Beyond Buy-and-Hold #4: Long-Term Timing Is Not At All Similar to Short-Term Timing
By Rob Bennett
Buy-and-Hold advocates often advise investors not to fall for market timing schemes. I am not too crazy about timing schemes myself. I avoid them. But I do believe strongly in long-term timing, the timing approach employed by Valuation-Informed Indexers. This timing approach is different. This timing approach is not a scheme.
I don?t have confidence in this approach because the data supports it or because I think that it may work or that it is likely to work. I have confidence in this approach because it must work. It is not possible for the rational human mind to imagine a circumstance in which this timing approach would not work. Could I state it any stronger?
Short-term timing — all the timing approaches properly referred to as ?schemes? fall into this category — involve guesses as to which way stock prices are going. Even in cases in which they work, they are tricky. I believe that it might be possible for a small number of sophisticated investors to succeed at short-term timing (changing your stock allocation with the expectation of seeing a benefit within a year or so). But I do not think that short-term timing is at all a good idea for the typical middle-class investor. I see eye to eye with the Buy-and-Holders re this one.
Long-term timing (changing your stock allocation in response to big valuation changes with the understanding that you may not see a benefit for doing so for as long as 10 years) couldn?t be more different. Do you know how those warning you that timing schemes don?t work point out that you would need to guess right two times for the timing scheme to pay off, that you would need to find both a good exit point and a good entry point? That?s so for the ?schemes.? It is not so for long-term timing.
Stock prices reached insanely high levels in January 1996. What happened if you missed that exit point? You got another change in 1997. And then another in 1998. And then another in 1999, 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, and 2008. It wasn?t hard to pick a good spot to get out.
And what will happen if you miss the good entry point that will be coming after the next price crash? You may have as long as 10 years to buy into stocks at a good price. That?s what happened after the crash we saw in the early 1970s. Stocks remained a good buy from 1975 all the way through 1995. You had 20 years to find a good time to get back in.
Long-term timing is very, very different from short-term timing. None of the pitfalls that apply with short-term timing apply for the timing approach used by Valuation-Informed Indexers. Because this is part of a strategy designed for long-term investors, it does not require any quick decisions. That?s why it is not properly referred to as a ?scheme.? And that?s why it works even though so many short-term timing approaches do not.
You need to think about long-term timing in a totally different way from how you think about any timing approach you have heard about before. There is no guesswork involved. All that a Valuation-Informed Indexer is doing is identifying value propositions and going with the strongest one. You don?t have to worry about whether it is going to pay off or not. Long-term timing must pay off, so long as the analysis underlying the timing decision is conducted properly.
There are some cases in which it is not clear whether stocks offer a good long-term value proposition or not. In those cases, it is of course possible to make a bad guess. But if that is your worry, there?s an easy way to address it. You of course have the option of sticking with a high stock allocation (the choice favored by Buy-and-Holders) in all cases in which making an allocation change is not sure to pay off. How often to engage in long-term timing is an individual choice.
Long-term timing is not a guessing game. It is a value-proposition assessment game. The thing to compare this to is your practice of checking prices before you buy a car or a large appliance or a vacation rental. Is it possible to imagine any circumstance in which paying attention to price could be a bad thing in such circumstances?
The same logic applies with stock investing. Stocks offer a better deal when selling at good prices. Go with a lower stock allocation at times of bad prices and you will have more money to invest in stocks at times when prices are appealing. You cannot lose.
Short-term timing gave market timing a bad name. The Buy-and-Holders did us all a favor by stressing how dangerous a game short-term timing is. But they threw the baby out with the bathwater when they led investors to believe that there is something questionable about long-term timing too.
Rob Bennett created an investment strategy calculator called ?The Strategy Tester.? His bio is here.
When I first learned of this approach I was hooked. It makes sense to look at the long term valuation of the market before jumping in – even if you plan to buy & hold! I’ve seen studies that indicate that these long-term valuation swings can take up to 18 years to come full circle.
It makes sense to look at the long term valuation of the market before jumping in ? even if you plan to buy & hold!
I very much agree, Khaleef.
I’ll give a concrete example. The P/E10 level dropped to 12 in March 2009. That’s an extremely attractive valuation level. I believe that we will be seeing another stock crash in the next few years and there will be some saying that it was a mistake to buy before a crash. I don’t think that’s right. You will be down for a time after the crash, to be sure. But those who bought when the P/E10 level was 12 will almost certainly end up okay at the end of 10 years. They will just need to be patient.
The same cannot be said for those who bought prior to the September 2008 crash. The P/E10 level was horrible at that time. Some who bought at that time are now thinking that they did not make such a big mistake because prices are up a bit again. But that next crash is going to ruin things for them. Even after 10 years, that group will still end up doing poorly.
The exciting thing about Valuation-Informed Indexing is that you know how your investment is going to turn out BEFORE you put money on the table. Stocks always perform well in the long run starting from good prices. And stocks always perform poorly in the long run starting from bad prices. There are no exceptions in the historical record. We cannot know precisely what our long-term returns will be. But we can have a good idea. Having a good idea of your long-term return reduces the stress of stock investing a lot!
I?ve seen studies that indicate that these long-term valuation swings can take up to 18 years to come full circle.
That’s so. Actually, the full cycle can be a bit longer that that. The most recent up cycle began in 1982 and ended in 2000. That’s 18 years just on the upside. Now we have had 10 down years and we are likely to see at least one more major crash (we always in the past have gone to one-half fair value on the downside before completion of the down cycle).
This is the key thing that Buy-and-Holders do not get. They think of the possibility of good and bad outcomes being the same in each year. Nothing could be further from the truth! Cycles have applied since the first day the market opened for business. There is a great book on this titled “Stock Cycles.”
You want the cycle on your side. You do not want to be fighting the cycle. Buy-and-Hold worked well from 1982 through 1999 because the cycle was on the side of stock investors. But Buy-and-Holders have no way of knowing when the cycle is going to switch from up to down. Miss that switch and you can lose on the down side everything you picked up on the up side.
Valuation-Informed Indexers do not know precisely when the switch is going to take place. I do not believe that there is any way to know this. All that we can know is that the odds of a switch grow much larger when valuations rise to insane levels. That happened in 1996. From that point forward, the odds of a switch taking place were high. If you lowered your stock allocation in 1996, you are ahead of the game today and you will be even more ahead after the next crash.
The reason why the Buy-and-Holders do not understand cycles is that they assume that investing is a purely rational endeavor. It is largely an emotional endeavor. All overvaluation and undervaluation is the product of investor emotion.
Rob