1) Long-Term Stock Returns Are Highly Predictable.
All the historical return data shows this. It’s been true for 140 years. But people have the hardest time believing it. No one can predict where stock prices will be next year. How the devil can it be possible to know where prices will be in 10 years just by looking at today’s P/E10 level?
It’s possible because it is investor emotion that determines stock prices and investor enthusiasm for stocks rises and falls in highly predictable long-term patterns.
2) There’s No Way to Make Lots of Money Quickly by Taking Advantage of This Reality.
Say that someone opens his mind to the idea that maybe long-term stock returns really are predictable. The next thought that pops into his head is that, even if this really were so, lots of people would have discovered it long before he did and would be making lots of money exploiting their superior knowledge. By doing so they would have caused price changes that would have shut down this anomaly of stock-market pricing.
Nope.
It’s true that long-term prices are highly predictable. But there’s no way to get rich quick taking advantage of this reality. It can take 10 years for prices to get to the place toward which P/E10 tells you they are headed. Short stocks when prices are high and you will get your head handed to you. Leverage your purchases when prices are low and you will go broke before the upturn comes along. Knowing where stock prices are headed supplies little edge in the short term.
3) The Long-Term Edge Gained by Knowing Where Stock Prices Are Headed Is Huge.
People lose interest in the idea of knowing where stock prices are headed once they learn that it can take as long as 10 years for this approach to investing to pay off. Anything that takes that long to produce good results can’t make much of a difference. Can it?
It makes a huge difference. That’s because of the power of compounding. Set your allocation by making reference to where prices are headed in the long run and you may only earn an extra point or two of real return each year. But over the course of an investing lifetime an extra point or two of real return makes all the difference in the world. Valuation-Informed Indexing turns the power of compounding returns to the investor’s advantage in the way that saving regularly turns the power of compounding returns to the saver’s advantage.
4) This Powerful Investing Technique Remains a Secret Today Even Though It Was Discovered 30 Years Ago.
I’m not telling you anything new. It was Yale Economics Professor Robert Shiller who discovered that today’s P/E10 level reveals to us the stock return that will apply 10 years from today. So why doesn’t every investment advisor recommend Valuation-Informed Indexing? Why doesn’t every personal finance magazine tout the idea on its cover?
The idea remains a secret. Why? From 1981 through 2000 we experienced the greatest bull market in U.S. history. No one was looking for a better way to invest in stocks in those days. And from 2000 until 2008 stocks did not perform poorly enough to make people forget the bull market. It’s only since the price crash of late 2008 that people have begun to open their minds to a better way to invest. And the idea has not yet gained enough momentum to replace the Buy-and-Hold concept in the minds of most investors.
5) Long-Term Market Timing Will Always Work.
Investors have grown properly skeptical of market timing claims. Show someone the research proving that long-term market timing has always worked and the reaction you are likely to hear is that it will stop working once enough people discover it.
That can’t happen.
Actually, it could be that long-term market timing will stop providing excess gains. That’s a real possibility. If all investors become long-term market timers, Valuation-Informed Indexers will from that day forward earn only the average long-term stock returns — That’s 6.5 percent real for the U.S. market.
But wait. Think what happens to stocks if we all become long-term market timers. Volatility disappears. A market in which investors pay attention to price when setting their allocations is a market in which prices become self-correcting. A market in which volatility disappears is a market in which risk disappears.
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There may come a day when Valuation-Informed Indexers earn returns no higher than other investors. But Valuation-Informed Indexing will still work on that day. In fact, it will work better than ever. It would be an amazing deal to be able to obtain a return of 6.5 percent real from stocks while taking on no more risk than what is taken on by those who invest in money market accounts. I pray for the day when all other investors discover the smart, simple and safe way to invest.
6) Investing Is a Community Endeavor.
Think about what has been said up above. I become a better investor not by outsmarting you and all other investors. I become a better investor by teaching you what works and by learning from you what works.
Investing does not have to be a dog-eat-dog game. In fact, it cannot be that if we are to achieve our highest potential as investors. The market is a tool by which we allocate capital to businesses that require it to grow. That tool performs its job more effectively when we are ALL investing effectively. I want you to do well. And, if you are truly a smart investor, you want me to do well.
It’s all very hard to believe. But I sincerely believe it is all true all the same.
Thanks for your comment, Brian.
I took a quick look at the site. I am not sure what specifically you are referring to.
Purple Chips appears to favor investing in individual stocks that meet certain tests. I don’t say that picking individual stocks can never produce good results. I believe that some people (like Warren Buffett) do it successfully. However, I think it adds an element of risk to stock investing that those who invest in index funds avoid. I believe that the average investor is better off in index funds.
If you followed the Purple Chips approach and it worked, you probably would get higher returns. But I would say that, if it didn’t work, you probably would get lower returns. By going with an index fund, you don’t need to be concerned about how any individual companies do. All that you need to be concerned about is that the U.S. economy as a whole remains roughly as productive as it has always been in the past. I believe that that takes a great deal of the risk out of stock investing.
If there is something more specific that you are concerned about that I am not addressing in my comments here, I hope you will let me know. I only looked at the site briefly.
My best wishes to you.
Rob
I want to preface my comment with the fact that I do believe in Index Fund investing. I’m an EMH-believer.
Eventually, when too many people hop on the index bandwagon, prices will increase simply because of demand (Asset Theory), negating above-average returns for new entrants.
Further, I’m not a strong EMH believer; I’m a weak EMH believer. Back in February, long before the Facebook IPO actually happened, I had all the information necessary to know that it was a poor investment – it would be overpriced relative to its actual value and potential trade (if you’d like a link to that blog post I’d be happy to provide it, but I don’t want to look like a spammer). It was the crazy bubble-esque mentality that drove the IPO so high; the reality that it was hype should have been priced into the stock according to EMH, since a rational forward-looking individual could have foreseen the inevitable result.
In the end, dividend investing is what counts. No matter what happens to the price (capital gains), you’re getting paid by dividends. Capital gains are a nice-to-have, but betting on them is SPECULATION, not investing.
Thanks much for sharing your thoughts, Joe.
Rob
Thanks for your kind comment Joyce.
Rob
Great post. I learned from a successful investor once that his main strategy was to invest in America’s best companies, and then never to sell unless you absolutely needed the money.