Only Those Who Engage in Market Timing Are Truly Following a “Strategy”

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They call Buy-and-Hold a “strategy.” But it’s not really that. Say that you needed to travel to a location 100 miles away from your home. Say that you looked at some maps and determined that there were different routes that could be taken. One route would work really well if traffic was light. But you knew from experience that that road could get seriously backed up and so the trip might end up taking much longer using than route B. The problem with route B is that there are heavy tolls associated with taking that route. So you might consider Route C. Route C has backups at a bridge that would show up early on in the drive. If you got started early in the morning, you could avoid that problem.

There are a number of considerations. The best strategy might be to wake up early enough in the morning to get on the road before the bridge backs up on Route C. There’s a case that can be made for both Routes A and B.

The act of strategizing is looking at the different considerations and making the choice that makes the most sense for you given the circumstances that apply at the time you begin the trip. Perhaps you have been working late hours recently and the idea of waking up early possesses little appeal. Perhaps you recently got a raise and the extra tolls associated with Route B aren’t much of a concern. Perhaps you are planning to make the trip on a day of the week for which it is unlikely that there will be much of a traffic problem on Route A.

The buy-and-hold strategy

Do you know how a Buy-and-Holder would solve this sort of problem? He would reason that: “Even cars that get stuck in massive traffic jams on Route A always make it to their destination eventually. So Route A is the only route that should be considered. It would be mistake even to look at the pros and cons of Routes B or C. It must always, always, always be Route A, regardless of how bad the traffic is or how much money you have or how much you are in need of extra sleep. There’s nothing to think about – it’s Route A!”

Buy-and-Hold is the absence of strategy.

It is the strategy for investors who don’t want to follow a strategy. Stocks are a great asset class. But they offer a better long-term value proposition at some times than they do at others. So they shouldn’t make up the same percentage of your portfolio at all times.

The most likely 10-year annualized return on stocks purchased in 2000 was a negative number. Do you really want to have the majority of your money invested in an asset class offering a negative long-term return? I sure don’t. But a Buy-and-Holder doesn’t even take the return he is likely to obtain on his investment dollars into consideration. That would be strategizing, which is something that Buy-and-Holders just do not do.

Buy-and-Hold is putting yourself into a straightjacket and then hoping that that works out. Adopting a Buy-and-Hold strategy is not about strategizing, it’s about following orders, orders delivered by people who just happen to make money when you buy stocks.

Strategizing for stock investments

No one could ever be convinced to follow a Buy-and-Hold approach but for one very important reality: Stocks offer the best average return of the asset classes that are suitable for the typical middle-class investor. The average long-term annual return on stocks is 6.5 percent real. That’s a fantastic return. So long as the CAPE level is somewhere in the neighborhood of the fair-value CAPE level (17), the Buy-and-Hold recommendation to go with something near a 60 percent stock allocation makes sense. However, the “idea” to not change that allocation when prices go to super high or super low levels does not compute.

The only reason I can see to go with such an approach is that it is very simple. With your retirement at stake, the price you pay for achieving that simplicity is far too high, in my assessment. It might be that that simplicity has appeal from a marketing perspective, which is probably one reason why our Wall Street Con Men friends go for it. But the downside of electing a strategy that is not truly a strategy at all is too great.

I am not suggesting that you adopt a complicated strategy. I like the focus on simplicity that is characteristic of the Buy-and-Hold Model. But there are limits. When the desire for simplicity puts you in 60 percent stocks at a time when the likely long-term annualized return is a negative number, you have permitted your desire for simplicity to become an unhealthy obsession.

You sometimes need to take a little off the stock table and you sometimes need to put a little extra on the stock table. Yes, stocks are in a general sense a great asset class. But there are some valuation levels at which they are a super great asset class and some others at which they are a mediocre or even a poor asset class. The dollar return that follows from distinguishing between those time-periods and choosing a stock allocation that makes sense given the realities that apply makes it more than worth it to go to the trouble to do a tiny bit of strategizing.

Would you consider not following any strategy when setting the speed at which your car travels, going at the same speed when it is a sunny day and when it is a rainy night and when the road is covered in snow and ice? I know of no sane person who follows such a non-strategic approach to driving. I wish that I could say that we all followed the same sensible strategic approach when investing in stocks.

Rob’s bio is here.