by Rob Bennett
John Bogle says that it is okay for investors to stay at the same stock allocation at all possible valuation levels. If 75 percent stocks is right for you when stocks are priced low, 75 percent stocks is also right for you when stocks are priced fairly and when stocks are priced insanely high. So says the Buy-and-Hold model, of which John Bogle is the world’s foremost proponent.
Bogle permits an exception to the general rule, however. He’s not enthusiastic about the exception. But he is willing to tolerate a wee bit of market timing in unusual circumstances.
That’s his limit. His personal belief is that it would be best if you stayed at 75 percent at all times. But if you must engage in market timing, he acknowledges that you might not suffer horrible consequences so long as you never go to a stock allocation of more than 90 percent or less than 60 percent. Those are the bounds for the intelligent investor, in Bogle’s assessment.
The most likely annualized 10-year return for stocks in 2000 was a negative 1 percent real. IBonds were paying 4 percent real at the time. So each dollar that you moved from stocks to IBonds was likely to deliver an increased return of 5 percent real for 10 years running. That’s a total increased return of 50 percent. 50 percent!
And you should limit the extent to which you participate in this bounty by following a 15 percent limit on market timing —
Bogle has never said. He has cited the 15 percent rule on numerous occasions. He has never once explained where it came from.
I have a hunch.
I think he pulled it out of the air.
I really do. I think he recognized that an absolute prohibition on market timing sounds too dogmatic. So he felt a need to note an exception to the general Buy-and-Hold rule. But his heart wasn’t in it. So he made the exception so tiny that it’s not likely to make much difference. So long as none of his followers ever see much benefit from market timing (which they cannot if they limit their allocation shifts to 15 percent), it will be hard for anyone to appreciate how much following a Buy-and-Hold strategy sets an investor back and the dominant Bogle idea (that market timing is not required) will remain in effect.
I have a big problem with this analytical approach.
Buy-and-Hold is in theory a numbers-based strategy, a data-based strategy, a research-based strategy.
There are no numbers supporting the 15 percent rule. There is no data supporting the 15 percent rule. There is no research supporting the 15 percent rule.
If our analysis of the market timing question is to be based on the same solid foundation as is used to support many other aspects of the Buy-and-Hold strategy, we should look at the numbers to see how much market timing is called for in various circumstances.
When stocks are priced as they were in 1982, the most likely annualized 10-year return is 15 percent real. Those circumstances call for a stock allocation of 90 percent for an investor with a moderate risk tolerance. When stocks are priced as they were in 2000, the most likely annualized 10-year return is a negative 1 percent real. Those circumstances call for a stock allocation of 10 percent.
The difference between 90 percent and 10 percent is 80 percent. Bogle’s 15 percent rule makes zero sense. It is not supported by the numbers.
My sense is that most, perhaps all, Buy-and-Holders fall into the same analytical trap that caused Bogle to get this one so wildly wrong. Buy-and-Holders accept the reality that valuations affect long-term returns. They all do. I know because I have spoken with tens of thousands of them over the past nine years. My claim that valuations affect long-term returns never generates much questioning. We enjoy a consensus on that one.
The question re which we do not enjoy a consensus is the one as to how much of an allocation shift is needed when prices go to insanely high or insanely low levels. Holding up the historical data to a Buy-and-Holder on this question is like holding up a clove of garlic to a vampire. They can’t take it. They cannot take it!
The problem is that Buy-and-Holders respect numbers. Their entire strategy is numbers-based. So they feel very uncomfortable hearing what the numbers say about market timing. The numbers don’t say that a little market timing is needed every ten years or so, they say that a lot of market timing is needed every ten years or so.
Buy-and-Holders cannot deal with that reality. They like to think that investing is a rational enterprise. If it were, prices could never rise so high or drop so low that allocation adjustments of 80 percent would be needed. So the Buy-and-Holders refuse to look at the numbers that they suspect will stomp out their illusions.
The answer is to look at the numbers more often, not less often.
If we all looked at the numbers relating to market timing at all times, prices could never get so high or so low as to require an 80 percent allocation shift. The Buy-and-Holders need to work hard to remain true to their belief that numbers matter. If they did, Bogle’s 15 percent rule might work in the real world.
For so long as the Buy-and-Holders continue to run screaming from the numerical truths of market timing, stock prices will continue to swing from wild extreme to wild extreme and we will continue to find ourselves in circumstances in which Bogle’s 15 percent rule is revealed as crazy, no-good, terrible, mixed-up investing advice.