A Rich Life

The Old Ideas on Saving & Investing Don't Work -- Here's What Does

Academic Researcher Wade Pfau: “Now That I Am Accounting for Risk, I Am Even More Amazed by How Well Valuation-Informed Indexing Works… Why Haven’t Academics Already Published Research About This?”

by

Yesterday’s blog entry reported on an e-mail that I sent to academic researcher Wade Pfau on February 21, 2011. He responded on February 24, 2011.

He said: “Now that I am accounting for risk, I am even more amazed by how well Valuation-Informed Indexing works. I’m so confused by why Fisher and Statman didn’t consider risk in their idiot switching tests.  VII is much less risky by pretty much any standard I consider.  I must wonder… did I make a mistake somewhere?  Why haven’t academics already published research about this?”

Wade provided a link to a Bogleheads Forum thread he started:

http://www.bogleheads.org/forum/viewtopic.php?p=970705#970705

He also set forth a link to an exchange he had with Drip Guy, one of the lead Goons:

http://www.bogleheads.org/forum/viewtopic.php?t=68683

He said: “He never responded to me.  But have you ever heard him express before that he essentially has a backup plan for the 4% rule, and that is to start cutting withdrawals should the need arise?”

“”If You Can Get Over the Fact That He Compared You to the Potato Famine and the Black Plague, I Think You Can Find a Compliment Buried in His Remarks”

by

Yesterday’s blog entry reported on an e-mail that I sent to academic researcher Wade Pfau on February 16, 2011. He responded on February 21, 2011.

He noted that there was a thread on safe withdrawal rates in progress at the Bogleheads Forum. He said that a poster named “sscritic” mentioned me. He also said that: “If you look carefully at DRiP Guy’s response and can get over the fact that he compared you to the potato famine and the black plague, I think you can find a compliment buried in his remarks.  Is it your first complement from him?  Perhaps progress is being made.”

Wade sent a follow-up e-mail in which he said that he now realized that he had misunderstood Drip Guy’s comment. He explained: “I thought he was complementing your idea of SWRs and valuations, but maybe he was just acknowledging the development of the Bogleheads board.”

My response is set forth below:

Wade:

That’s okay. I’m grateful for your kindness in letting me know of what you thought for a time MIGHT have been a compliment from Drip Guy.

The fact that I was responsible for the founding of the Bogleheads Forum amazes me. it is not possible! Buy yet it is so!

There have been a few times at the Goon Central board where Drip Guy has put forward words that could be interpreted as backhanded compliments of me (mixed in with heavy helpings of abuse). There was one not too long ago where he said that, even if I am right that all of what I say follows from Shiller’s findings, Buy-and-Hold still is not a Get Rich Quick approach because those following it did not intend to be following a Get Rich Quick approach. Implicit in his post was a hint that he does not entirely dispute my claim that what I say follows from what Shiller says (he would not acknowledge that publicly, of course).

The Bogleheads SWR Wiki contains unacknowledged backhanded compliments of me too.

It’s always nice to hear from you. You keep fighting the good fight!

Rob

Academic Researcher Wade Pfau: “Though I Was Only Trying to Do an Old-School Safe Withdrawal Rate Study, All That I Ended Up Doing Was Showing in a Different Way What You Had Been Saying All Along — The SWR Changes With Valuations”

by

Yesterday’s blog entry reported on an e-mail sent to me by academic researcher Wade Pfau on February 22, 2011. On February 15, 2011, I received an e-mail from Wade on a different topic, his research on safe savings rates.

He said: “You and DRiP Guy realized immediately about my new paper what it took me a few days to come to grips with: though I was only trying to do an old-school SWR study, all that I ended up doing was showing in a different way what you had been saying all along: the SWR changes with valuations.  I guess I’m cursed by valuations now 🙂 I hope my paper can help that idea get acceptance, since I don’t really mention valuations in it, but once people get warmed up to the idea, they will realize, as I did, that valuations are the driving factor.  But perhaps it is better for people to realize that for themselves, rather than to point it out to them directly.”

I sent my response the following day. Here is the text:

Wade:

We are ALL cursed by valuations!

My true belief is that we are all BLESSED what we have learned about valuations. Unfortunately, for the moment it FEELS like a curse.

It’s possible that coming at the valuations question from an indirect angle might help you slip through the radar. I wouldn’t bet big money on it. But there’s certainly no harm in trying something new. And in any event I think that looking at things in this way highlights some new points. So I very much see this as being a highly positive thing.

I agree to a point with your statement that “the biggest risk of VII is that a prolonged boom leaves you sitting on the sidelines too long.” It doesn’t do this if it is followed in a reasonable way. But if someone overacts, this is indeed a serious risk. The answer here is not to avoid discussing the strategy. The answer is to discuss it with enough care so that people come to understand how it works.

There are two competing realities. One reality is that stocks are generally the best asset class. Anytime you lower your stock allocation, you are going against that reality. So it would be fair to say that you better have a good reason for going against that reality.

The other reality is that the riskiness of stocks increases with increases in valuations. This is ALSO an important reality. It’s not the only reality but it is not a reality that may safely be ignored.

The trick is to keep BOTH realities in mind when making stock allocation choices. It cannot be done right any other way. It is unbalanced to consider either of the realities in isolation.

I think this can be compared to raising kids. We all know parents who set zero boundaries and whose kids suffer as a result. And we all know parents who come down too hard and whose kids suffer as a result. We just have to accept that it is possible to come down too hard and that it is possible to come down not hard enough and to try to avoid the extremes.

So it is with considering valuations when setting one’s stock allocation. It is possible to give valuations too much consideration and it is possible to give valuations too little consideration.

What people are missing is how EXTREME Buy-and-Hold is. Buy-and-Hold takes the most extreme position possible (don’t adjust for valuations at all!) and puts it forward as the norm. Nothing could be more irresponsible, in my view. We should all be giving people all the help we can supply re balancing the competing considerations. No one should be arguing the merit of one side of the story being the only one that can be heard.

Rob

Academic Researcher Wade Pfau: “No Matter What I Try, Valuations-Based Strategies Tend to Produce the Same or Greater Returns at Lower Risk Than Fixed Allocations”

by

Yesterday’s blog entry reported on an e-mail sent to me by academic researcher Wade Pfau on January 21, 2011. The text of my response follows:

Wade:

I would of course be thrilled if you called the paper “Valuation-Informed Indexing.”

There is no question in my mind that the paper MERITS inclusion in the Journal of Finance. I have no idea how these things are decided, so I have no idea whether they would take it. But this is as new as it gets and as important as it gets and as solid as it gets. So by rights it should be in the #1 journal.

Rob

My next e-mail to Wade was sent on February 22, 2011. The text follows:

Wade:

I came across this

http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2011/02/21/stay-out-of-the-room.aspx

today. Ed is a great guy. He participated in a long interview/discussion with John Walter Russell and me at the old SWR Reseaerch Group board a good number of years ago. Actually, all community members were welcomed to participate. But the discussion was boycotted and those who showed an interest in participating were intimidated into not doing so. All the same, Ed and John and I had a great time talking about all the various issues.

Ed’s new book looks like it is going to be a barn-burner!

Rob

Wade responded the same day. He said that he intended to read both Easterling’s old book and the new one.

His e-mail stated: I’ve been plugging away with the valuations stuff.  No matter what I try, valuations-based strategies tend to produce the same or greater returns at lower risk than fixed allocations.  I’m using a number of formal risk measures to show this now.”

He also noted that Felix Salmon has written a review of his safe savings rate paper.

In a follow-up e-mail, Wade said that he did not plan to use my terminology of referring to allocation shifts based on valuations as “strategic” rather than “tactical,” which is the common practice, but said that he wanted to make note of the distinction in a footnote to the paper.

In my response, I noted that Felix has once written a kind review of The Stock-Return Predictor.

In his response, Wade linked to Felix’s review and commented “Yes, that’s a good one.” He observed that Felix did not refer to the allocation shifts as “market timing,” and offered the view that this is “nice to see.”

Academic Researcher Wade Pfau: “You Deserve Much of the Credit [For My Research Findings] As the Whole Idea of Valuation-Informed Indexing Belongs to You”

by

Wednesday’s blog entry reported on an e-mail that academic researcher Wade Blog sent to me on January 20, 2011. The text of my response is set forth below:

Wade:

I just saw the entry at your blog. It’s stunning. It’s so good and raises so much promise that it scares me to let in the words put forward there. It’s going to take some time for the full impact to hit.

I hope that this is the thing that opens the door (my heart has been crushed re this matter many times in the past). If it is, or if it loosens the door enough so that someone else is able to swing it open with one more further little push, we are going to see some amazing things in days to come.

You obviously get it re valuations. But my experience with this is that, the deeper you go with it, the more you learn; the potential here is truly beyond belief — we are on the threshold of the development of a new and improved free market economic system (if people are able to learn about the effects of valuations, significant levels of overvaluation become a logical impossibility, which means that the economic crises that follow from times of extreme overvaluation are avoided).

I’ve had the strange experience for nine years now of seeing both the most wonderful things I have ever seen and the most awful things I have ever seen combined in the same grand debate. I sure would like to see forces set in motion that let the good stuff become dominant and the bad stuff to be pushed into a far-off corner.

My deep thanks for the breakthrough and inspiring work you have put forward. You’ve helped many, many people.

Rob

Wade responded later the same day. He thanked me for my comments and said: “Of course you deserve much of the credit as the whole idea of Valuation-Informed Indexing belongs to you.” He added that Stein and DeMuth have examined similar ideas but noted that ” they were too caught up in that 100% stocks /100% bills idea for it to be useful for long-term conservative investors.  You are the one who laid out strategies like 30-60-90 that will be the basis for all my simulations.”

Wade asked: “Do you mind if I call the paper “Valuation-Informed Indexing”?  I thought that would be the best name for it, and of course I would credit you as the originator of the term.” His e-mail stated: I have been toying with the idea of sending the paper to the Journal of Finance, which is the most prestigious journal in academic finance. There is a high chance that they will reject the paper for publication, but I think it is worth a shot.  At any rate, I am hopeful that the eventual paper can be published in a good academic or practitioner journal, and that will help bring more recognition for these ideas.  If it is in a good journal, Robert Shiller might even read it.”

Wade Pfau: “Bennett Desperately Wants Someone Besides Him to Say That the Trinity Study Needs to Be Corrected, But I’ve Explained That This Isn’t How Research Works”

by

Academic researcher Wade Pfau has posted a blog entry making a remarkable claim — John Greaney was right all along in his safe withdrawal rate claims and Rob Bennett caused all the trouble by not promptly acknowledging this! The blog entry is called Valuations and Withdrawal Rates.

Juicy Excerpt #1: Yes. If you want to keep using 4% it is up to you, but what was ultimately shown by people applying Campbell and Shiller’s regression methodology to this question is precisely this outcome suggested by intercst. This is the end of the debate. So what have people been discussing for the past 10 years? I think the answer lies in the misstep hocus took in his follow-up reply later that afternoon.

Juicy Excerpt #2: Current conditions matter more than historical averages, stocks are risky even over the long term, and markets are unpredictable.

Juicy Excerpt #3: It is why financial economists find it so perplexing to discuss the concept of a safe withdrawal rate. There isn’t one. The U.S., even since 1871, represents a rather unique period in world history. The worst-case that showed up during this time can hardly be expected to be representative of the future.

Juicy Excerpt #4: He just finished explaining why we don’t have enough data to have a good understanding about the full range of potential outcomes, and then he wants to torture the data more by trying to define different safe withdrawal rates for different valuation levels based on even more limited subsets of data? Though creative, it doesn’t work.

Juicy Excerpt #5: I do think valuations may help gain insights about what the withdrawal rate will be, but this certainly does not make the estimates safer.

Juicy Excerpt #6: Hocus desperately wants someone besides him to say that the Trinity study needs to be “corrected,” but I’ve explained that this isn’t how research works. Rather, new studies with new methodologies come to replace old studies. This is a case, however, in which old studies were already available to suggest that we shouldn’t project the findings of the Trinity study forward to future retirees.

Juicy Excerpt #7: A number of leading financial economists (including Zvi Bodie, Laurence Kotlikoff, Moshe Milevsky, William Sharpe, and others) have condemned the 4% rule. Financial economists do not respect the Trinity study for a variety of reasons.

Juicy Excerpt #8: Just as historical withdrawal rate outcomes don’t guarantee future safety, the relationship between valuations and withdrawal rates can change as well. We are still prone to black swans.

Juicy Excerpt #9: Past is not necessarily prologue. Don’t treat the predictions coming from a model incorporating valuations as a guaranteed annuitization rate from your portfolio, especially when trying to extrapolate outcomes when valuations reach previously unseen levels. Trying to estimate safe withdrawal rates after incorporating valuations does not “correct” anything. End of story.

There was a discussion of Wade’s post at the Goon Central board. The thread is titled Wade Pfau Sets Hocus Straight.

I posted the following words as a comment to the blog entry, but Wade deleted them:

Hocus desperately wants someone besides him to say that the Trinity study needs to be “corrected,” but I’ve explained that this isn’t how research works.

This is shameful stuff, Wade. I am very disappointed in you.

You’ve visited the Motley Fool’s Retire Early board. If you look at more than that single thread, you will see that there were threads appearing at that board on a daily basis in which my fellow community members were relying on the 4 percent rule to plan their early retirements. Those people are in very bad shape today. Not because they did anything wrong. They did the right thing. They checked the research. The research told them that their early retirements were “100 percent safe” (that’s the phrase used in Greaney’s “study”). We owe those people nothing, according to Wade Pfau. Rob Bennett very much does not agree.

Was a retirement that began in January 2000 and that took a 4 percent withdrawal safe or was it not? There are 20 places in your words above in which you indicate that you don’t think it was safe. And yet there is no need for a correction in the studies that caused millions of middle-class people to believe they were doing something safe when they were in fact doing something wildly risky?

I don’t know precisely what the ethical standards in your profession call for in this sort of situation, Wade. My common sense tells me that there are standards that address this sort of behavior. You know about the death threats and defamation and other intimidation tactics that Lindauer and Greaney have been employing for 10 years now to silence discussion of these questions. You shouldn’t be aligning yourself with them in any way, shape or form, I know that much for certain.

If Shiller is right (and there is now 30 years of research backing up his findings), we are in the early days of this economic crisis. We have another 65 percent price drop ahead of us. People are not going to find the safe withdrawal rate “joke” so funny when we are all living through the Second Great Depression.

I have the greatest possible respect for the research you did on the effect of valuations on long-term returns. I have told you that I think it merits a Nobel prize and I stand by that assessment today. I have long considered you a personal friend and I cherish that friendship and I still call you a friend today.

But today I need in conscience to say that you are a friend of whom I am ashamed.

I of course wish you the best in all your future endeavors and hope that there comes a day when we will be able to look back at these sad and difficult times and laugh at the foolishness we displayed in our behavior at the time. Please take good care.

Rob

“I Was Thinking About Taking Taylor [Larimore] to Task for This [Mischaracterizing Bogle’s Position]…. Other People Have Already Pointed It Out to Him and He Doesn’t Seem to Care.”

by

Yesterday’s blog entry reported on an e-mail that I sent to academic researcher Wade Pfau on January 20, 2011. Wade responded the next day.

He said: “If you do have any suggestions about how I explained why long-term market timing works, but not short-term market timing, I would love to hear it.” He added, though, that he did not want me to have to retype points I had already made in materials at my web site. He explained that: “I think this is something you’ve addressed in your various articles, and I will read everything before finalizing my paper.”

Re Larimore’s mischaracterization of Bogle’s position, Wade said: “I was thinking about taking Taylor to task for this, but in the end I’ve decided not to. That guy is over 80 years old and he seems to be a bit of a follower. I don’t really feel a need to argue with him at this point. Especially since other people have already pointed it out to him and he doesn’t seem to care.”

Wade told me that he had “big news.” He had posted preliminary results of his research:

http://www.bogleheads.org/forum/viewtopic.php?t=67093

He noted that “Richard disappeared after I took him to task about being full of it with regards to ‘standard statistics.’ ” He explained that: “I think on those message boards that all those guys repeat that mantra so much that they do not think it is standard statistics, when in fact the issue of rolling periods is a rather advanced topic well beyond the reaches of Statistics 101, and their assumptions are not necessarily right.”

Academic Researcher Wade Pfau: “Two Papers by FIsher and Statman Are Still All I Can Find That Provide Evidence Against Long-Term Market Timing”

by

Yesterday’s blog entry reported on an e-mail that I sent to academic researcher Wade Pfau on January 17, 2011. Wade responded on January 20, 2011.

He described a thread that he started at the Bogleheads Forum:

http://www.bogleheads.org/forum/viewtopic.php?t=67093

He said that it was not his intent to start a debate on the merits of Valuation-Informed Indexing since he hadn’t yet finished his research paper. However, he wanted to know if anyone was aware of studies concluding that Valuation-Informed Indexing does not work. He explained that: “Once I finish my study, I would like to refer to the concept as Valuation-Informed Indexing, but I called it long-term market timing in this post since I really was trying to avoid controversy and just uncover more background reading materials.” He reported that: “Two papers by Fisher and Statman are still all I can find that provide evidence against long-term market timing.”

“I Have Not Been Able to Find Anyone Who Has Made a Serious Effort to Explore the Practical Strategic Implications of Shiller’s Work. It’s Just Been Sitting There Waiting for Someone to Jump On It.”

by

Yesterday’s blog entry reported on an e-mail sent by academic research Wade Pfau to me on January 16, 2011. My response is set forth below.

Wade:

Your last sentence is the amazing thing. I cannot get over this. Shiller’s book was very well received and it has been out for over 10 years. But I have not been able to find anyone who has made a serious effort to explore the practical strategic  implications of Shiller’s work. It’s just been sitting there waiting for someone to jump on it.

The subtitle of the paperback version of Shiller’s book is: “The National Bestseller That Revolutionized the Way We Think About the Stock Market.” So it should not be a surprise to anyone that agreement with these ideas leads to the adoption of new strategies.

In fairness, this didn’t hit me either for a long time. I just kept drilling in different areas and then one day it hit me that the common thread was that everything I did was an attempt to identify strategic implications of Shiller’s findings. The reason this is controversial is that no one has done this before. People want to see it approved by experts before they go with it. Somebody needs to go first to get the ball rolling.

I do not have the ability to do research and have no interest in developing that ability. My aim is to be the journalist who tells the story of the shift to the new model and who explains to the typical middle-class investor what the research that
will be done means for him or her. I need to have people do the research so that I can demonstrate to readers that experts have signed off on all this.

It’s an exceedingly odd story. But that’s indeed where things stand, so far as I am able to figure all this out.

Rob

“I Definitely Need to Cite [You] as the Founder of Valuation-Informed Indexing…. Shiller Pointed Out the Predictive Power of P/E10 But Never Discussed How to Incorporate It Into Asset Allocation.”

by

Yesterday’s blog reported on an e-mail that I sent to academic research Wade Pfau on January 16, 2011. Wade responded later the same day. He endorsed John Walter Russell’s characterization of a paper purporting to show that long-term timing does not work as testing “idiot switching.” He said: ” ‘Idiot switching.’  That is great, and describes exactly what the Fisher and Statman paper does.  You and John have a great knack for coining new terms.  I think VII is a much better term than any alternatives I’ve come across.” He added that he did not think it would be appropriate to use the term “idiot switching” in an academic paper.

Wade also reported that “as always, I will be reading all your links.” He said: “I definitely need to cite some of your work as the founder of VII, as I have not found anyone else who can lay claim to that.  Shiller pointed out the predictive power of PE10 but never discussed how to incorporate it into asset allocation, as far as I know.”