By Rob Bennett
One Thanksgiving a few years back, I got into a conversation with my brother Richard about stock investing. I told him about Valuation-Informed Indexing, about how it is possible to earn far higher lifetime returns while taking on dramatically reduced risk just by practicing long-term timing (adjusting your stock allocation in response to big shifts in valuations with the understanding that you may not see benefits for doing so for as long as 10 years). He was highly skeptical. He asked lots of good questions, and I did my best to respond to them. He never said that he was convinced. I would say that we ended the conversation by agreeing to disagree.
A few days later, I was talking to my brother Steven and I mentioned the conversation with my other brother. Steven told me that Richard had told him that he was impressed by what I said in the earlier conversation. I was surprised to hear this. If he had found my arguments compelling, why hadn't he told me so at the time I was presenting them to him? Why would he hold back on something like that?
I thought of it as a little mystery. And I have found that it is often by solving little mysteries that I have achieved important breakthroughs in my efforts to understand something. Today, I think I can say why Richard was reluctant to acknowledge to me that he was impressed by the case that I made for Valuation-Informed Indexing at that Thanksgiving dinner conversation.
I believe that evolution instilled in human beings a strong reluctance to break with the herd. Those who were separated from the herd lost the protections that follow from traveling with a herd and were killed by predators. We are followers. We check our tentative beliefs with others, and when others approve of them, we gain confidence in them. When others react in violently negative ways to our tentative beliefs, we reconsider. We put serious effort into the project of reconfiguring our beliefs to bring them back into accord with what our fellows signal to us is acceptable.
Richard is smart. He probably knows as much about stock investing as the typical intelligent investor, not much more and not much less. So he has heard the phrase "Timing doesn't work" enough times to believe that it must be so. So my claim that long-term timing is a positive, and indeed, even a necessary thing for investors who want to keep their risk profile roughly stable over time elicited a negative reaction from him. He figured that I must be mistaken, that I must have made an error in logic somewhere along the line that had caused me to come to believe in some shaky stuff. He made an effort to reveal the mistake by putting forward questions that he thought would make it clear. But he found himself unable to stump me. He found it hard to accept that the herd was wrong. But he couldn't put his finger on the reason why I was wrong. So he left the conversation impressed that I had been able to hold up my end of the argument as well as I had.
Humans are not only members of a herd. We are capable of putting our creative minds to work developing better ways of doing things. The herd was probably skeptical of fire on that magical day when one of theirs worked up the courage to try out his idea and see what sort of reaction it evoked. We are herd creatures capable of independent thought. We are creative minds who rein in our creativity with a fear of coloring outside the lines. We are two sorts of beings mixed into one. We are always reaching upward. And we are always looking about to see who is offended by our reaching so that we can knock it off if we learn that we need to stay out of trouble.
I believe that we learned something important in 1965 when Eugene Fama published his peer-reviewed research showing that short-term timing doesn't work. And I believe that we learned something important yet again in 1981 when Robert Shiller published his peer-reviewed research showing that long-term timing always does work. I long for the day on which we integrate the two powerful insights into what will be the first true research-based investing strategy, the first one developed at a time when both of the fundamental insights were available to us and at which we were thus finally capable of putting together something that truly will hold together for many years to come.
Getting there is a process. It would have been nice if everyone would have made the switch to Valuation-Informed Indexing when Shiller showed that it is just as important to practice long-term timing as it is to avoid short-term timing. But the herd doesn't take kindly to that way of doing things. The herd wants lots of time to think this one over. There have been lots of books published rooted in the old way of understanding how stock investing works. There have been lots of retirements planned in accord with that old understanding. There have been lots of careers built based on promotion of that old understanding. We are, as a people, in the process of making the transition from Buy-and-Hold to Valuation-Informed Indexing, but it is not a process that we are inclined to rush through.
It's so big. Next week's column will be my 400th at this site, and I have written hundreds more at other sites. If Shiller is right, we need to readjust our thinking on just about every stock investing question that has ever been considered. We are in the process of achieving a paradigm change. The herd says to go slow. Perhaps it is right to do so. Paradigm change is not something that one should take on rashly.
My brother Richard was struggling internally with the points that I was advancing at that Thanksgiving dinner. His intellect told him that there was something there. His respect for the herd belief told him to exercise caution in considering these seemingly reasonable, but yet possibly dangerous, ideas. That's why he was both genuinely impressed with the ideas he heard and yet strongly resistant to them. He needs to consider them from many possible angles before accepting them as real. We all do.