Beyond Buy-and-Hold #106
The academic research of the last 30 years teaches us so many new things about stock investing that it’s no longer safe to trust your old beliefs on even the most basic questions.
You have a choice. You can have a portfolio worth $300,000. Or you can have a portfolio worth $200,000. Or you can have a portfolio worth $100,000. Which is better?
This doesn’t seem like a hard one. More money is always better. $300,000 is always better than $200,000 and $200,000 is always better than $100,000. No exceptions!
It’s not so!
There are circumstances in which a $100,000 portfolio possesses more long-term value than a $300,000 portfolio. As is so often the case, it is our failure to take valuations into consideration that makes fools of us.
I used The Investment Strategy Tester to compare three scenarios: (1) a scenario in which the investor holds a portfolio of $100,000 at a time when the P/E10 level is 8 (half of fair value); (2) a scenario in which the investor holds a portfolio of $200,000 at a time when the P/E10 level is 14 (fair value); and (3) a scenario in which the investor holds a portfolio of $300,000 at a time when the P/E10 value is 32 (double fair value). The graphic below shows the results:
The most likely results is the number at the intersection of the blue and yellow bars. The best possible results are those covered by the green bars. The worst possible results are those covered by the red bars.
When numbers lie—or so it seems
At five years out, the $300,000 portfolio is still the largest. But the $200,000 portfolio has almost caught up.
At ten years out, the $300,000 portfolio has the lowest values. The $200,000 portfolio has the best numbers. The $100,000 portfolio is close.
At 15 years out, there is no longer any contest. The numbers for the $100,000 and $200,000 portfolios are very close. The numbers for the $300,000 portfolio are far below them.
At 20 years out, the $100,000 portfolio becomes dominant. At 25 years out, the $100,000 portfolio remains dominant.
At 30 years out, the three portfolios give roughly equal results. The $100,000 portfolio remains only slightly ahead.
So which is better? A $300,000 portfolio? A $200,000 portfolio? Or a $100,000 portfolio.
The $100,000 portfolio is clearly superior. If we all accepted what we have learned from the last 30 years of academic research, our stock investing experience would be changed in a fundamental way.
We would no longer root for bull markets—we would disdain them
We would no longer view stocks as risky. We would avoid them at times when they provide poor long-term results and thereby avoid all price crashes (there has never been a lasting price crash starting from a time of fair or low prices).
We would in all likelihood not experience further major recessions or depressions. Every economic crisis we have seen from 1870 forward has followed a time-period when we let stock prices get out of control.
So why don’t we all become Valuation-Informed Indexers?
It’s hard to accept that a $100,000 portfolio is really of more value than a $300,000 portfolio. Darn the numbers! It just doesn’t make sense!
It doesn’t make sense, that much is so
You know what? The real problem is that it is the way we invest in stocks that doesn’t make sense. We look at price when buying every product and service we spend money on other than stocks. But with stocks we follow Buy-and-Hold strategies. With stocks we stay at the same stock allocation regardless of the price at which stocks are selling.
That makes the market dysfunctional. That causes all the problems we experience investing in stocks and many of the most important problems we experience in the overall economic system. No market can function without price discipline. Price discipline disappears from the stock market when a large percentage of us become persuaded that Buy-and-Hold can work.
Please look at that graphic again. It tells an important story.
The graphic is telling us something crazy. It is telling us that we are investing in crazy ways and that our crazy investing practices are making the market go so haywire that things can reach a point where a $100,000 portfolio offers the promise of more lasting wealth than a $300,000 portfolio.
It doesn’t have to be like this. Sane investing is possible. We all need to begin looking at price when we set our stock allocations. Once we do that, we will make stock investing sane again and $300,000 portfolios will once again be better than $100,000 portfolios.
Let’s do it!