Market timing is either the key to long-term stock investing success or the worst idea imaginable. If you are a Buy-and-Holder, it’s the worst idea imaginable. If you are a Valuation-Informed Indexer, it’s key.
Is there life outside these extremes?
Q3 2019 hedge fund letters, conferences and more
In practical terms, yes. Few investors are dogmatic Buy-and-Holders and few investors are dogmatic Valuation-Informed Indexers. Most investors believe that valuations matter. But most also believe that Buy-and-Hold generally makes sense and are reluctant to engage in more than minimal amounts of market timing.
However, in theoretical terms, this middle position cannot be quite right. If the market is efficient, it really is foolish to engage in market timing; the odds that it will work out in the long run are nil. And, if valuations affect long-term returns, it is the idea of failing to engage in market timing that is foolish. If valuations affect long-term returns, market timing is price discipline and it is not possible for the rational mind to imagine a scenario in which it would not be a good thing to exercise price discipline when buying something.
I believe that market timing works. I believe that market timing is a plus. I believe that market timing is essential. I think that it is unfortunate that in a theoretical sense market timing is either all good or all bad because most investors are intrigued by the idea of engaging in market timing and would be perfectly happy to explore its possibilities if not for the fierce objections of the Buy-and-Holders, who view any consideration of the merits of market timing as a threat.
If the Buy-and-Holders are right, the safe withdrawal rate is always 4 percent. If the Valuation-Informed Indexers are right, it is a number that varies from 1.6 percent to 9.0 percent depending on the valuation level that applies on the day the retirement begins. Most investors can accept the claim that the safe withdrawal rate can drop below 4 percent but find it impossible to accept that it could ever fall to 1.6 percent. So, for time time being, the Buy-and-Hold number is generally accepted as legitimate.
I would like to see widespread discussion of the issue. If there were widespread discussion, we would see a range of positions expressed. Some would go with the 4 percent number, some would go with the 1.6 percent number, most would go with some number between those two. My guess is that the most popular choice would be a number somewhere near 3.5 percent, a number a good bit down from the conventionally cited one but also a number not nearly as shocking as the 1.6 number that I claim to be the accurate one.
My ultimate goal is to gain widespread acceptance of the 1.6 number. But I see that we would get there a lot quicker if people felt comfortable saying that they believe that the correct number is 3.5 percent. Once that became a choice that people felt comfortable citing in polite company, we would see more people suggesting that perhaps 3.0 percent is a better number. Then, in the next stage of discussions, we would hear arguments for the merit of 2.5 percent. In time, we would work our way to widespread acceptance of the 1.6 percent number that I have advocated for a good number of years now.
The trouble is that dogmatic Buy-and-Holders are able to sense where things will go once discussion of possibilities other than the good old 4.0 percent number are permitted. The 4.0 percent number has been around for a long time. And it has been promoted as a number that is the product of science. Scientific investigations are supposed to be hard and objective. If the number can change, it really wasn’t the product of science. And, if the number is not the product of science, then it can be almost anything. If the number is not obviously 4.0 percent, it could possibly even be something crazy like 1.6 percent. Buy-and-Holders cannot bear the thought that large numbers of investors will begin to think along these lines, so they do what they can to cut off debate before it produces any good fruit.
It’s a big jump from 4.0 to 1.6. And so it is a big jump from Buy-and-Hold to Valuation-Informed Indexing. And the human mind is skeptical of big jumps. People like to be converted to a new idea in steps. First a Republican comes to appreciate one idea put forward by Democrats. That makes it easier for him to accept a second Democratic idea at a later time. Then a third. One day, he wakes up thinking of himself as a Democrat across the board. Conversion is a snowballing process.
It is hard, though, to identify a middle-ground position between Buy-and-Hold and Valuation-Informed Indexing. John Bogle once gave it a shot. He once said that he could see how investors might get good results from changing their stock allocation six times over the course of an investing lifetime, three times when stocks were priced at crazy highs and three times when stocks were priced at crazy lows. That’s market timing! That’s Valuation-Informed Indexing! That’s what works!
Bogle was careful, though not to show too much enthusiasm for the idea. His tone suggested that, while the idea might well produce good results, Buy-and-Hold was also a perfectly good approach and there was no reason why investors should feel bound to consider crazy new ideas. So his effort at compromise died on the vine. No Buy-and-Holders showed as much excitement over the effort at compromise as I did.
I am as extreme in my belief in Valuation-Informed Indexing as my Buy-and-Hold critics are in their belief in Buy-and-Hold. So I see where they are coming from. Middle-ground positions don’t have theoretical support. Either Fama is right or Shiller is, it cannot be that both are a little right and a little wrong. But it is hard for the human mind to process the thought that the Buy-and-Holders got it so wrong that they condemned market timing when it is in reality the key to successful long-term stock investing. So we are where we are.
Rob’s bio is here.
