Valuation-Informed Indexing #130
by Rob Bennett
Buy-and-Hold never works.
I make that claim all the time. I say that the 140 years of historical return data available to us today backs me up.
Lots of good and smart people don’t buy into what I am saying.
Huh? What’s the disconnect?
Buy-and-Hold never works for an investing lifetime. That’s what I mean when I say that Buy-and-Hold never works. That’s what matters. Obtaining good results for limited time-periods won’t help you finance your retirement. You need a strategy that works for 60 years or so (say, from age 25 to age 85). Anything that doesn’t work for that long doesn’t do the job.
But that’s an unusual standard. That’s not a standard that most people apply when they are trying to determine whether something “works” or not.
A household appliance that works for five or ten years works, period. warranties rarely cover longer time-periods. Most of us don’t think it is fair to demand that a good or service provide good results for 15 years or 20 years or 25 years.
Buy-and-Hold has in the eyes of many been working for 30 years.
The bull market began in 1982. Stocks provided amazing returns until 2000. We experienced a slow-leak crash from 2000 through 2008. People didn’t like that but they didn’t get too upset about it; the amazing returns for the earlier 18 years were good enough to make it possible to overlook eight years of so-so returns.
Then we saw the price crash. That shook people up in a serious way. But stocks have bounced back to some extent over the past four years. You would have been better off had you switched to TIPS or IBonds in the late 1990s. But not by all that much. It’s possible for a reasonable person to look at the performance of stocks over the past 30 years and conclude that the strategy works.
My argument is that we should not be looking at three decades of price performance to answer the question. The entire benefit of using academic research to guide our strategies is to help us to go beyond subjective impressions, which are heavily influenced by recent price trends. Research gives us something objective to look at. We should make an effort to rise above our knowledge of how things have played out in recent decades, look at the entire record of 140 years, and use the data to answer the more fundamental question -- How does this business of investing in stocks really work in the long run?
The problem with what I am recommending is that the idea of using the academic research to inform our views is a new idea. People have only been studying stock investing in a systematic way for 50 years or so. So all findings are tentative and have not been subjected to sufficient scrutiny to justify calling them “proven.” So I do think you should be skeptical of my claims. The other side of the story is that I think that you should be skeptical of the claims of the Buy-and-Holders as well. Neither model has been proven. Both models are rooted in limited amounts of research.
My worry is that too many of us have come to feel excessive confidence that the Buy-and-Hold Model explains how stock investing works. There was no research-supported model prior to the development of the Buy-and-Hold Model. So it is understandable that people were drawn to it. But it is a terrible mistake to place excessive confidence in a model that has not been proven. A strategy that appears to be rooted in science but isn’t is more dangerous than a strategy that is known not to be rooted in science because the thought that science supports the strategy can cause investors to stick with a failing strategy far longer than they would in other circumstances.
Buy-and-Hold always fails because it encourages investors not to exercise price discipline. Buy-and-Holders believe that stocks are a good investment at any possible price. So they don’t even take price into account when deciding on their stock allocations.
No market can work without price discipline. Price discipline is the magic that permits markets to do the good stuff they do. Take away price discipline and the stock market always crashes hard enough to bring on an economic crisis.
But not right away!
The market can operate for many years without price discipline before it crashes. That’s the tragic reality. That’s why so many of us get sucked in.
Our investing crisis is much like our budget crisis. The reason why there is little alarm in Washington about out-of-control deficits is that people have been ringing alarms about out-of-control deficits for years and we somehow have managed to just keep on keeping on. The problem gets worse over time. But, as the problem gets worse, the ability to tune out those raising concerns grows stronger and stronger.
I have hopes that this will be the last time we will experience a crash. We have recovered from earlier crashes without knowing what brought on the crashes. This time we will know. We now have three decades of academic research showing why Buy-and-Hold can never work. We have tuned it out for a long time but there will be no reason to tune it out after the next crash comes. And, once we acknowledge what the research says, it is hard to see how stocks could ever again become so overpriced as to bring on a crash and an economic crisis.
So the long-term looks promising. If we can only survive one more stock crash!