Beyond Buy-and-Hold #61
For Buy-and-Holders, investing is a zero-sum game. To the extent you do well, the other guy does poorly. To the extent the other guy does well, you do poorly. The reason why Buy-and-Holders don?t believe in trying to beat the market is that each investor is aiming to ?exploit? all other investors. So there is risk attached to doing anything other than just accepting the market return at all times.
It?s a very different story for Valuation-Informed Indexers. The idea with the new strategy is to tap into the power of the 30 years of academic research that was published after development of the Buy-and-Hold strategy. That research permits us all to become more effective investors at the same time.
Can we really ?beat the market? in stocks?
Is that really possible? Can we all earn higher returns at lower risk? Where does the money come from?
The money comes from us having a more productive economy. Buy-and-Holders have lost sight of why it is that we have a stock market in the first place. The stock market is not a casino. Investing is not a game. The stock market serves an economic purpose. It is the means by which corporations finance their growth.
If investors act in such a manner as to facilitate that growth process, there is more growth and thus more profits to benefit all of us. If investors act in such a manner as to hinder that growth process, we are all losers. Investing is not a zero-sum game. We are all enriched when we all invest effectively. When too many of us make poor investing choices, we cause economic crises that impoverish all of us.
Say that there are two companies, a company that builds and sells McMansions and a company that builds and sells well-priced homes. Say that the natural market for the well-priced homes is strong and that the market for the McMansions is weak. A free market economy would reward the company serving market needs and punish the company failing to serve market needs. The rewards would be delivered in the form of higher profits and the punishments would be delivered in the form of diminished profits.
Why the stock market goes berzerk
But the market doesn?t do its job once Buy-and-Hold strategies become popular. Buy-and-Holders don?t lower their stock allocations when stock prices rise to insanely high levels. So bull markets always go out of control once Buy-and-Hold strategies become popular. That means that the nation?s financial resources are wildly misallocated.
The market was priced at three times fair value in 2000. So those who held $100,000 of lasting wealth were under the temporary impression that they held $300,000 in wealth. Those who held $200,000 of lasting wealth were under the temporary impression that they held $600,000 in wealth. And those who held $300,000 of lasting wealth were under the temporary impression that they held $900,000 in wealth.
How do you think these bull market fantasies affected the spending decisions of millions of investors?
It caused them to spend far more on high-priced homes and cars and vacations than they would have spent had they possessed an accurate understanding of how much wealth they possessed. That is, it caused companies that built and sold McMansions to become far more successful than they would have been had the market been functioning properly and it caused companies that built and sold well-priced homes to become far less successful than they would have been had the market been functioning properly.
Buy-and-Hold destroys wealth by taking profits that should be going to companies doing a good job of serving customer needs and allocating it instead to companies doing a poor job of serving customer needs. It does this for many years running and on a widespread scale. Allowed to continue long enough, the bull markets created by the promotion of Buy-and-Hold strategies bring a free market economy to its knees.
Look around you. It has happened once again.
Will our economy ever recover?
It will. It will recover when the idea that Buy-and-Hold can work dies in the minds of the millions of middle-class investors who came for a time to believe in it. When we permit the free market economy up off the ground again, we will all once again become able to enjoy the benefits of living in a free market economic system.
I want you to invest more effectively. By doing so, you enrich not only yourself but me and all other investors as well. Invest effectively and you free our economy to generate wealth for all of us.
Investing is not a zero-sum game. Investing is the means by which we reward well-run businesses and punish poorly run ones. We all should be helping our friends and neighbors and co-workers to invest as effectively as they possibly can. The better we all invest, the richer we all become.
Rob Bennett writes about Stock Valuation Made Easy at his website. His bio is here.
I have to admit that I haven’t heard anyone blame buy and holders for the market’s woes. The blame is usually on institutions or short sellers. You have an interesting perspective, but not one I necessarily agree with.
First off, I don’t think buy and hold investors think the markets is a zero sum game. The market grows with the world’s economies. As they expand so does the market. When a buy and hold investor sells it doesn’t mean that the buyer on the other end will lose money. If the stock continues to climb then both parties will have made money.
Another angle to consider is that buy and hold investors may actually provide stability in the market. By not selling when there are declines, there is a limit to just how low things will go. If instead everyone sold, the damage could be greater or occur more rapidly.
Anyway, I’m always interested in other perspectives so I’m happy your shared yours.
Thanks for sharing your thoughts, Darren.
It’s fair-minded people like you that caused me to fall in love with Buy-and-Hold back in the days when I was in love with it.
Rob