Beyond Buy-and-Hold #96
One of my favorite sections of the book Irrational Exuberance is the section in which Robert Shiller makes reference to how the relentless promotion of Buy-and-Hold investing strategies generates inequalities in wealth. And, boy, does it ever!
The book states: “It is a serious mistake for public figures to acquiesce in the stock market valuations we have seen recently, to remain silent about the implications of such high valuations, and to leave all commentary to the market analysts who specialize in the nearly impossible task of forecasting the market over the short term and who share interests with investment banks or brokerage firms.”
It continues: “The valuation of the stock market is an important national — indeed international — issue. All of our plans for the future, as individuals and as a society, hinge on our perceived wealth, and plans can be thrown into disarray if much of that wealth evaporates tomorrow. “
Where it all leads: speculative bubbles
Then we get to the words that are the focus of this column entry. Shiller says: “The tendency for speculative bubbles to grow and then contract can make for very uneven distribution of wealth. It may even cause many of us, at times, to question the very viability of our capitalist and free market institutions. It is for this reason that we must be clear on the prospect for such contractions and on what should be our individual and national policy regarding this prospect.”
Those are important words. We are seeing in the early years of the Buy-and-Hold Crisis how the uneven distribution of wealth causes millions of middle-class people to lose confidence in our economic and political systems. And for good reason!
It’s one thing to see huge wealth disparities due to differences in work ethic or talent. But huge wealth disparities that are attributable to nothing more than date of birth? That’s a sign of a free market system that is in the state of collapse. That’s a sign of a political system that has been bought off by one super-wealthy industry.
Birth order and wealth disparities
Let’s take a look at how Buy-and-Hold investing causes these wealth disparities, using The Stock Investment Strategy Tester to generate the numbers needed to make the issue concrete and easy to understand.
Say that there are two individuals who both spent their 20s paying off student loans and then were given promotions at age 30 that put them in financial circumstances in which they could begin making $10,000 annual contributions to their retirement plans. For the next 30 years they both make these contributions. The only difference between these two individuals is that one turned 30 in 1982, before Buy-and-Hold was being promoted heavily and stocks were still priced well, and the other turned 30 in 2000, after decades of the promotion of this strategy sent stock prices to the most dangerous levels ever seen in history.
What sort of difference in return should these two individuals expect to see by virtue of the fact that the first was born in 1952 and the second was born in 1970? (I assumed that both investors went with a 60 percent stock allocation for the entire time-period.)
At Year 10, the most likely portfolio value for the investor lucky enough to be born in 1952 is $166,000. The most likely portfolio value for the investor unlucky enough to be born in 1970 is $109,000.
The best possible portfolio value for the born-lucky investor at Year 10 is $210,000. The best possible portfolio value for the born-unlucky investor at Year 10 is $137,000.
The worst possible portfolio value for the born-lucky investor at Year 10 is $134,000. The worst possible portfolio value for the born-unlucky investor at Year 10 is $87,000.
The disparity grows over time
At Year 20, the wealth disparity worsens.
The most likely portfolio value for the born-lucky investor at Year 20 is $480,000. The most likely portfolio value for the born-unlucky investor at Year 20 is $327,000.
At Year 30, the difference in most likely portfolio values is $118,000. The number for the first investor is $914,000. The number for the second investor is $796,000.
Both investors did the same things. They saved at the same rate. They invested in the same asset classes and in the same percentages and for the same length of time. Why is one investor likely to end up with a portfolio value of more than $100,000 greater value?
It’s because of the promotion of Buy-and-Hold investing. If investors knew that it is in their best interest to adjust their stock allocations in response to valuation shifts, we would not see out-of-control bull markets and the out-of-control bear markets that inevitably follow them. Our investment results would depend not on the year in which we were born but on how much we saved and on whether we made good investment choices or not.
That’s how a free market system should work. Wealth disparities are not a bad thing when they are the result of meaningful distinctions. Investors who save more should end up with greater wealth. But it’s arbitrary that some of us are able to retire years sooner solely because we happened to be born so as to come of investing age at a time when stocks were priced low rather than high.
To win the respect of its citizens, our economic system needs to be perceived as fair. Shiller is right. Policymakers need to be devoting more attention to the wealth disparities caused by out-of-control bull markets and to The Stock-Selling Industry’s relentless promotion of investing strategies most likely to bring on such bull markets.
Rob Bennett has written about why you might or might not want to read investing newsletters. 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.