Beyond Buy-and-Hold #30
I bill myself as the most severe critic of Buy-and-Hold Investing alive on Planet Earth today. I say that it is likely going to cause millions of failed retirements. I say that it was the primary cause of the economic crisis. I say that it cancels out the effect of teeth whiteners.
Well, maybe not that last one. But if there?s something bad and scary going on in the world, there?s a good chance that Rob Bennett has attributed it to the popularity of Buy-and-Hold Investing.
This angers some and mystifies many. What?s the story? Why have I made this my obsession? What can?t I just let it go? What has Buy-and-Hold ever done to me?
When an investment strategy looks too perfect watch out!
The trouble is that Buy-and-Hold comes so tantalizingly close to being the perfect investing strategy that it has taken in millions of smart and good people. These people are my friends. I could learn lots of good stuff from these people if we could engage in civil and reasoned discussions of realistic investment strategies. But their belief in Buy-and-Hold makes that impossible.
The differences between Buy-and-Hold and Valuation-Informed Indexing (the strategy I favor) are so fundamental that the two strategies lead to entirely different places on just about every question that comes up. It would be fair to say that Valuation-Informed Indexing is the opposite of Buy-and-Hold.
What?s so bad about Buy-and-Hold?
Warren Buffett follows it, doesn?t he?
Warren Buffett does not follow Buy-and-Hold.
Warren Buffett does it right. Warren Buffett?s strategy is the opposite of Buy-and-Hold.
Warren Buffett follows a two-step approach: (1) he researches and researches and researches until he finds a strong value proposition; and (2) he sticks with his decision long enough for it to pay off.
Step Two is essential. The thing that makes stock investing tricky is that what works in the short term is often not what works in the long term. Buffett doesn?t permit himself to be fooled by the short-term noise. If he identifies a good stock and invests in it and it does poorly for some time, he doesn?t let that phase him. He sticks with his choice. He holds. More often than not, his choice pays off in the long run.
All that makes sense. Buy-and-Holders incorporate this element of Buffett?s genius into their strategy. That?s great. It?s because Buy-and-Holders know to stick with their choices for the long run that Buy-and-Hold offers such promise. It is this element of the strategy that pulls in so many smart people.
The forgotten Step Two of the investment world
But Step One of the two-step Buffett process is also essential.
Yes, you want to stick with your investing choices for the long run. That?s critical. But you must make good choices for this strategy to pay off. You don?t want to stick with bad choices! Sticking with bad choices will ruin you. Sticking with bad choices is the anti-Buffett approach. Sticking with bad choices is dumb and dangerous.
Why would anyone want to stick with a bad choice? Why? Why? Why?
Most Buy-and-Holders don?t pick individual stocks, like Buffett. They are indexers. That?s fine. Most middle-class investors don?t have the time to do the sort of research that Buffett does. Indexing is a great choice for the vast majority of investors.
But picking indexes doesn?t free you of the need to identify strong value propositions and to refuse to put money on the table until you find one. What make the ?hold? part of Buy-and-Hold work is that it takes time for strong value propositions to pay off. Guess what happens in the long term to poor value propositions? They reveal themselves as poor value propositions, just as surely as strong value propositions reveal themselves over time as strong value propositions.
Fail to limit your investing to strong value propositions and you take the magic of long-term investing and turn it against you. There?s a chance that a poor value proposition will pay off in the short-term. There?s almost no chance that it will pay off in the long term. Invest your money in a poor value proposition as a Buy-and-Holder and you lock in a loss by sticking with that choice for the long term.
Indexers need to direct their investing dollars to strong value propositions every bit as much as stock pickers. Stock pickers do it by identifying good companies. Indexers do it by going with high stock allocations only when stocks are low or moderately priced. Buy-and-Hold cannot work because it doesn?t call for the investor to change his stock allocation in response to price changes and thus often leaves the investor holding to an investment choice that he should not have made in the first place.
Rob Bennett admires John Bogle but believes that he made a big mistake with his endorsement of Buy-and-Hold. His bio is here.