Value Investing

Buy-and-Hold Will Fall All At Once Rather Than Gradually

Valuation-Informed Indexing #177

by Rob Bennett

It shouldn’t have played out this way.

Buy-and-Hold was an important advance.

Before Buy-and-Hold, there was little systematic study of how stock investing worked. Lots of people put forward their opinions. But stock investing was not the subject of much University study. So you never really knew whether the research you were looking at was the real thing or just the product of a marketing campaign.

Buy-and-Hold changed all that. Buy-and-Hold brought some standards to the investing advice field. You no longer could have four equally qualified experts advancing four conflicting ideas about how stock investing works. By rooting their strategies in what the peer-reviewed academic research says, the Buy-and-Holders insured that we would stop going around in circles and that knowledge would advance over time.

Then there was The Mistake.

There was never a study that showed that timing doesn’t work. Buy-and-Holders still say that to this day. But there never was even a tiny grain of truth to the claim. There were studies showing that short-term timing doesn’t work and the Buy-and-Holders jumped to the conclusion that neither short-term timing nor long-term timing works. The first person to test whether long-term timing works was Yale Economics Professor Robert Shiller in 1981. His research showed that long-term timing ALWAYS works. The Buy-and-Holders ignored that finding and continued advocating strategies rooted in their false belief that timing in general either doesn’t work or isn’t required for long-term success.

There are a number of things that should have happened following the publication of Shiller’s research. The Buy-and-Holders should have expressed great concern that their model might have been built on a shaky foundation and that they might be giving bad investing advice as a result. There should have been a call for lots of follow-up research aimed at determining whether the market is efficient or whether valuations affect long-term returns (it can’t be that both things are so!). There should have been lots of books written and lots of magazine articles published exploring the strategic implications of Shiller’s finding (which are breathtakingly far-reaching). There should have been a national debate on the question of how the Buy-and-Holders got it all so wrong and about what we need to do to insure that we are protected from mistakes with such frightening public policy implications in the future.

We played it precisely the opposite way.

We covered up The Mistake. Buy-and-Hold remained the dominant model for 32 years after it was discredited by the peer-reviewed academic research even though the findings of the peer-reviewed academic research are supposed to count for something in this field.

We have seen a change since the 2008 price crash. Today’s investors fear for their financial futures. Today’s investing analysts are abashed over the thunder they employed to power their dubious assurances that we could survive the out-of-control bull market of the late 1990s, that this might be the first bull in history that would not end badly. People are looking for a way out today.

But how do we turn this thing around at this point? In 1981, we could have said “oopsie!” and started over. That hardly flies three decades down the road. Millions of lives have been destroyed because of our reluctance to come clean re our mistakes for those 33 years. What would have been very easy to do in 1981 has become very, very, very hard to do in 2014.

So the cover-up continues. We tell ourselves that valuations might matter a little bit but not enough to destroy the retirement plans of those who follow the advice advanced by the Buy-and-Holders. We know of no research supporting this idea. But what alternative is there, given the 32-year delay in getting the errors in the dominant strategy fixed?

It’s not a happy story.

But I believe that it’s important that we look for an optimistic angle to give us some hope that we can set things right in coming years.

The good news is that lots of smart people who have been reluctant to speak out for years now have all the while been thinking over these matters in their own minds. Had the ordinary course of business applied, it probably would have taken 10 years for us to have completed the transition from Buy-and-Hold to Valuation-Informed Indexing. Shiller’s finding really was “revolutionary” (the word he uses to describe it). It was a shock and even in the best of circumstances a society cannot absorb a surprise of that magnitude in just a few months or even in just a few years.

So in ordinary circumstances Valuation-Informed Indexing would have become the dominant model in the late 1980s or the early 1990s. Given the 32-year delay, we are not now going to have to wait until the year 2024 to being reaping the benefits of the first true research-based strategy.

Given the 32 years of growing doubts re Buy-and-Hold that have been kept quiet, I believe that we will now be able to make the transition to the new model in six months or a year or at most two years.

That’s good news because it does not seem likely that we are going to have much time. Stock are priced for a price crash of 65 percent. The collective loss of consumer buying power will be in the trillions. We saw political friction from both the left (the Occupy Wall Street Movement) and the right (The Tea Party Movement) following the 2008 crash. The next one will hit a lot harder and will bring on a far more intense version of the story we saw in 2009 and 2010.

But the transition to Valuation-Informed Indexing should settle things. That next crash will permit us for the first time to tap into the benefits of the wonderful move led by the Buy-and-Hold Pioneers to general acceptance of research-based strategies.

We cannot afford to take 10 years to make the transition given the 32-year delay in our getting to work to make good things happen. Fortunately, it appears that there is good reason to believe that we won’t need to. A job that would have taken 10 years to complete had it been tackled promptly is probably not going to take more than a year or two to bring to completion when we finally are forced to get serious about it.

Rob Bennett has recorded a podcast titled Bogle and Valuations . His bio is here.

  • RobBennett

    This comment makes no sense, Sammy. Robert Shiller is the grandfather of the Valuation-Informed Indexing concept. He is the researcher who discovered that valuations affect long-term returns and that long-term timing always works and is always required. All of the work I have done over the past 12 years explores the implications of Shiller’s “revolutionary” (his word) finding.

    I wish you well.


  • RobBennett

    I am not able to help you out, Sammy.

    You are being argumentative. And I of course recognize you from the Goon Central board. You have a long history of posting with bad intent.

    I pushed a button to delete your post. But it appears that there is some sort of quirk in the system and it did not go away.

    I naturally wish you the best of luck with whatever investing strategies you elect to pursue in any event.


  • Sammy Soda

    Shiller says it is not good for timing the market……period. He is 50% invested into the market. Based on this, he would not be as you describe as a “valuation-informed indexer”.

  • Sammy Soda


    You haven’t answered my questions. Is there a fund that has traded with your strategy. Yes or no? What Buffett is doing is NOT based on anything close to what you are saying. Third, you have not answered my questions about the 65% number you have thrown out.

    Please try again.

  • RobBennett

    Hey, Joe! It’s great to see your name here!

    Yes, I expect the price drop to go down to 8 or possibly even lower.

    That is NOT rational. The rational thing is, as you suggest, that we fall only to fair value.

    The reason why my expectation is that we will go a lot lower than that is that today’s investors are NOT rational. We are close. We now have the research available to us to build a model that would help us become rational. But that has been so only since 1981 and the huge bull market has been holding up progress for a long time now.

    The big distinction between Buy-and-Hold and Valuation-Informed Indexing is that Buy-and-Hold PRESUMES. It also posits that price changes are caused by unforeseen economic developments and that thus risk is stable. Valuation-Informed Indexing posits that price changes are caused by shifts in investor emotion and that risk VARIES with changes in valuation levels.

    Emotional extremes beget emotional extremes. It was extreme for us to go to a P/E10 level of 44 in 2000. We are now working through the emotional fallout. The emotional fallout doesn’t take us just to fair value but well below that. We have been through four of these bull/bear cycles. Every single one has taken us to a P/E10 of 8 or lower. There has never once in U.S. history been an exception.

    To understand why, you need to consider the effect of bull markets on the larger economy. Bull market money is Pretend Money — it doesn’t last. But business owners and consumers treat that money as real. So hundreds of thousands of businesses that cannot possibly succeed once the Pretend Money disappears are built. And millions of consumers spend Pretend Money on cars and houses and vacations. When the Pretend Money disappears (it always does), all of that spending power is removed from the economy. The market contained $12 trillion of Pretend Money in 2000. We are in the process of seeing all that Pretend Money disappear.

    The disappearance of $12 trillion in consumer spending power ALWAYS caused a recession or a depression. What else could happen? THere have been four secular bull markets in U.S. history since 1870 (that’s as far back as we have records) and there have been four economic crises since 1870. There has never yet been a bull market that did not bring on an economic crisis and there has never yet been an economic crisis that was not preceded by an out-of-control bull market.

    The good news here is that, now that we know what causes economic crises, we can bring an end to them. We need to educate investors as to how stock investing really works, according to the last 33 years of peer-reviewed academic research. Once we do that, there can never be another bull market. Each time the value proposition of stocks drops very low, investors will sell stock and that will bring prices back to fair-value levels. Stock market prices are self-correcting so long as investors don’t come to believe that Buy-and-Hold strategies (strategies in which investors do not exercise price discipline when setting their stock allocations) can work in the long term.

    Super question!


  • RobBennett

    Valuation-Informed Indexing has provided far superior returns at greatly reduced risk compared to Buy-and-Hold for 140 years running, Sammy. You can check out the data at Shiller’s site.

    Yes, Buy-and-Hold posits that we cannot predict market ups and downs (market timing). There is now 33 years of peer-reviewed academic research showing that this claim is false. It is true that short-term timing (changing your stock allocation with the expectation of seeing a benefit in a year or so) never works. But long-term timing (changing your stock allocation in response to big valuation shifts with the understanding that you may not see a benefit for up to 10 year ) ALWAYS works and is ALWAYS 100 percent required. If you fail to engage in long-term timing, you are failing to exercise price discipline and you are permitting your risk profile to get wildly out of whack. There is no worse mistake you could make as an investor.

    You are wrong in your idea that there has been some dramatic change in market valuations recently. Stock prices dropped a bit below fair value in early 2009, then rose. We have been priced for a crash ever since because prices always drop to one-half of fair value at the bottom of a secular bear market.

    When I say that confidence in Buy-and-Hold will collapse quickly, I am not referring to stock prices. I am talking about the transition that we are in the process of making from a discredited model for understanding how stock investing works to the first true research-based model. If men were angels, that transition would have begun in 1981, when Shiller showed that valuations affect long-term returns (which means that Buy-and-Hold cannot possibly work for even a single long-term investor — if valuations affect long-term returns, the investor’s risk profile changes with changes in valuations and an investor who is unwilling to change his stock allocation (a Buy-and-Holder) is deliberately causing his risk profile to go wildly out of whack). Buy-and-Hold remained dominant because the Pretend Money created during the bull market made it popular. But. once the Pretend Money disappears, so will the only thing keeping Buy-and-Hold alive. The intellectual case for Buy-and-Hold was defeated over 30 years back.

    I could write a book on the cover-up of the errors of the Buy-and-Hold Model (and I am!). I am the person who discovered the errors in the Old School safe withdrawal rate studies. I put up a post reporting on those errors on May 13, 2002. There is universal agreement today that the studies are in error. But not one of the discredited studies has not yet been corrected! That’s the cover-up in a nutshell. Investors don’t press for corrections because they like believing in the Pretend Money created by high valuations. It is of course foolish for people to use retirement studies that get the numbers wrong. But millions have done it and many continue to do it today. We humans are drawn to Get Rich Quick strategies!

    Buffett doesn’t say what you here say that he says. He of course opposed short-term timing, as do I. But Buffett ALWAYS looks at the value proposition he is purchasing when he buys stocks. Valuation-Informed Indexing is a combination of the core insights of Buffett and Bogle. Buffett’s Value Investing is the best strategy of all, in my assessment. The problem with it is that most middle-class people do not possess the skill needed to execute it well. Bogle’s Buy-and-Hold is very simple but never works in the long run because it ignores value propositions. Valuation-Informed Indexing works because it focuses on long-term value propositions but it is every bit as simple as Buy-and-Hold, if not more so. Buffett and Bogle go together like chocolate and peanut butter!


  • RobBennett

    Shiller is still in the market.

    Following a Valuation-Informed Indexing strategy means adjusting your stock allocation in response to big shifts in valuation levels, Sammy. Ir doesn’t mean necessarily mean getting entirely out of the market even when valuations are very high.

    Note that he says that CAPE is not good for timing the market.

    The reference is to short-term timing. No Valuation-Informed Indexer believes in short-term timing. We agree with the research findings on that point that short-term timing never works. We have the Buy-and-Holders to thank for that one.

  • Sammy Soda

    Just saw this article:

    Shiller is still in the market. Note that he says that CAPE is not good for timing the market.

  • Sammy Soda

    Rob says “There was never a study that showed that timing doesn’t work.”

    We can all look in reverse and see various scenarios that could have worked and provided superior returns. That is why we always look at actual results of a strategy that has been implemented. Can you show us anyone that has followed this strategy over a long period of time so that we can look at the end results? We can do that with strategies that have been labelled as buy and hold. The idea behind buy and hold is that we cannot predict the market ups and downs (market timing). On a related note, I recall reading all these same points from you over two years ago. At that time, I believe you also stated that the market was set to drop 65%. The market is considerably higher now, yet you are still using the same figure of 65%. If you are factoring this on the market metrics, I would expect that your calculation would be different. Is this just a talking point or are you saying your calculations in the past were incorrect?

    Secondly, what facts support your statement that buy and hold will fall all at once versus gradual drops. I don’t agree with you that we are going to see some drastic drop like you are suggesting, but if I just go ahead with your assumption, what specific facts tell you that the drop is going to be a fall all at once versus gradual drops?

    Third, what facts do you have to back up your comments that there is some “cover up”. You repeat the comment, but I see nothing to support it. Like I said before, we can look at a number of buy and hold strategies that have been successful. Guys like Warren Buffett tell us that the we can’t time the market and would be much more successful with buy and hold. Are you saying Warren Buffett is in on the cover up or is just dumb when it comes to investments?

  • JoeTaxpayer

    65%? Aren’twe at a Shiller 26 P/E with a potential target of 16 or so? Do you expect the correction to swing past equilibrium on the down side that far? To a P/E of 9?