The following is a guest post from Rob Bennett of A Rich Life. Rob is a tireless critic of Buy and Hold investing. Instead, he recommends Valuation Informed Index investing. If you lost a bunch of money in the market, you should read this post.
I’m not a Buy-and-Holder. I believe that Yale Economics Professor Robert Shiller’s research has shown Buy-and-Hold to be a gravely flawed strategy and that Valuation-Informed Indexing (which teaches that investors must change their stock allocations in response to big valuation swings) is far more sensible and effective approach.
Shiller published his research showing that valuations affect long-term returns in 1981. The obvious question is — What took so long? Why is it that it is only in recent years that large numbers of investors have begun to wonder if Buy-and-Hold is dead?
I can offer six explanations.
1) The implications of Shiller’s research are so far reaching that even his supporters do not yet fully appreciate them.
Shiller showed that valuations affect long-term returns. To know what affects returns is to know what causes them.
What Shiller really showed is that overvaluation causes poor returns. His research is showing us for the first time in history how stock investing really works. Valuations are key.
Once we learn how stock investing really works, we become able to avoid the risks of stock investing. For those who understand Shiller’s research, stocks are a significantly less risky asset class than they are for all others.
This is of course wonderful news. But it is not news that is easy to accept. Most advances in knowledge are
achieved in small steps. The Shiller Revolution represents a huge leap forward. It is taking us some time to absorb how much we have learned.
2) In practical terms, Buy-and-Hold caused no problems for 15 years after Shiller published his research.
Buy-and-Hold never “worked” in an intellectual sense. It is rooted in a false premise (Buy-and-Hold assumes the efficient market theorized by University of Chicago Economics Professor Eugene
Still, in a practical sense, Buy-and-Hold worked just fine from 1981, when Shiller published his
groundbreaking research, until 1996, when stocks prices first rose to insanely dangerous levels. Both Buy-and-and-Holders and Valuation-Informed Indexers go with high stock allocations at times when prices are reasonable. So Buy-and-Holders were adopting proper stock allocations for the wrong theoretical reasons for those 15 years. It was a case of “no harm, no foul.”
3) The extent of the problem with Buy-and-Hold did not become apparent until the 2008 crash.
Shiller predicted in Federal Reserve testimony delivered in 1996 that those going with high stock allocations at the prices that applied at the time would live to regret it within 10 years or so.
We know today that he was right. Those who went with far safer asset classes (TIPS, IBonds or CDs) are now ahead of those who invested in stocks at the time.
But Shiller’s prediction was not proven correct in the eyes of many until prices crashed in late 2008. Stocks started performing poorly in 2000. But the losses suffered by stock investors were not big enough to impress those who believed in Buy-and-Hold until the crash hit.
4) An entire industry has been built up to promote Buy-and-Hold.
It’s wonderful news that we now know how to invest in a way far more effective than the way advocated by
Buy-and-Hold enthusiasts. Making the transition to Valuation-Informed Indexing is not a simple business, however.
There are now thousands of books promoting Buy-and-Hold. There are hundreds of calculators promoting
Buy-and-Hold. There are thousands of experts who made their reputations promoting Buy-and-Hold. In short, there are lots of powerful people and institutions with a strong financial interest in promoting the failed strategy rather than its replacement.
5) Most investors are emotionally invested in Buy-and-Hold.
What the research says will win the day in the long run. But we humans are not entirely rational creatures. We allow our emotions to influence what research we are willing to consider.
Millions of people have staked their retirements on Buy-and-Hold and told friends or co-workers or neighbors about it. These millions of people very, very much do not want to acknowledge the flaws in the Buy-and-Hold Model regardless of how exciting an approach Valuation-Informed Indexing might appear to be according to the research.
6) We have so far only seen a small portion of the damage that Buy-and-Hold will likely do to us.
This is the fourth time in U.S. history that Buy-and-Hold strategies have become popular. On the earlier three occasions, we ended up with stock prices at one-half of fair value. The inevitable return to fair value prices always causes an economic collapse and the economic collapse always causes prices to fall far below fair value.
That’s a price drop of 60 percent from where we stand today. After that price drop, we will likely be in living in the Second Great Depression and no one will be singing the praises of Buy-and-Hold anymore. Until we get there, it will remain possible for many to keep their hopes in Buy-and-Hold alive.
The question is not — Is Buy-and-Hold dead? Buy-and-Hold has been dead intellectually for three decades. The question is — When are enough of us going to acknowledge what the research says and begin making the changes we need to get our economy and our retirement portfolios back on track?