Free Ebook.

Enter your email address:

Delivered by FeedBurner

« Manage Your Finances and Think Like a Millionaire | Main | Does Your Will Leave Money to Charity? »

May 19, 2012


Feed You can follow this conversation by subscribing to the comment feed for this post.

The Shiller P/E ratio helps determine the expected forward-looking return of an investment or index, not if you should be in or out of the markets. Another measurement is the forward-looking P/E ratio. It uses projected earnings for the next 12 months.

Thanks for posting this article. I advocate Valuation-Informed Indexing. I have had a hard time convincing people of the merit of it because it is at odds with the conventional Buy-and-Hold approach. So anything that questions the conventional thinking on asset allocation questions is a plus in my book. People need to revisit a lot of the fundamental questions that we once thought had been settled for all time.

If I understand properly what is being proposed here (I am not sure that I do), you are using not only P/E10 but ALSO a forward P/E1 number. I am a HUGE believer in using P/E10 to make allocation adjustments but I am also highly skeptical of the idea of using forward P/E1 instead of P/E10 or in conjunction with P/E10.

If you are using forward P/E1, you are engaging in short-term timing. That is, you are making an allocation change based on an assessment of current market conditions that you expect to see produce a payoff within a year or two. My personal view is that the Buy-and-Holders are right that short-term price movements are entirely unpredictable. There is a large body of research showing that long-term market timing always works but that short-term market timing never does (at least that is my understanding of what the research says).

I apologize if I am misunderstanding the concept being advanced here. In any event, I am certainly grateful to see a thought-provoking article presenting some fresh asset allocation ideas.


>Tilting dynamically between asset categories can boost returns even more than asset allocation.

I see the following potential problems:

#1 It is a lot more complex than rebalancing to a fixed asset allocation. Unless there is great evidence I prefer to keep investing simple. Complex system that look good from the limited historical data available today can end up in deep trouble tomorrow, like mortgage-backed securities:
Mortgage-backed securities looked like they couldn’t fail based on all of the available data. However it eventually did fail horribly because the system changed: The value of the securities were calculated using data that did NOT include a time when anyone with a pulse qualified for a mortgage and did NOT include a huge drop in house prices. Those two factors made the default rates shoot up dramatically and the securities plummeted in value.

#2 If you write out equations there are going to be a fair number of adjustable parameters in the Marotta allocation method. Even if you are using the right metrics to predict an “optimum strategy” you also have to figure out the right constants. Even if you have enough data to fit the constants, I wouldn’t be surprised if the constants varied over time. There may be no reliable way to calculate the constants without knowledge of the future.

#3 It isn’t clear that the Marotta method will perform better than a fixed asset allocation. For example when the market behaves irrationally it can do so for a long time- like the .com bubble. The Marotta allocation method would move away from the wildly appreciating tech stocks near the start of the bubble. That is fine for lowering volatility, but you also miss out on gains of a fixed asset allocation strategy. The fixed asset allocation strategy could capture some of those gains by rebalancing before the market crash.

-Rick Francis

The comments to this entry are closed.

Start a Blog


  • Any information shared on Free Money Finance does not constitute financial advice. The Website is intended to provide general information only and does not attempt to give you advice that relates to your specific circumstances. You are advised to discuss your specific requirements with an independent financial adviser. Per FTC guidelines, this website may be compensated by companies mentioned through advertising, affiliate programs or otherwise. All posts are © 2005-2012, Free Money Finance.