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 How to of Valuation-Informed Indexing: Part One and The How-To of Valuation-Informed Indexing: Part Two).
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?