Buy-and-Hold Rules Out the Possibility of Investors Exercising Price Discipline When Buying Stocks

12
Buy-and-Hold Rules Out the Possibility of Investors Exercising Price Discipline When Buying Stocks
Mediamodifier / Pixabay

What is my beef with Buy-and-Hold?  It’s that it is a discipline indifferent strategy. If you don’t time the market, you are going with the same stock allocation regardless of the price at which stocks are selling. That makes no sense. How could price not matter? We consider price when buying everything else we buy. How could it be a good idea to ignore it when it comes to buying stocks? It’s worse than that. Buy-and-Holders aren’t just price indifferent. They are outright hostile to the idea of exercising price discipline when buying stocks.

 

They say that timing doesn’t work (this is true of short-term timing but not of long-term timing). They suggest that investors who elect to lower their stock allocation at times when prices are high will somehow “miss out” on stock gains as a result. To my mind, practicing long-term market timing is exercising price discipline. I have a hard time imagining how exercising price discipline could cause me to miss out on anything good. It is of course possible that stocks could provide good returns even starting from times when they are overpriced.

Hedge Fund Launches Jump Despite Equity Market Declines

Last year was a bumper year for hedge fund launches. According to a Hedge Fund Research report released towards the end of March, 614 new funds hit the market in 2021. That was the highest number of launches since 2017, when a record 735 new hedge funds were rolled out to investors. What’s interesting about Read More

Risk-Reward

But I would be taking on more risk to obtain those returns. So long as results are assessed on a risk-adjusted basis (as they always should be, in my view), it is a logical impossibility that long-term timing could ever not work.

But the poor results that Buy-and-Hold offers to the individuals who follow the strategy is only the small part of the story. The more significant downside is what a widespread belief in Buy-and-Hold does to the market as a whole and to the economy as a whole and ultimately to the confidence that citizens of our nation have in our system of government.

Robert Shiller predicted the 2008 economic crisis. He stated in March 2000 that: ““If, over some interval in the first decade or so of the twenty-first Century, the U.S. stock market is going to follow an uneven course down, as well it might – back, let us say, to its levels in the mid-1990s or even lower – then individuals, foundations, college endowments and other beneficiaries of the market are going to find themselves poorer, in the aggregate by trillions of dollars. The real losses could be comparable to the total destruction of all the schools in the country, or all the farms in the country, or possibly even all the homes in the country.” It was the widespread promotion of the Buy-and-Hold strategy that pushed stock prices high enough to cause him to advance that warning.

2008 Crash

Tens of thousands of entrepreneurs saw their businesses fail in that economic crisis. Millions of workers lost their jobs. And millions saw their hopes for financial security in their old age diminished. Investment strategies that discourage price discipline cause a lot of pain for the unfortunate humans taken in by them.

I’ve written here before about the craziness of price crashes. It’s understandable that we would see prices go up a bit at times and down a bit at times. But price drops that cause trillions of dollars of wealth to disappear overnight should simply never happen. Such price dops cannot be explained rationally. They are the product of shifts in investor emotion. And it is the “idea” that it is not necessary to practice price discipline that makes investors so emotional as to cause such price drops. The human mind is not capable of ever fully accepting the idea that price doesn’t matter when buying stocks. Sooner or later, confidence in that idea fails and the pretend gains caused by years of price indifference go “Poof!”

Price discipline is what makes markets work. The core job of a market is to get prices right. The reason why capitalism is a more productive system than communism is that prices are set by a small number of people in a communist economy while the brains of millions of consumers collectively set prices in a capitalist economy. Our system works better than the competition because our system sets prices better.

Exercising price discipline in a fluctuating market

We toss that advantage away in our stock market. When investors are taught that it makes no difference whether stocks are priced at one-half of fair value or at fair value or at two times fair value or at three times fair value, the market is not able to impose any penalty for mispricing. That might seem like a good thing in the short term. But it is a very bad thing in the long term. The entire history of the market shows that eventually it will set prices properly, at a CAPE value of about 16.

The longer that magic is delayed, the harder it is to accept the change when it comes. If we all exercised price discipline on a daily basis, price levels could never move too far from fair-value levels and we would never have to endure the pain associated with a long bear market. That would be a better world.

I often wonder why it is that so many smart and good people see no problem with an investment strategy that rules out the exercise of price discipline as a core principle. I believe that there are two things going on. One, there can be a long delay between the time when prices first get out of hand and when the market resets them to more reasonable levels; prices got out of hand in 1996, more than 20 years ago. And, two, it makes strong intuitive sense to believe that the numbers on one’s portfolio statement reflect reality.

Exercising price discipline and today’s investors

If Shiller is right that valuations affect long-term returns, today’s portfolio statement numbers overstate the real and lasting value of our stock holdings by 100 percent (stocks are today prices at two times their fair value). That’s a reality that is hard and scary to accept, regardless of how many decades of peer-reviewed research support it.

Shiller has described the intellectual leap from the finding that short-term price changes are unpredictable (University of Chicago Economics Professor Eugene Fama showed this in research published in the 1960s) to the Buy-and-Hold belief that the market sets prices properly as “one of the most remarkable errors in the history of economics.”

Andrew Smithers,  co-author of Valuing Wall Street,  has written: “It is sad that the idea that price doesn’t matter…should ever have been seriously considered.” Price discipline is essential to the proper functioning of all markets. The stock market is not the first exception to this universal rule, despite anything that our Buy-and-Hold friends say about the subject.

Rob’s bio is here.

Updated on

Rob Bennett’s A Rich Life blog aims to put the “personal” back into “personal finance” - he focuses on the role played by emotion in saving and investing decisions. Rob developed the Passion Saving approach to money management; Passion Savers save not to finance their old-age retirements but to enjoy more freedom and opportunity in their 20s, 30s, 40s, and 50s - because they pursue saving goals over which they feel a more intense personal concern, they are more motivated to save effectively. He also developed the Valuation-Informed Indexing investing strategy, a strategy that combines the most powerful insights of Vanguard Founder John Bogle and Yale Professsor Robert Shiller in a simple approach offering higher returns at greatly diminished risk. Tom Gardner, co-founder of the Motley Fool web site, said of Rob’s work: “The elegant simplicty of his ideas warms the heart and startles the brain.”
Previous article New AR filter calls people to demand that ‘malaria must die’
Next article Apple Watch Series 5 vs Series 3: Why the older one is a better buy

No posts to display

12 COMMENTS

  1. The only thing I agree with is your statement about a failed retirement being a serious life set back. That is what happened to you. You caused your own failed retirement. You seem to want to blame someone else.

    John Greaney did not cause your retirement failure. You were wrong about John as has been explained over and over again. I think you just keep targeting John as he publicly humiliated you and, as such, he has been the focus of your attacks.

  2. My very first post on investing, which I put forward over 17 years ago, noted that the retirement study posted at John Greaney’s web site lacks an adjustment for the valuation level that applies on the day the retirement begins. The study has not been corrected to this day. But the reality is that thousands of people have looked at that study over the past 17 years and NOT ONE has been able to identify a valuation adjustment in it. What does that tell us, Sammy?

    That’s amazing. There is no other word for it. Getting the numbers right in retirement studies is an amazing advance. People use retirement studies to plan their retirements. A failed retirement is a serious life setback. So getting the numbers right in retirement studies is a big deal.

    And please understand that it is not only people who used the Greaney study to plan their retirement who were misled by the methodology used in that study. Greaney used the same methodology as was used in the Trinity study, a peer-reviewed study that was used as the basis for THOUSANDS of newspaper articles that people used to plan their retirements. There are MILLIONS of people who used the discredited Buy-and-Hold retirement studies to plan retirements.

    Pointing out that error was a very, very big deal. Pointing out that error was nothing short of amazing. And that was just the first day. My post pointing out that error was advanced on the morning of May 13,2002! I have had thousands and thousands and thousands of follow-ups in the years since.

    We need to get this stuff right, Sammy. There’s no getting around it. And it is not possible that both Fama and Shiller are right. They are saying opposite things! We need to as a people figure out which of the two of them is right and which of the two of them is wrong. The only way to do that is to launch a national debate re these matters. Suppressing discussion gets us nowhere. We need to permit discussion. And then we need to go a step further and actually ENCOURAGE discussion.

    That’s my sincere take, in any event.

    Rob

  3. I’ve done amazing work, Sammy. I have been told so by many big-name experts and also by many ordinary investors. I’ll get compensated for it down the road. People earn big incomes when they add significant value with their work. I have done that. So I will wait for the compensation.

    I obviously wish that there had not been a delay. But the delay just shows me how important it is that we open up every site on the internet to honest posting re the last 38 years of peer-reviewed research in this field. If people who came before me had stuck to their guns and insisted on their right to post honestly, the things that happened to me never would have happened. So I am helping out the many who will come after me by insisting on MY right to post honestly.

    When everyone feels comfortable saying what they believe, we all will be learning like crazy and we all will be better off. Anytime someone gives in to intimidation tactics, we all as a nation take a step back. Anytime someone insists on his or her right to post honestly re the last 38 years of peer-reviewed research, we all as a nation take a step forward.

    I am very proud of the work that I have done. Yes, I want to be compensated for it. But getting compensated immediately is not the test of whether work is good or not. The fact that I have not been compensated for such good work shows that the need for people to stand up for themselves is very important in this field. It makes the work more valuable. And I am confident that down the line a bit it will make the compensation paid for that work bigger.

    But we’ll see, you know?

    I naturally wish you all the best that this life has to offer a person, in any event.

    Rob

  4. I say that people should stay in the market even when stocks are priced high but not at the same stock allocation. If valuations affect long-term returns, then stock investing risk increases as prices increase. Investors who want to maintain a constant risk profile MUST practice market timing to achieve that goal.

    I don’t think that Buy-and-Holders have done well at all. The peer-reviewed research that I co-authored with Wade Pfau shows that Valuation-Informed Indexing strategies have been far superior to Buy-and-Hold strategies for as far back as we have good records of stock prices. As Wade concluded at the end of our research project: “Yes, Virginia, Valuation-Informed Indexing works!”

    Rob

  5. No, your work is not amazing. That is why you haven’t earned anything. You seem to recognize this as you have said you need to go back to work. You just can’t admit to it.

    Just stop a minute and look at this. You have spent two decades trying to convince people you are some expert or thought leader on investing, yet you have not owned stocks during that time and your retirement plan failed.

    Maybe you should shift gears. Why not show people your mistakes and how they can learn from them.

  6. Funny how you avoid talking about your failed retirement plan. Like always, you change the topic by repeating previous lies, that have all been addressed before.

    Maybe you should spend your time on your job search.

  7. Shiller said in the days following the 2008 crash that investors should not get back into stocks until the CAPE level dropped below 10. That’s market timing, Sammy.

    I don’t agree with you that Buy-and-Holders did well following the crash. I agree that most BELIEVE that they did well. They believe that because they count the numbers on their portfolio statement as real. They do not divide by two to adjust for the effect that irrational exuberance has on those numbers at a time when stocks are priced at two times their real value. Make that adjustment and you come to very different conclusion.

    That’s the dispute. Does irrational exuberance produce real. lasting value? Or is it just a temporary thing that fools investors into thinking for a time that they are richer than they are and to make poor financial planning decisions as a result.

    This is a critical question. We all need to know the true value of our portfolio. Do we need to adjust for the effect of irrational exuberance or do we not? That’s the entire different between Buy-and-Hold and Valuation-Informed Indexing. Buy-and-Holders say that there is no need to make an adjustment. Valuation-Informed Indexers say that adjustments are needed.

    My best wishes to you.

    Rob

  8. Wrong again, Rob. Shiller has continued to say that people should stay in the market. You have been given this link time and again. Buy and holders have done well. We can see the returns. You have said many times that you are not a numbers guy and now you again confirm this by the silly statements you make.

    In comparison, we can go back and see the numbers YOU used for your retirement plan. We can then see how your retirement plan failed and how, after the age of 60, you need to return to the job market.

    It is really a joke as to how you talk about others having a poor financial plan, when your plan has gone down in flames.

  9. Buy and holders did great with the 2008 crash. Take a look as to how they have been rewarded with the market rise since that time. Buy and holders, by definition, held their position and kept on buying when stock were low and continued to buy thereafter. Market timers, like Rob Bennett, have not done well. Robert Shiller tried to warn them by telling them to not use CAPE for timing the market, yet some are not willing to listen.

Comments are closed.