Buy-and-Hold is dangerous.
It took me a long time to work up the courage to advance such a frank assessment. Most investors follow an investment strategy that is at least in part influenced by the Buy-and-Hold concept. So saying that Buy-and-Hold is dangerous is a surefire way for someone writing about investing to get off on the wrong foot with the majority of people that he is hoping to reach.
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Also, I believe that the ideas brought to the world by the Buy-and-Holders have advanced our understanding of how stock investing works in many important ways. When I find fault with Buy-and-Hold, I am finding fault with a collection of ideas that I believe contains many positives. I don’t enjoy the feeling that comes from separating myself from people whom I think of as friends. So I say that Buy-and-Hold is dangerous only with a great deal of reluctance.
But I do say it. I have come over time to believe that it is not possible to offer effective investment advice without addressing the ways in which the Buy-and-Hold idea has led investors to a dead end. Buy-and-Hold is dangerous. That needs to be said. It’s not a matter that can be ducked forever.
Buy-and-Hold is dangerous because it blocks us from learning things that we need to learn.
I am the person who discovered the errors in the Buy-and-Hold retirement studies. I pointed out back in May 2002 that the conventional safe-withdrawal-rate studies do not contain valuation adjustments. If Shiller is right that valuations affect long-term returns, it is not possible to calculate the safe withdrawal rate accurately without taking the valuation level that applies on the day the retirement begins into consideration (since the long-term return obtained on the portfolio obviously affects the amount that can be safely withdrawn from it each year). There are two responses to the discovery of the errors in these studies that would have been acceptable.
One, the studies could have been quickly corrected to include valuation adjustments. That would have been the ideal, in my assessment. That’s the response that I hoped for (and expected to see) at the time.
But there is another response that I believe today would have been at least acceptable. Cognitive dissonance is a real phenomenon. There are lots of articles in the psychology literature showing this to be so. I often point out that Shiller has referred to his research finding that valuations affect long-term returns as “revolutionary” in scope. It is that. It is revolutionary changes that are most likely to cause cognitive dissonance on the part of those emotionally invested in old ways of thinking about things. The Buy-and-Holders believed in the days before Shiller’s research that they had discovered how stock investing works. They were shocked to learn that perhaps they did not have it all quite figured out perfectly. Given this reality, I think it would have been acceptable if the Buy-and-Holders continued to say that they believe that the safe withdrawal rate is always 4 percent while also noting that there is another school of academic thought that holds that valuations affect long-term returns and that according to this school the safe withdrawal rate is a number that varies with changes in valuation levels.
The Buy-and-Holders did not get behind either response. There are a good number of individuals who did. It has been gratifying for me to see a good number of ordinary investors and a not insignificant number of experts endorse my work on safe withdrawal rates. But the studies claiming that the safe withdrawal rate is always 4 percent have not been corrected and no cautionary language has been added to the studies noting that an analysis containing valuation adjustments would have produced very different results. The vast majority of investors who go searching on the internet for information on safe withdrawal rates don’t even learn that there is any controversy re how the Buy-and-Hold studies were put together.
Buy-and-Hold is a research-based approach. And it is a numbers-based approach. That is what I love about it. I was a Buy-and-Holder myself once upon a time. I once went looking for an investment strategy that was rooted in something more than one person’s personal opinion and, when I discovered that Buy-and-Hold was rooted in science, I knew that I had found my home. Only in subsequent years did I discover the downside of rooting an investment strategy in objective, research-proven realities.
The downside is that science does not stand still. We thought we knew how stock investing worked in the 1960s and 1970s, when Buy-and-Hold was being developed and popularized. Then we learned in 1981 that our fundamental beliefs were not nearly so solid as we had once imagined, The trouble with a numbers-based model is that, if mistakes are made, the model produces numbers that are wrong. The certainty that goes with an objective approach becomes illusory. A model that produces false numbers retains the appearance of objectivity but no longer is animated by the spirit of a scientific endeavor. Science that is not corrected for a long period of time becomes anti-science.
I believe that we are going to achieve all of the good that Buy-and-Hold promised in its earlier days and I believe that we are going to see that good was achieved through the work of many good people doing many good things. But I also believe that we are going to need to see a good bit of human suffering before we will as a society work up the courage to launch the national debate that we need to have to sort out whether it is Eugene Fama’s research or Robert Shiller’s research that points us to the essential realities of the stock investing project.
Until then, we need to try to gently steer people in the right direction. Have the Buy-and-Holders taught us all many important truths about stock investing? Without a doubt. I never hesitate to say so and I never hesitate to encourage others to say so, But are there things that the Buy-and-Holders got wrong in the event that Shiller is right that valuations affect long-term returns? That is also undeniably so. And so it must be observed from time to time that Buy-and-Hold is in this transition period a set of ideas that contains hidden dangers for investors who accept the entire concept whole without knowing of the realities presented by the last four decades of peer-reviewed research in this field.
Buy-and-Hold is a wonderful advance going through a time-period in which it carries with it significant dangers for those who have not thought through carefully the entire story and moving toward a day in which fixes will be made to render it an even bigger wonderful advance in days to come.
Rob’s bio is here.