I am not a Buy-and-Holder. I like to think of myself as the foremost critic of Buy-and-Hold alive on the planet today. It is my view that Buy-and-Hold is a pure Get Rich Quick approach because Buy-and-Holders disdain market timing, which is the only means available to us of keeping irrational exuberance under control.
Buy-And-Hold Porports To Be A Research-Based Strategy
However, there is one aspect of the Buy-and-Hold concept that I absolutely love. Buy-and-Hold at least purports to be a research-based strategy. I don’t believe that it truly is that because the Buy-and-Holders have never updated their strategy to reflect Robert Shiller’s Nobel-prize-winning research findings. But I do think that the Buy-and-Holders were sincere about wanting to craft an investment strategy rooted in science and I believe that in the long term it will be their legacy that they planted in investors’ heads the idea that an investment strategy should be science-based.
Michael Mauboussin’s 10 Attributes of Great Investors [Pt.1]
In 2016, Michael J. Mauboussin completed his 30th year on Wall Street. The analyst, who was working at Credit Suisse at the time, decided to celebrate by reflecting on the ten attributes of great investors he had observed over the previous three decades. He published his ideas in a report in August 2016. I've summarised Read More
If only the Buy-and-Holders had stuck to their core belief!
A key principle of science is that scientific claims must be falsifiable. Most Buy-and-Hold claims are not. That’s why I no longer think of Buy-and-Hold as a science-based approach.
Does market timing work? The Buy-and-Holders say it does not. Say that someone disagrees with that claim? How would he go about disproving it?
He wouldn’t be able to shoot holes in the research showing that market timing does not work. There is no such research! People think there is. Buy-and-Holders make the claim so often that people assume that there must be some research supporting it. But no. There is research showing that short-term timing (changing your stock allocation with the expectation that you will see a benefit for doing so within a year or so) does not work. But showing that short-term timing does not work is not at all the same thing as showing that timing in general does not work. There has never been any peer-reviewed research published showing that market timing in general does not work.
Valuations Affect Long-Term Returns
So what can someone trying to make the case for market timing do? In theory, he could show that market timing has always worked. Shiller did that. He showed that valuations affect long-term returns. If valuations affect long-term returns, the long-term value proposition for stocks has to be stronger at times of lower valuations and so investing more heavily in stocks at such times must produce a payoff. Wade Pfau and I produced research looking at this question more directly and of course our research showed that investors who engage in market timing lower their risk and increase their long-term return by doing so.
The response of Buy-and-Holders has been to say: “Oh, but you never know about such things! It could be that everything will be different on a going-forward basis.” In fact, I wrote an article here a few weeks ago in which Wade himself said something along these lines. He said that he used to believe in market timing but that, given how stocks have performed from 1996 forward, he no longer does. Shiller famously predicted in 1996 that investors who stuck with their high stock allocations would live to regret it within 10 years. But the reality has been that stock prices have remained high for the 24 years since Shiller advanced his prediction (with the exception of a few months at the end of 2008 and at the beginning of 2009).
It could be that everything changed in 1996. There’s no way to prove otherwise. If stock prices crash hard within the next few years, I doubt that anyone will be saying that the rules of stock investing changed in 1996. If we experience the horrors of a price crash and the economic collapse that would likely accompany it, everyone in the field will be cracking his copy of Irrational Exuberance to figure out where he got on the wrong track in his understanding of how stock investing works. But the damage will have been done at that point. The time at which we need to take Shiller’s research findings into consideration is now. And, as of today, the popular idea is that the basics of how stock investing works changed in 1996.
Which is a non-falsifiable claim. Say that you do not believe that the basics changed in 1996 and the Buy-and-Holders will point to today’s high prices as evidence that you are in the wrong. Had you followed Shiller’s advice in 1996, you would have “missed out” in the gains experienced over the past 24 years (gains that are to a large extent the product of irrational exuberance, according to Shiller’s understanding of the subject). The only thing that could ever prove to a Buy-and-Holder that his strategy is not sound would be a devastating price crash that would render the question of what works in stock investing moot (since the gains produced by irrational exuberance would at that point be gone).
Scientific claims have to be falsifiable. The Buy-and-Hold claim that market timing does not work is not falsifiable. It is a claim that sounds good for so long as prices remain high and then becomes irrelevant for practical purposes when they crash.
Rob’s bio is here.