How Has Buy-and-Hold Survived So Long?
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
Fama).
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?
Rob Bennett believes that IBonds are a greatly under-appreciated asset class. His bio is here.
I would like to comment about buy and hold. As far as stocks go I believe that buy and hold forever is dead. But not buy and hold for 2 to 5 years.
The holding period depends a lot on the investment.
Millions of investors thought they could just buy an index fund and forget about it. Obviously, they didn’t do so well over the past decade. My Mom had stock from Sears and GM that my Grandmother had given her. Thankfully, she was smart enough to sell them a long time ago. I have some very good actively managed mutual funds and I only need to change them about every decade or so.
The Bottom Line is that you have to watch investments and decide when it’s time to sell them. People are always looking for a magical formula or a lazy way to invest. But, investing takes time and experience. The market isn’t a static environment.
investing takes time and experience
I understand your point, Bret, and I agree that in the ideal case the investor puts time and effort into the investing project.
But what do we do about the millions of people who have zero interest in putting any time into this, people who have no choice but to invest in stocks if they are to have any hope of being able to retire someday but who just do not care to spend time on it?
Despite my strong opposition to Buy-and-Hold, John Bogle is one of my heroes. The reason is that he is the only big name in this field who has put a lot of effort into helping the millions of ordinary middle-class people who invest in stocks not because they want to but because they must.
I think the investing game changed with the termination of most defined benefit plans. We need to have a simple way to invest in stocks for the ordinary middle-class person. I view Buy-and-Hold as a first-cut attempt at developing a solution to this problem. My view is that the first cut has not worked out. But I do admire the people who at least put their efforts into developing a first-cut solution.
Do you have thoughts on what we should tell these people? Should we tell them to avoid stocks? Should we tell them to follow Buy-and-Hold strategies? Are there other good options?
(Many thanks again for running the Guest Blog Entry. As I mentioned in my e-mail to you, I think it is a great community that meets here.)
Rob
“But what do we do about the millions of people who have zero interest in putting any time into this, …?”
Rob,
That is the question of the century and one I wish I could answer. If I only knew, I could make a ton of money and millions of people happy at the same time.
Right now, those people are at the mercy of their stock broker, financial advisor or the default investments in their 401K plan. Others, go it alone with index funds or index ETFs. Most of them are paying a heavy price for their ignorance of the markets. And, to be quite honest, most of the pros aren’t doing so hot either.
Your solution, Valuation-Informed Investing, seems like a sound potential strategy. But, we can never tell from back-testing how a strategy will perform in the future. Even worse, once a strategy outperforms the market, everyone rushes to adopt it. Then, it loses it’s effectiveness or becomes a bubble and bursts.
Let’s play what-if for a second and imagine millions of naive and/or lazy investors adopt VII. Do you think it would still perform as advertised with millions of people using it? Would investors always exit the market when the P/E rose and invest when it falls? Or, do you think they would pick an index fund and go to sleep on it? Would it make or lose money? Only time will tell.
I could make a ton of money and millions of people happy at the same time.
Hey, that’s my plan! And I was first!
I’m just joking around (kinda, sorta), Bret.
we can never tell from back-testing how a strategy will perform in the future.
I agree. I personally believe this works. But who am I, you know? I’m some doofus who figured out how to get stuff posted to the internet. Skepticism is very much in order here.
Let’s play what-if for a second and imagine millions of naive and/or lazy investors adopt VII. Do you think it would still perform as advertised with millions of people using it?
Yes.
It would no longer provide outsized returns, that much is so. But if millions of people followed this, stock prices would become self-correcting. Each increase in valuations would bring on sales and the sales would bring valuations back to fair value levels.
We would never again have an out-of-control bull market. That means that we would never again have a huge bear market, the kind that bring on the economic crises that have followed every major bull market in our nation’s history. We would all earn “only” 6.5 percent real per year (the return that applies when valuations remain stable) and we would never again have to worry about massive unemployment and paying for huge economic stimulus programs and all this political friction we are seeing today. I could live with that!
The idea that investing is a zero-sum game is itself a product of Modern Portfolio Theory, Bret. I believe that, until we know all there is to know about how stock investing works (I don’t believe we are even close today), there will continue to be huge advances, advances that enhance the lives of each and every one of us.
Look at my situation. I may be wrong about VII. But say for purposes of discussion that I am right. This means that in investing terms I will do far better than the Buy-and-Holders. A fat lot of good it will do me if the overvaluation brought on by promotion of Buy-and-Hold puts us in the Second Great Depression. What good will my fancy stock returns do me when the U.S. government collapses and the dollar is destroyed?
My view is that we are all in this together and we all should be helping the other guy or gal to invest as effectively as he or she possibly can. Your loss is not my gain and my loss is not your gain. We all benefit from participating in the market. So we all should want the market to function as smoothly and effectively as possible. For that to happen, we all need to understand how markets work. That means we all need to do our part to educate our fellow investors (and not go looking for opportunities to “exploit” their mistakes, as is suggested in Modern Portfolio Theory).
Anyway, those are my thoughts. I really have been wrong about lots of stuff in the past. It could be that this is just another case in which I will end up wearing the dunce cap.
I am grateful to you for putting the post up and giving your readers a chance to hear both sides and think it over a bit for themselves, Bret. That means a lot to me. My view is that that’s what this blogging business is all about.
Rob
Rob,
You are a knowledgeable guy with an open mind and I really enjoy chatting with you. Here is my take:
“We would never again have an out-of-control bull market.”
I would love to see a reduction in volatility, but I think it will get worse. The people with real money, such as investment banks and hedge funds, are profitting from these bubbles. Some people, such as Matt Taibbi of Rolling Stone, have written articles suggesting they are causing the bubbles on purpose. The Fed is a contributing factor in my mind. Then, there are super-fast trading computers and way too much leverage from derivatives. The sheeple investors are always a sucker for bubbles. Whether it is stocks, housing or tulips, they never learn. If VII can overcome all of that, God bless you.
“The idea that investing is a zero-sum game is itself a product of Modern Portfolio Theory”
One of the reasons I invest in equities is because they should grow naturally, with inflation and the growth of the companies. But, two huge problems have surfaced and this concerns me. First, investment banks and hedge funds are poaching spreads and manipulating the markets. Second, companies are making huge profits, while their stock prices are crashing. Neither of these things are good for individual investors.
“My view is that we are all in this together and we all should be helping the other guy or gal to invest as effectively as he or she possibly can.”
This is the whole reason I started my blog. I figure if I can help some people get started investing and live a better life, I will have made a huge contribution.
You are a knowledgeable guy with an open mind and I really enjoy chatting with you.
Backatcha, Bret.
If VII can overcome all of that, God bless you.
Another way of looking at it is that it would be the internet overcoming all that.
What the stock sellers do is take advantage of principles of marketing. People believe a foolish thing they hear repeated 100 times over a logical thing they hear said only once. That’s how the brain works. We all say that television commercials don’t influence us, but when it comes time to pick a brand of toothpaste, we reach for the one we saw on TV. That’s why Super Bowl commercials cost millions.
The Personal Finance Blogosphere is not owned by The Stock-Selling Industry. Some of us make a few bucks here and there, not enough to make that much of a difference in our coverage. So, if we started asking hard questions and having two-sided discussions, people would for the first time become able to learn things they have never been able to learn before.
Here’s the killer. The Stock-Selling Industry would do just fine if people learned the realities. Stocks really are a wonderful asset class. These people have a great product to sell. They can take credit for all the wonderful insights the Buy-and-Holders really did put forward. And the economic stability that would follow if we did something to cut back on runaway bulls and runaway bears would make millions of people more comfortable buying stocks in the long run.
I truly believe that this is a win/win/win/win/win in the long run. It is like the invention of electricity. There is no downside. The only thing holding things back is that people who have written books or created calculators or whatever feel threatened. But even those people would be better off writing new books or producing new calculators. A rising tide lifts all boats.
The sad part of this is that people do not see this. People see things the way they are today and they cannot imagine them ever being different. I like the people in The Stock-Selling Industry. I really do. I want to bring them around and I want to work with them to make things better for investors AND for The Stock-Selling Industry.
I’ll acknowledge that it has taken a lot longer than I anticipated to make this happen. A lot longer. Holy moly! But I truly do believe that it is going to happen. If anything, I am more sure of that today than I have ever been. And there really are lots of optimistic signs. Things are changing because they have to change.
I have to say again how grateful I am that you are helping to move the ball forward. You know what we need most? We need to make people comfortable just talking about these things. A Social Taboo has developed re speaking frankly on these matters and people are social creatures. So, when some crazy person like me speaks up, the room gets real quiet real quick. That is what needs to change. When it does, there will be no stopping us.
Many Buy-and-Holders are good friends of mine. Many are smart, good people. My dad was the biggest Boglehead there ever was. He taught me never to invest anywhere but Vanguard. The people who work in The Stock-Selling Industry are hard-working and smart people. They want to help people, just as all the rest of us do. We have to help them out. We need to give them a little push and make them feel comfortable about doing the right thing.
It’s always darkest before the dawn. People need to look past this economic crisis and try to picture all the great stuff awaiting us on the other side of the Big Black Mountain. I cannot wait to see us all turn that corner. I am going to be very psyched to be working with all the people who today are trying to shout me down.
I’m a 60s guy, for good or for ill. Love is the answer, in my mind. I really believe that, as stupid as I know it sounds.
Rob
Buy and hold strategy applies to few companies only as it all goes according to the fluctuation in market. Currently its not a time to buy and hold anything. The only way to make profit today is to be less greedy.
Actually, buy-hold-rebalance strategies have survived so long because they work so well and are easily implmented. Vanguard’s Wellington and Wellesley Income Funds are good example of successful buy-hold-rebalance strategies with long-term histories, and extremely simple as one has only to purchase a single fund. For a look at how other diversifed “Lazy Portfolios” have fared Google “Bogleheads Simba’s Spreadsheet” which contains returns for various such portfolios from 1985. Those returns show the utility of investing in a diversified basket of equity classes.
It’s important to remember that Mr. Bennett is touting the timing of a single asset class, the S&P 500 Index. And the backtested results one sees for his system are highly dependent upon both the what percentage of the S&P 500 is held at various PE10 levels and at what PE10 point one uses to signal a buy or sale. Also important to note is that neither the optimal percentage of S&P 500 to hold nor the optimal PE10 switch point were known back at the time, they were deduced solely by looking back at the data to make that determination. That accounts for why some backtests of his strategy show good results while others do not. Will those particular optimal PE10 points found in a single backtest hold true in the future? Only time will tell.
Actually, buy-hold-rebalance strategies have survived so long because they work so well and are easily implmented.
Well, yes, there’s that.
Thanks for stopping by to help us all out by presenting the other point of view, Carlyle. I never went to investing school and I never managed any big funds. I could be wrong in everything I say. Anybody who invests according to what I say solely because I say it is a darn fool.
Rob
Mr. Bennett, I’m terriby sorry you found my examples illustrating why Buy-and-Hold has endured to be so emotionally distressing for you. It must very painful to see how easily one of your most strongly held beliefs can be shown to be in error. While I hesitate to bring this up given your present emotionally labile state, it can also be easily shown that many of your other equally strongly held beliefs–that Buy-and-Hold is the dominate investment strategy, that Buy-and-Hold investment strategies are the root cause of all recessions, that arithmetical errors exist in the Trinity and Retire Early Studies of SWR’s, etc–can also be shown to be merely strongly held opinions which also have no basis in fact.
But to your credit, it is good of you to list your many accomplishments which you deem sufficient to qualify you to offer expert personal financial advice on the blogosphere.
can also be shown to be merely strongly held opinions which also have no basis in fact.
Here’s a link to the home page of my blog, Carlyle:
http://arichlife.passionsaving.com/
If you look to the left-hand side of the page, you’ll see a section called “People Are Talking.” That section contains over 100 comments on my work advanced by both big-name experts in the field and ordinary investors who have been pleased finally to find a source of information on how stock investing works that hangs together. All the quotes are sourced and links are provided for all of them.
People can read that and form their own assessments of the realities here. I’m proud of the work I’ve done showing the dangers of Buy-and-Hold and pointing us all to something 100 times better (Valuation-Informed Indexing). I look forward to the day when those who endorsed Buy-and-Hold in days when we didn’t have the research available to know better can get over their feelings of hurt pride and join forces with the Valuation-Informed Indexers to help us all learn together what really works in stock investing.
That’s what it’s all about. That’s what got all of those working in this field started doing the work they do. When we get back to where we once belonged, the sort of thing we see in your post above will be a thing of the past and we will all be focused on constructive and positive and life-affirming goals.
I wish you the best of luck in all your future endeavors, Carlyle. There’s life after Buy-and-Hold, my good friend. I hope there will soon come a day when you will devote some of your life energies to learning more about all the good stuff that can be enjoyed living it.
Rob
“If you look to the left-hand side of the page, you’ll see a section called “People Are Talking.” That section contains over 100 comments on my work advanced by both big-name experts in the field and ordinary investors who have been pleased finally to find a source of information on how stock investing works that hangs together.”
And a detailed accounting of how you misprepresented, misappropriated and misconstrued those comments from “big-name experts…and ordinary investors” may be found here:
http://www.s152957355.onlinehome.us/cgi-bin/yabb2/YaBB.pl?num=1189390571/4#4
And Mr. Bennett, I wish you the best of luck in your quixotic endeavor to acquire the fame and fortune you think is owed to you for all the time and effort you’ve expended trying to convince the personal finance blogosphere that your S&P 500 market timing strategy is the greatest thing since sliced bread.
That’s fair enough, Carlyle. People can check out what both sides say and figure things out for themselves. That’s as it should be.
I do indeed think that Valuation-Informed Indexing is the greatest advance in our understanding of how stock investing works achieved in my lifetime. I hope to obtain the credit due me for the contributions I have made. But I also very much want the hundreds of others who deserve credit for helping out to obtain the credit they merit as well. I don’t think it hurts to add that that group includes lots of Buy-and-Holders, just in case there is anyone reading these words who somehow or other picked up a different idea.
Please take care.
Rob
Its the herd mentality and naive/ignorance…as long as things keep going up albiet slowly it works out fine. Once panic sets in, the herd runs for whatever cover they can…usually that means selling.