Beyond Buy-and-Hold #75
By Rob Bennett
You?re a Phillies fan. You have hopes for the team winning the World Series next year. The manager is interviewed on television. You are reassured to hear him say that ?pitching is what matters in this game, it?s all about pitching.?
The next day, the manager releases the team?s best five pitchers on waivers. You are shocked. You tune in to the news that night to hear his explanation. He says: ?I strongly believe that pitching matters. That said, I know of no reason to believe that teams with better pitchers win more games. So I am not even a tiny bit concerned that we are losing all our best pitchers. I am convinced that pitching matters a great deal in baseball, but I also am confident that it has no effect on whether you win or lose games.?
That?s crazy talk. To say that pitching matters is to say that, all else being equal, teams with good pitchers win more games than teams with bad pitchers. The idea in the game of baseball is to win games. To say that something matters in baseball is to say that it helps you win games.
Everyone understands this logic for so long as the discussion relates to baseball. Things get foggy for many when we turn our focus to stock investing.
Valuations matter in stock investing
There is something close to a universal consensus on this point. I have talked to tens of thousands of investors and I have never met one who disagreed.
But I have met many investors who argue that, while valuations matter, paying attention to valuations will not help you achieve better investing results. That is, valuations matter, but having valuations on your side (by investing more heavily in stocks at times of low valuations than at times of high valuations) will not help you win at the game of investing.
All Buy-and-Holders believe this. If they didn?t, they wouldn?t be Buy-and-Holders. If you believe that having valuations on your side helps you win at investing, you would obviously set your allocation in such a way as to have valuations on your side. That is, you would go with a higher stock allocation when prices were low than you did when price s were high. Investors who do that are Valuation-Informed Indexers.
Valuations versus ?anytime is a good time to be in the stock-market?
Why do Buy-and-Holders hold this contradictory belief? Why do they believe that valuations matter but that having valuations on your side does not help you win at the game of investing?
It?s because of a mistake that was made in the early 1970s. The people who developed the Buy-and-Hold Model discovered that short-term timing doesn?t work. They didn?t know at the time of the need to distinguish short-term timing from long-term timing; the research showing the importance of this distinction was not published until 1981. So they concluded that timing in general does not work. And they made that the fundamental premise of their investing model.
Having rooted all their beliefs about investing in a conviction that timing does not work, they didn?t pay much attention to the research showing that long-term timing always works when it was published. They ignored it. Then they ignored the confirmations of that research. Then they ignored the confirmations of the confirmations.
It?s getting harder to ignore the 30 years of research showing that the fundamental premise of Buy-and-Hold Investing is the opposite of the reality now that the widespread promotion of Buy-and-Hold has caused the second worst economic crisis in U.S. history. But the desire to ignore that 30 years of research is today greater than ever. Had the flaw in the Buy-and-Hold Model been acknowledged in 1981, when it was discovered in an intellectual sense, the model could have been changed before it did harm to anyone. It would have been a case of no harm/no foul. We cannot say that it is that today. Today we need to say that Buy-and-Hold has caused more human misery than any earlier idea in the history of personal finance.
The stock market and its affect on the economy
Will we ever be able to fix the mistake and bring our economic crisis to an end?
I sure hope so. I don?t think we can wait for the investing experts to come around. I have contacted many of them and have found them to be resolute in their conviction that these errors must never be publicly discussed or corrected. The Buy-and-Hold Model is going to be fixed when the investors suffering the losses resulting from the flaws in it demand that it be fixed, not before.
So we all need to begin asking ourselves some very basic questions about this wildly popular investing strategy. Does it make sense? If you are going to put your retirement money at stake on the merits of Buy-and-Hold, you had better be sure it is a strategy that at least makes some sense. Does it? Is there even a tiny bit of logic that supports the idea that valuations matter but that there is no need to change your stock allocation in response to big swings in valuations?
I submit to you that there is zero logic supporting that claim. Buy-and-Hold makes not a lick of sense. Going by logic, we should all expect Buy-and-Hold to cause the millions of middle-class investors following it to suffer frightening financial wipeouts, wipeouts big enough to cause the global economy to collapse.
My sense is that many of us had doubts all along. The story never held together. We should have spoken up. During the bull market, Buy-and-Hold became so popular that we permitted ourselves to become intimidated by its apparent success. Now we are paying the price for our cowardice. Now we are seeing not only a collapse of our economic system but even signs that our political system may be vulnerable to potential collapse.
Valuations matter. The Buy-and-Holders got that one right. Since valuations matter, investors must take valuations into consideration when setting their stock allocations. There?s no getting around it. Buy-and-Hold is dead. We need to get about the business of building an investing model that works.
Rob Bennett has written about the eight investing questions you need to ask before putting money on the table. His bio is here.
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