The Good Side Of Buy-And-Hold

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I am not a Buy-and-Holder. I once was. I wrote a post to a discussion board on May 13, 2002, pointing out that the Buy-and-Hold retirement studies lack adjustments for the valuation level that applies on the day the retirement begins and the reaction of my Buy-and-Hold friends to that one convinced me that Robert Shiller is right that stock investing is a highly emotional endeavor and I moved on.

But there’s still a lot that I like about Buy-and-Hold.

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One thing is those safe withdrawal rate studies. The Buy-and-Holders say that the safe withdrawal rate is always 4 percent. That can’t be. Robert Shiller showed in 1981 that valuations affect long-term returns. If that’s so, then it is a logical impossibility that the safe withdrawal rate is the same at all valuation levels. I would like to see those studies corrected. That said, the Buy-and-Hold retirement studies advanced our knowledge of retirement planning in a big way.

Before those studies came out, lots of smart people (including Peter Lynch) thought that the safe withdrawal rate was 6.5 percent real because that’s the average long-term return generated by U.S. stocks. That sounds plausible enough, doesn’t it? If stocks are increasing in value by 6.5 percent per year, retirees should be able to take that amount out of their portfolio to cover living expenses and not have to worry about depletion of capital. It was the Buy-and-Holders who showed us that the sequence of returns that generates the 6.5 percent return makes a big difference. A sequence in which there are small returns in the early years supports only a lower withdrawal rate because such a sequence does not provide as much in the way of compounding benefits. I believe that the Buy-and-Hold studies are in error but also that they helped people. It is possible for both things to be true.

The thing that I like most about Buy-and-Hold is that it is the first investment strategy that at least purports to be rooted in science. The big problem in this field is that there is so much money to be made that people who work in the field are tempted to permit marketing considerations have too much influence over the advice they offer. The Buy-and-Holders showed us the way out of that trap by arguing that investment strategies should be rooted in peer-reviewed research. I fault them for not acknowledging Shiller’s “revolutionary” (his word) research from 1981 forward. But we need to give the Buy-and-Holders credit for making the case that peer-reviewed research matters. At least they have prepped the field for the acceptance of better approaches down the line a bit.

I love it that the Buy-and-Holders urge us to tune out the noise. Most coverage of the ups and downs of the stock market is noise. Investors need to be warned not to let it distract them from their long-term plan. Unfortunately, the Buy-and-Holders are not able to appreciate that returns of greater than 6.5 percent real (the return supported by economic growth) are so much noise. Irrational exuberance is noise.

I also love it that the Buy-and-Holders advise investors to Stay the Course. Again, I question whether the Buy-and-Holders possess a sure understanding of what the phrase entails. In the minds of the Buy-and-Holders, an investor is staying the course if he sticks to the same stock allocation at all times. If valuations affect long-term returns, risk is greater at times of high prices and investors seeking to maintain the same risk profile at all times must adjust their stock allocations in response to big valuation shifts. It is the investors who practice long-term timing (price discipline) who are Staying the Course in a meaningful way. But it is the Buy-and-Holders who popularized the idea of Staying the Course in the first place. That’s was a major contribution.

I like it that the Buy-and-Holders are pro-stock. Stocks are the best asset class for the typical middle-class investor. The Buy-and-Holders have done a lot to spread the word. They undo a lot of their good work when they suggest that stocks are such a good asset class that there is no price at which they are not a good buy. That idea is flat-out silly. Still, I like it that many people have learned to love stocks by listening to the arguments of our Buy-and-Hold friends.

Buy-and-Holders generally seek to keep fees low. That can be a big plus. Investors don’t have control over many aspects of the stock investing project. They do have control over how much of their possible return gets eaten up in fees. Those who follow the advice of the Buy-and-Holders generally pay lower fees and that means that they keep more of the returns generated by their holdings than do stock investors following other strategies,

Indexing is a breakthrough concept. Indexing reduces risk through diversification while still delivering plenty-good-enough returns. What’s the downside? We owe the development and promotion of indexing to our Buy-and-Hold friends. We should be grateful for their efforts in this respect.

Buy-and-Hold is not perfect. It is a gravely flawed strategy because it fails to take valuations into consideration in the advice it offers. The valuation level that applies when a stock purchase is made is often the most significant factor determining the return ultimately obtained from that purchase. But the Buy-and-Holders got a lot of things right too and those of us who have made it a practice to point out the strategy’s weaknesses should make an effort not to forget all the good that it has done.

Rob’s bio is here.

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