Beyond Buy-and-Hold #92
Last week’s column examined how stock returns play out in the short-term, in the long-term, and in the distant long-term. We saw that returns are unpredictable in the short-term and thus short-term investors do not need to take valuations into consideration. In contrast, valuations are the primary influence on long-term returns. So long-term investors MUST take valuations into consideration when setting their stock allocations.
But valuations don’t matter all that much in the distant long-term. In the distant long-term (30 years out to 60 years out), we are seeing the influence of multiple secular bull/bear cycles. So the return is always something in the neighborhood of 6.5 percent real, the average long-term return for U.S. stockholders. So it is at least arguable that Buy-and-Hold is not so terrible a strategy in the distant long term.
Buy-and-Hold is always terrible
I say that I don’t buy it…for four reasons.
First, there is a difference even in the distant long-term returns. When stocks are priced at one-half fair value, the most likely 60-year annualized return is 6.78 The number for when stocks are priced at three times fair value is 6.24. The difference between a return of 6.2 and a return of 6.8 over the passage of one year is not great. The difference is much bigger when we are talking about a 60-year time-period. Those 0.6 points of real return are adding to the multiplier for compounding purposes in the case of the stocks purchased at a low price. The compounding effect is counter-intuitively large. Earning 0.6 points real of added return every year for 60 years running makes a difference.
Two, it is highly unlikely that any Buy-and-Holder will be able to hold stocks into the distant long-term. They say they will. They promise they will. They vow they will. They swear they will. But they won’t.
How do I know?
Stocks are always priced at one-half fair value at the end of secular bear markets (we are in the early stages of one today). Stocks were priced at three times fair value at the top of the 1990s bull market. To go from 3x to 1/2x means a loss of five-sixths of the value of a portfolio. There are no middle-class people who can lose five-sixths of their accumulated wealth of a lifetime and not freak.
A promise that can’t be kept
The Buy-and-Holders cannot do what they promise they are going to do. It’s easy to say you are going to stick with a Buy-and-Hold strategy during the Get Rich Quick years. It is not realistic to expect that you really will stick with it when the phony gains disappear from your portfolio statement.
The full reality here is that it is the sales of the Buy-and-Holders that bring the stock price to one-half fair value in the first place. If Buy-and-Holders never sold, stocks prices would never return to fair-value levels, which is of course a logical impossibility.
Buy-and-Holders are already selling. Most of them won’t acknowledge it. But, if you visit discussion boards at which Buy-and-Holders congregate, you will see that many Buy-and-Holders have been questioning the “hold forever” dogma in recent years and a good number have begun selling.
The number of Buy-and-Holders selling will accelerate with the next crash and it will be when something close to 100 percent of the Buy-and-Holders have given up the ship when we get to one-half of fair value and the market becomes able once again to move upward for the long term. It’s the sales of Buy-and-Holders that permit the market to recover.
Time value of money
Three, there’s a time value to money. If you tell me in advance that one investor is going to achieve at least decent returns for every year of a 30-year time-period and that a second investor is going to achieve poor returns for 10 years out and 20 years out but will do okay at 30 years out and 60 years out, I will tell you that the strategy being followed by the first investor is superior. Why would you want to be down for 10 or 20 years?
Four, you might need the money in those years. Most experts in this field act as if there were only one purpose for which to invest — to finance an old-age retirement. Huh? People use their portfolios to come up with down payments on houses and to send their kids to school and to start businesses. If you decide that you would like to start a business 10 years from now and are not able to do so because you followed a Buy-and-Hold strategy that will leave you dramatically down for 25 years, you have missed out on a golden opportunity for no good reason.
Buy-and-Hold does not look as bad at 30 years out as it does at 10 years out and 15 years out and 20 years out. But I don’t recommend Buy-and-Hold even for those investors focused on the distant long-term. The idea that Buy-and-Hold can work in the distant long-term is an argument cooked up by investors who are emotionally addicted to their Buy-and-Hold strategies and are trying to concoct excuses for sticking with them in the face of 30 years of academic research showing that this is a loser strategy.
Rob Bennett often writes about the why stocks crashed. His bio is here. For background on the Big Fail of Buy-and-Hold and on the need to move to Valuation-Informed Indexing, please check out the “About” page at the “A Rich Life” blog.