the reality that the investor cannot know when prices will peak and then start heading downward. If that is the concern, the remark is entirely correct but betrays a misunderstanding of how Valuation-Informed Indexing works.

Valuation-Informed Indexers do not engage in short-term timing. We do not know when prices are likely to turn and we do not pretend to know. The fundamental principle that makes Valuation-Informed Indexing so powerful a strategy is that there is no need for investors to be able to time price shifts to be able to take advantage of the benefits obtained by investing more heavily in stocks when the long-term value proposition is strong and less heavily when the long-term value proposition is weak.

Bogle is not a Valuation-Informed Indexer. But I do not view him as being entirely unsympathetic to the concept. I believe that we will win Bogle over in time and that he will provide a huge help in promoting the strategy to millions of middle-class investors. I certainly hope that it turns out that way!

What are your thoughts?

Comments

  1. Jon Evan

    To me, Bogle’s remarks are cryptic and vague. It does him injustice to speculate what he is really thinking. Would he not be interested to explain these remarks more fully if asked?

    Regarding some ‘buy and holders’ with whom I have engaged they don’t necessarily completely practice what they preach. They do in fact take advantage of market downturns to time their rebalancing of their asset allocations and when confronted they get angry and say it’s just common sense!

  2. Andrew Hallam

    Hey Kim,

    I’m not sure if I would be considered a value indexer or not. To be honest, I don’t think I’m smart enough to know when stocks are at fair value and when they’re at double fair value so I probably wouldn’t fit the mold.

    I think it’s a lot easier (especially when markets are volatile) to simply rebalance a portfolio than trying to determine when it’s above or below fair market value. A lot of money, I believe, can be made by rebalancing when markets go nutty. And the only way I know of determining when they go nutty is when my allocation of stocks/bonds gets significantly out of alignment.

    Bogle isn’t a fan of rebalancing, suggesting that it doesn’t necessary work in the long run. He might be right. I don’t know.

    But about 12 years of rebalancing my portfolio has given me returns that exceed 12% annually, during the “lost decade”. Buying the lagging indexes every month, and rebalancing when things have gotten crazy (2001,2003,2008/2009) has been incredibly profitable. I didn’t wait until the end of the year to rebalance. I bought the lagging index every month (whether it was a stock or bond index) and if the markets sent my portfolio allocation to crazy levels of misalignment, I simply rebalanced.

    I’m not smart enough, as mentioned, to know fair value when I see it. But I can tell when my bond allocation rises to 60% of my total, versus the 40% target allocation that I have. When it does, I sell bonds to buy stocks, bringing my portfolio back to the allocation I initially set for it (no more, no less) During a long bull run, this wouldn’t work as well. I realize that. But I’m OK with that. Being frugal, investing over 20 years and rebalancing over the past 11 or 12 years has served me pretty well.

  3. Rob Bennett

    To me, Bogle’s remarks are cryptic and vague. It does him injustice to speculate what he is really thinking. Would he not be interested to explain these remarks more fully if asked?

    This is the best we are going to get out of Bogle for the time-being, Jon. I have written him three e-mails asking for clearer statements and not received a response. I also offered to make a presentation to one of the annual Bogleheads meetings at which Bogle appears and have Bogle respond to the points made. The leaders of the group responded to that one by shutting down the board and moving it to a new place where they could control who was permitted to speak and then banning me.

    Bogle says opposite things on valuations in almost every speech he gives. He always says that valuations affect long-term returns, which is true. But he also always says that investors do not need to change their allocations in response to big valuation swings, which cannot possibly be true if valuations affect long-term returns.

    The root problem here is that our understanding of how stock investing works is primitive. We put some important pieces together in the days when Buy-and-Hold was developed (for example, it really is so that short-term timing doesn’t work), but we did not at that time know all there was to know. In later years, we got more pieces to fit in an intellectual sense. But the people who had been promoting Buy-and-Hold did not want to admit that they had made mistakes in their first-draft effort. So we got no corrections. We are today in a strange Twilight Zone in which those who are familiar with the academic research know (at least intellectually) that Buy-and-Hold can never work but dare not say so publicly. Those who say so publicly are shunned by everyone else in the field because all feel embarrassed for the human misery they have caused (not by being wrong, which is nothing, but by not acknowledging the mistakes when they were brought to their attention).

    There is no injustice being done to Bogle by quoting his words. He sounds confused because he is confused. He very, very, very much wants to believe that Buy-and-Hold can work. He feels that his entire reputation is riding on this. But he is not able to explain the academic research of the past 30 years. Contrary to popular belief, there has never been a single study showing that timing doesn’t work. There are lots of studies showing that short-term timing doesn’t. But every study of long-term timing shows that it always works. So the statement “timing always works” is every bit as true as the statement “timing never works.” Whether timing works or not is entirely dependent on what form of timing it is that you are practicing.

    It is the people who advise Bogle to keep this covered up who are doing him a great injustice. Bogle is a giant in this field. He is responsible for perhaps a dozen of the most important insights in the history of stock investing. Valuation-Informed Indexing is the future. VII is as much John Bogle’s creation as it is Rob Bennett’s creation. All I did to develop VII was to take Buy-and-Hold and drop out the Get RIch Quick stuff (Bogle did not know it was Get Rich Quick stuff at the time he adopted it because the research showing this had not yet been done at the time). VII is going to permit all middle-class investors to retire five to ten years sooner than they can hope to today. It is a huge advance. And Bogle is going to get a huge portion of the credit for it. I am going to see to it.

    The only thing Bogle ever did wrong was to fail to make the changes when the research showed that they were needed. Bogle talks about this sort of possibility in one of his books. He says that, if ever he makes a mistake, he hopes that his friends will point it out to him. I am the biggest Boglehead in the world. I am the man’s friend. So I have done what he has said he wants me to do and what I would want him to do if the places were changed.

    Bogle is hurting himself today. He is human and he has given in to feelings of pride. We all are capable of doing such a thing. We all should be seeking clear answers from him, not to embarrass him but to get things back on the right track for him and for all the rest of us too.

    Bogle is in pain at the moment. He has done wonderful work for us for many years. He made one perfectly understandable mistake (there are lots of smart and good people who made the same mistake). He is now engaged in rationalization aimed at keeping knowledge of the mistake from others and even from himself (cognitive dissonance is a real phenomenon down here in the Valley of Tears). And the worse the economic crisis gets, the more pressure he feels.

    Bogle very much needs to offer a fuller explanation and to respond to questions and all this sort of thing. But he does not today possess the courage to do this. All of those who care about him (and about the survival of our economic system) need to do what we can to push him into doing what needs to be done as soon as possible. On the day Bogle walks to the front of the room and says those three magical words “I” and “Was” and “Wrong” (or even just “I’m” and “Not” and “Sure” — those slightly less magical words would also be enough to get the job done), all sorts of wonderful things begin to happen.

    We have dover the past 30 years developed hundreds of insights about how stock investing works that we are not today able to share with others because to do so would embarrass the Buy-and-Holders. The Buy-and-Holders did not mean to cause an economic crisis when they were starting out. They never imagined things turning out this way. We need to open the floodgates of knowledge and launch a national debate on what works in stock investing that will generate the greatest period of economic growth in our history. I have studied this subject in great depth for nine years now and I can tell you that the numbers suggest that, within six months of the day Bogle gives that speech, we will all be looking at the economic crisis in the rear-view mirror.

    We need to stop looking backward and start moving forward again. Bogle is a leader in this field and we need his help to get this done. Bogle wants to help, at least part of him does. We need to place our confidence in the better part of the man and implore that better part of him to get up on that stage and say what needs to be said. If enough of his friends get to work on this, it will happen. I have seen the last page of the book and I am pleased to be able to report that this one has a happy ending.

    Rob

  4. Rob Bennett

    when confronted they get angry and say it’s just common sense!

    There you go, Jon. That’s the entire story in a nutshell right there!

    We all possess two contrary emotional impulses. We all possess a Get Rich Quick impulse. And we all possess an emotional desire to make use of our common sense. The two are always at war with each other. This is the entire story of stock investing. This is what it is all about.

    Stock investors are capable of having the stock price be whatever they want it to be. All they have to do is bid prices up and it happens. We all want to be able to retire sooner. So in bull markets we all make a silent agreement to bid prices up to insanely dangerous levels. It’s like somebody cutting a chocolate cake up into small slices and pretending to themselves that they are not taking in any calories because the slices are all so small. It’s pure silliness. But we are drawn to this silliness by our Get Rich Quick urge.

    If the Get RIch Quick urge were all we had, prices would continue going up and in not too much time the market would become so dysfunctional that there would no longer be any market. But the humans also have an urge to follow their common sense! Sooner or later, that urge kicks in and we send prices tumbling down. That’s when we have major recessions and depressions. There has never been an economic crisis that was not preceded by super-high stock prices and there have never been super high stock prices that did not lead to a major recession or depression.

    Buy-and-Hold is the rationalization that we use to indulge in the Get Rich Quick impulse. There are no studies supporting it. That’s a myth. Ask for a link to the study supporting Buy-and-Hold and see what happens. I have tried this, I speak from experience. You’ll hear lots of mumbo jumbo excuses about why the study is not available for review just at this particular moment. Come back next Tuesday. We say that there is a study supporting Buy-and-Hold because this provides us with emotional satisfaction for a time. The Get Rich Quick impulse wants what it wants and so it makes up the idea that there are studies to rationalize decisions that give it what it wants.

    But, as you note, even the Buy-and-Holders see that Buy-and-Hold does not jive with common sense. So, just as you say, they make a million exceptions to the “rules” of the Buy-and-Hold approach. You’ll note that Buy-and-Holders never object to people who don’t follow the rules. It doesn’t bother them. Why? Because those people are not pointing out that there are no studies. So they represent no threat.

    It’s the people who take Buy-and-Hold seriously and ask to see the studies that are trouble. Buy-and-Hold is an emotional phenomenon. The Buy-and-Holders don’t want their ideas to be taken seriously and get angry with those who do take them seriously. Ideas that are taken seriously can be held to certain standards. What they want is to indulge that Get Rich Quick impulse, nothing more or less.

    Buy-and-Hold could never remain popular if people were pointing out the flaws. So we cannot have a bull market without adopting a Social Taboo on pointing out what the research really says. We all know intellectually that this stuff doesn’t work. But we have all learned through interactions with our friends and neighbors and co-workers that some things are just never said. So the charade continues for a time.

    However, it cannot continue indefinitely. Bull market gains are not real money. Those gains are cotton-candy gains fated to be blown away in the wind. The economic crisis that is causing so much human suffering today is the fruit of years of Buy-and-Hold thinking.

    I don’t say this to hurt people’s feelings. I say it to bring an end to the economic crisis. We cannot end the crisis until we begin talking seriously about what caused it. It wasn’t the Democrats and it wasn’t the Republicans. It wasn’t young people and it wasn’t old people. It wasn’t bankers and it wasn’t government regulators. It was all of us. We all either bought stocks at insanely inflated prices or watched others do so without speaking up about the dangers. So we all played a role.

    When we acknowledge that horrible truth, we all get to the other side of the Big Black Mountain. That’s where all the goodies are. It’s good stuff piled on top of good stuff piled on top of good stuff. It all becomes ours just by our becoming willing to say the Three Magic Words.

    The Buy-and-Holders don’t take Buy-and-Hold seriously. That’s what you are saying in your words above. You are 100 percent right. I could provide 100 links showing this. If the people who say they believe in this stuff don’t take it seriously, why should any of the the rest of us? I call it the most dangerous Get Rich Quick scheme ever concocted by the mind of mortal man because it pretends to be science. It is fantasy dressed up as science. That’s a combination guaranteed to cause trouble somewhere down the line.

    Rob

  5. Rob Bennett

    I don’t think I’m smart enough to know when stocks are at fair value and when they’re at double fair value

    I’m grateful to you for stopping by and putting forward some words expressing the other point of view, Andrew. Heaven knows there have been enough words in this thread coming from my side of the table!

    Rob

  6. Summer

    Buy-and-Hold is a religion with proper tenants, prophet and the rest of it just that way it is marketed. But we should always ask the question from one of buy-and-holders’ favourite books edited for clarity which is, where is your yacht?

    There should be as many early retirees in the buy-and-holders’ community as there is outside it so they are pretty normal if not worse. They just talk about retirement more giving a false picture of higher success among them.

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