The Valuation Informed Indexing Advantage
Valuation Informed Indexing offers a tremendous advantage. Here are some numbers based on the most likely values of P/E10 from Year 2000 to Year 2030.
From Year 2000
Back in Year 2000, P/E10=44 and the most likely return of stocks was 4.7% per year (real, annualized, total return) at Year 30. This is the baseline. It lifts the balance by 1.047^30 over the 30 year period.
In Year 2000, it was easy to buy TIPS with a coupon rate exceeding 3%. This lifts the initial balance by 1.03^10 over a ten year period.
In Year 2010, P/E10 is likely to be 8. If so, the most likely return of stocks over the following 20 years will be 12% per year (real, annualized, total return). This lifts the midterm balance by a factor of 1.12^20.
Using Valuation Informed Indexing over the 30 years, the TIPS-stocks combination lifts the original balance by (1.03^10)*(1.12^20)=12.96=(1.089^30). That is, the TIPS-stock combination using Valuation Informed Indexing lifts the most likely 30 year return from 4.7% to 8.9% per year real, annualized, total return.
Valuation Informed Indexing offers a huge increase: 4.2% per year over 30 years.
Along the Way at Year 20
Now let us look at what happens along the way at Year 20.
The Year 2000 stock investor had a most likely Year 20 return of 1%. At Year 20, his most likely real, annualized, total return would be 1.01^20. This is a factor of only 1.22 (plus inflation) over two decades.
Assuming that prices fall to P/E10=8 in Year 2010, the following Year 10 real, annualized, total return of stocks will be a mouthwatering 14.5%. The Valuation Informed Indexer can expect to see a return of (1.03^10)*(1.145^10)=5.2=(1.086^20).
At Year 20, the Valuation Informed Indexer is ahead by an amazing 8.6%-1%=7.6%.
The advantages of Valuation Informed Indexing are tremendous. They are already 4%+ based on a simple TIPS versus stocks comparison at Year 10. They will be a fantastic 7.6% per year (real, annualized, total return) at Year 20. They will still offer an advantage of 4.2% per year at Year 30 assuming that the correct decision is to remain in stocks.
John Walter Russell
July 23, 2009