You sometimes hear people say that those who live in democracies have no one but themselves to blame for the government they get. I feel that way about the models for understanding how stock investing works that come to dominate our thinking. If Buy-and-Hold is a bad model, as I believe it is, we all share in the blame for the harm that it does. Buy-and-Hold didn’t become popular by edict. We made it popular.
Q2 2021 hedge fund letters, conferences and more
Buy-And-Hold Is Bad News
I of course have to note that the Buy-and-Holders came up with lots of wonderful stuff. Investors need to focus on the long term. They need to turn out the noise relating to day-to-day developments in the market. They need to keep costs low. They should recognize that stocks are an amazing asset class. They should look to peer-reviewed research to guide their investment decisions. All of those ideas check out.
Buy-and-Hold is bad news, in my assessment, because it discourages market timing. Market timing is price discipline. If investors stop exercising price discipline (that is, if they stop engaging in market timing), prices eventually get out of control. Once that happens, the only way to get them right again (a market must eventually get prices right if it is to continue to exist) is to crash them. Crashes cause businesses to go under and economies to crater and workers to lose their jobs and retirements to fail. Lots of human suffering.
Given that we all know to practice price discipline in every other market in which we participate, it is a remarkable reality that the idea that it is not 100 percent required in the stock inverting realm ever caught on. The problem seems to be that the academics fell in love with a theoretical construct (the idea that investors always engage in the rational pursuit of their self-interest) and failed to be sufficiently careful in thinking through how that construct would apply in the real world. Academics don’t always get it right.
But why did we fall for it? When the academics told us that market timing is not required (or that it might not work!), we could have asked some hard questions. Our retirement money is riding on our ability to get stock investing right. The academics were trying to do a good thing. If we made it harder for them to fall into the trap of believing that market timing is not required, they might well have stumbled into some descriptions of how stock investing works that ended up evidencing much longer-term explanatory power.
The Necessity Of Price Discipline
The academics should have worked it harder. I don’t entirely want to let them off the hook. The claim that price discipline is not necessary when buying stocks is an exceedingly counter-intuitive claim, one that would likely prove to be highly dangerous if it did not stand up to scrutiny. So the academics certainly share a portion of the blame for this long-discredited (Shiller published his research showing that valuations affect long-term returns in 1981) investment strategy.
The deeper problem, however, is that we liked what they told us when they were telling us tall tales. If market timing is not required, price discipline is not required. If market timing is not required, then we can push stock prices up to whatever levels we please and realistically treat those prices as being rooted in something real. If market timing is not required, stock gains greater than those that support the 6.5 percent real annual return that has been the norm for U.S. stocks for a long, long time now are magic money. We all have a desire to obtain something for nothing. We all find ourselves drawn to the magic money concept.
In the mid-1990s, I was seeking to save enough money to leave my corporate journalism job and do independent journalism work, the work that I have been doing since August 2000. I was counting the months until I would be able to prudently make that shift, given my responsibilities to my family. My then-wife and I had made a tradition of heading off to a bed and breakfast at the turn of the new year and writing our budget (our “Life Plan”) for the coming year. I recall one year looking at the numbers for our stock portfolio in preparation for the budget-crafting task and being delighted at how much the stock gains for the year had made it so much easier to achieve my goals.
Spending Cuts
Spending cuts? Who needs spending cuts when you can create imaginary money with bull market gains and thereby get to the same place? I obviously didn’t see it that way at the time. But I try to bring that moment to mind when I am struggling to understand how Buy-and-Hold became so popular despite the obvious danger of going with an approach that disdains market timing/price discipline. I made Buy-and-Hold popular! At least at that moment in time I did! Because I experienced the same Get Rich Quick impulse that everyone else experiences. And so I felt that same warm feeling when hearing about bull market gains that everyone else feels.
It always ends in tears. That’s what the historical return data examined in Robert Shiller’s Nobel-prize-winning research teaches us. But a man hears what he wants to hear and disregards the rest. So the songwriter explains. Our 40 years of ignoring Shiller’s findings lend a good bit of credibility to the sobering observation.
Rob’s bio is here.
