Beyond Buy-and-Hold #12
By Rob Bennett
I sold my stocks in the Summer of 1996. My money has been in Treasury Inflation-Protected Securities (TIPS), IBonds and Certificates of Deposit (CDs) for the past 14 years.
Some people think I have made “extreme” choices. I do not. I hope you are willing to listen to my case.
The words “extreme” and “moderate” are relative terms. What is extreme in some circumstances can be entirely moderate in others. For example, driving at a speed of 60 miles per hour is certainly not extreme for those driving on a highway but is entirely out-of-the-ballpark nutso for those driving in residential neighborhoods.
Any fair analysis of the question of whether my stock allocation is an extreme one or not requires consideration of the circumstances in which that allocation was elected.
From a Buy-and-Hold perspective, my allocation is extreme. The Buy-and-Hold Model posits that it is not possible to know in advance how stocks are going to perform at any given time. If that is so, then the best way to assess whether stocks are a good buy or not is to assume that you will receive a long-term return somewhere in the general neighborhood of the average long-term return — 6.5 percent real.
No other asset class offers a value proposition that good. Under the Buy-and-Hold Model, it never makes sense to go with a low stock allocation and a zero stock allocation is always extreme.
There’s a time to be playing it super safe
I don’t believe in the Buy-and-Hold Model.
I believe that long-term stock returns are highly (but not precisely) predictable. I believe that the valuation level that applies when you buy stocks determines the long-term return you obtain from them. That is, the price paid determines the value proposition obtained.
If that’s so, there are circumstances in which going with a low stock allocation makes sense. Say that you could obtain as high a long-term return from one of the super-safe asset classes as you could obtain from stocks? Do you think it would make sense to go with stocks in circumstances in which you expected to obtain a lower long-term return in “compensation” for taking on the extra risk? The question answers itself.
I was able to obtain a return of 3.5 percent real or higher from my investments in super-safe asset classes for the entire time-period from the Summer of 1996 through today. I of course understand that such rates are not available today. But I have been disenchanted with stocks for 14 years. So I have been looking for appealing alternatives for that entire time -period. When TIPS and IBonds were offering long-term returns of 3.5 percent real, I locked in that rate.
I have a calculator at my web site that performs a regression analysis of the historical stock-return data to reveal the most likely annualized 10-year return for stocks starting from any of the various valuation levels. At no time in the past 14 years (with the exception of a few months in early 2009) has the most likely annualized 10-year return for stocks been greater than the 3.5 percent real return that I have been obtaining from TIPS, IBonds and CDs.
The validity of the calculator has been vindicated over the 14-year time-period. The benefits of staying out of stocks for so long as they are insanely overpriced is no longer merely a theoretical one for me. I am today ahead in dollars-and-cents terms of where I would be if I had been putting most of money into stocks from 1996 forward.
I haven’t missed out!
If you believe in Buy-and-Hold, my zero stock allocation has been extreme. If you believe that valuations affect long-term returns and that valuations are likely in the future to have roughly the same effect on future returns as they have always had in the past, there has been nothing whatsoever extreme about my zero stock allocation. A zero stock allocation is an entirely moderate choice in circumstances in which the super-safe asset classes are paying higher long-term returns than stocks.
There clearly is something extreme going on, however. An objection that I often hear when I describe what I have done is that 14 years is too long a time-period to be out of stocks. Many investors would be willing to lower their stock allocations for a year or two but feel very uncomfortable with the idea of doing so for 14 years.
I get the point. It is indeed an exceedingly strange reality for the super-safe asset classes to over a better deal than stocks for so long a time-period. It should never happen. But it did happen. The numbers are our best guide to the realities. It is not Rob Bennett who says that this strange reality is so. Rob Bennett merely reports the numbers. It is the numbers that say that this is so. My view is that it would be immoderate behavior on my part for me to ignore what the numbers say.
Most middle-class investors are moderate people. They disdain extremism. When they hear that I have been going with a zero stock allocation for 14 years, it is a turnoff for them.
I understand the reaction. I disdain extremism too, especially in money matters. My point here is that, from the standpoint of someone who believes that valuations affect long-term returns, a zero stock allocation is not extreme. It is high valuations that are extreme. And, since it is the widespread belief in Buy-and-Hold that has kept investors from selling and thereby pulling prices back to reasonable levels for all that time, it is Buy-and-Hold that is extreme in my eyes.
It’s not that some of us are extremist and some of us are not. It’s that some of us believe in Buy-and-Hold and some of us do not (another way of saying it is that some of us believe that valuations affect long-term returns and some of us do not). That’s something we all should be talking about.
If the Valuation-Informed Indexers are right that valuations affect long-term returns, it is those who stuck with high stock allocations for the past 14 years who have been following extreme strategies without meaning to do so.
Have you been solidly invested in stocks since 1996? Are there times you wished you’d invested in your money in super safe interest-bearning instruments during that time? With the market hanging around Dow 11,000 where should we be investing our money going forward?
Rob Bennett says that we are living in a time in which even the experts don’t necessarily get the investing basics right. His bio is here.