Robert Shiller published his “revolutionary” (his word) research challenging the Efficient Market Theory and the Buy-and-Hold investment strategy that follows from it in 1981. From 1981 forward, the S&P 500 had provided an annualized real return of 8.1 percent. That’s why Buy-and-Hold remains popular to this day.
If you count from 2000 forward (because that’s when prices for the current bull/bear cycle peaked), you get a different story. The annualized real return for those 20 years is only 3.7 percent. That’s a good bit off from the historical average return of 6.5 percent real. Those 20 years of sub-par returns has left the retirement accounts of millions of investors underfunded compared to the expectations that were formed in the late 1990s. Two decades of dramatically sub-par returns has a counter-intuitively big effect because the compounding returns phenomenon is diluted for that time.
Still, the reality that has more influence on the thinking of most investors is that Buy-and-Hold has produced even bigger returns than expected in the post-Shiller era. An 8.1 percent real return for nearly 40 years is amazing. There’s no other word for it. There are millions of investors who today feel that they have Buy-and-Hold to thank for putting them in a position in which they will be able to retire when they hoped to be able to do so (or for retirements that have already begun).
On top of that, the return for the past 10 years has been 11.2 percent. The one time in the post Shiller era when a significant number of investors began to harbor serious doubts about the merit of the Buy-and-Hold strategy was in the days following the 2008 price crash, which came as a shock to investors who had been told by the experts that stocks were an asset class that always performed well in the long run. Those who resisted the urge to panic after the crash were rewarded with outstanding returns for the following 10 years, reassuring them that they had been following the right strategy all along.
So why can’t I buy in? Why do I continue to find fault with the Buy-and-Hold concept?
I don’t think that 40 years is a long enough test!
I acknowledge that that’s sounds a little crazy. One would think that a test that extends for 40 years would be plenty long enough. I can understand why many perfectly reasonable investors would conclude that an investment strategy that offers super returns for 40 years is an investment strategy that has earned one’s confidence. Buy-and-Hold has been getting the job done for a long, long time. And, on the one occasion on which it appeared to have let investors down, in the wake of the 2008 crash, it came through yet again for those who held on.
To my way of thinking, the real question is not what returns have been provided over what time-period. The real question is whether stock price changes are determined by economic developments, as the Buy-and-Holders believe, or by shifts in investor emotion, as Shiller has proposed. If it is economic developments that determine stock price changes, then Buy-and-Hold is the ideal strategy. If shifts in investor emotion determine stock price changes, then Buy-and-Hold is dangerous.
We cannot say when the dangers of Buy-and-Hold will reveal themselves. But if Shiller is right in what he says about what causes stock price changes, we can say for certain that sooner or later they will. Because, if Shiller is right, none of the numbers that I cited at the beginning of this article are legitimate. If Shiller is right, all of those numbers need to be adjusted for the effect of overvaluation (investor emotion). If the numbers were adjusted, investors would form very different conclusions about the merit of the Buy-and-Hold strategy.
Stocks are priced at roughly two times fair value today. If prices are over the next few years going to return to fair-value levels, we are going to see a lot of human misery appear before our eyes. Millions of retirement plans will fail. Hundreds of thousands of businesses will go under (because the stock losses will diminish consumer spending power dramatically). Millions of workers will be fired from their jobs by the businesses that go under.
That’s the difference between a world in which it is economic developments that cause stock price changes and a world in which it is shifts in investor emotions that cause stock price changes. In a world in which it is shifts in investor emotions that cause stock price changes, the numbers that we use to determine whether investment strategies are doing well are rooted in illusion. The illusion at the root of the Buy-and-Hold strategy (that the market is efficient, that investors are engaged in the rational pursuit of their self-interest rather than in dangerous self-deceptions) makes it hard for them to appreciate that their strategy is not working as well as they believe it to be working.
Buy-and-Hold appears to have produced good results of the 40 years since Shiller published his amazing research. But will investors still see it that way after a price crash that takes us back to fair-value price levels or perhaps to something worse (price levels dropped to one-half of fair-value levels at the end of every earlier bull/bear cycle)?
Rob’s bio is here.