Beyond Buy-and-Hold #58
The only difference between Buy-and-Holders and Valuation-Informed Indexers is that Buy-and-Holders say that there is no need to engage in market timing and Valuation-Informed Indexers say that those who fail to engage in long-term timing will sooner or later see their risk profiles go wildly out of whack (because the riskiness of stocks changes with changes in valuation levels). Is it really that big a deal?
This article sets forth nine reasons why I think it is a big deal.
1) Those who engage in long-term timing obtain far higher returns.
The most likely annualized 10-year return for stocks when selling sat the price that applied in 2000 is a negative 1 percent real. IBonds were available at the time paying a return of 4 percent real. Earning 5 percentage points less on your retirement money each year for 10 years running makes a big difference.
2) The return differential compounds over time.
The difference in return is actually the small thing in dollars-and-cents terms. The compounding returns phenomenon causes that differential to grow dramatically over the years. I have runs comparisons in which the Valuation-Informed Indexing portfolio grows to more than double the size of the Buy-and-Hold portfolio in 30 years.
3) Taking valuations into consideration reduces the risk of stock investing by 80 percent.
Stocks have never performed poorly for the long-term investor starting from a time of low or moderate prices. Stocks have never performed well for the long-term investor starting from a time of super-high prices. The risk of stock investing is concentrated. It kills those who invest heavily in stocks at times of high prices. It rarely has much effect on those willing to lower their stock allocations at times when prices go off the rails.
4) Buy-and-Hold causes economic crises.
It?s not just that Buy-and-Holders see much of their accumulated savings of a lifetime disappear in stock crashes. Those stock crashes bring on economic crises that cause the value of their houses to crash and that threaten to cause them to suffer job losses. When the Buy-and-Hold bubble bursts, Buy-and-Holders often need to endure multiple financial hits all at the same time.
5) It?s impossible for Buy-and-Holders to plan their financial affairs effectively.
Stocks were priced at three times fair value in 2000. That means that the investor with a portfolio nominally priced at $300,000 possessed $100,000 of lasting wealth. Valuation-Informed Indexers discount their portfolios to reflect their true value. Buy-and-Holders do not. So Buy-and-Holders had no way of knowing whether they really could afford to buy bigger houses or newer cars or to go on longer vacations.
6) Buy-and-Holders don?t know where the market or the economy is headed.
All the experts I know who advocate valuation-informed investing strategies predicted the 2008 stock crash years in advance. Buy-and-Holders were surprised.
7) Valuation-Informed Indexers enjoy emotional calm.
When you know where things are headed, you are able to prepare yourself for future twists and turns. The 2008 crash did not worry me personally because I was going with a zero stock allocation at the time (I was of course concerned about the damage that was being done to our economic system). There is a benefit to not experiencing feelings of regret and confusion and panic.
8 ) Valuation-Informed Indexers are able to lock in good returns from non-stock asset classes when they become available.
IBonds were paying 4 percent real in 2000. Valuation-Informed Indexers took advantage of this once-in-a-lifetime opportunity to obtain a solid long-term return from a risk-free asset class. Buy-and-Holders took a pass because they didn?t see the need to invest in a non-stock asset class. After the crash, many looked into other asset classes but found that the super returns available in earlier days no longer applied.
9) Valuation-Informed Indexers are better positioned to invest heavily in stocks when they are available at good prices.
The market provides most of its returns in those time-periods following the years in which stocks are selling at low prices. The next stock crash will provide an opportunity to buy stocks at prices at which they are likely to provide an annualized 10-year return of 15 percent real or more. Investors who have not suffered losses from 2000 forward will have more funds to invest in stocks at those prices and will feel better emotionally suited to invest in stocks as well.
Rob Bennett writes about how much to save at his web site. Rob?s bio is here.
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