I am not a Buy-and-Holder. Buy-and-Hold encourages people to believe that irrational exuberance (stock gains that are rooted only in investor emotion and that thus never last) is real. I believe that we all should be engaged in market timing to the extent needed to keep irrational exuberance under control.
3844328 / Pixabay – Valuewalk
Q4 2021 hedge fund letters, conferences and more
But I think that it is healthy every now and again to consider the argument against one’s own beliefs. So here is the case for Buy-and-Hold, as seen by a strong Buy-and-Hold critic.
Valuation-Informed Indexing vs Buy-and-Hold
I often say that precisely 100 percent of the evidence available to us today supports Valuation-Informed Indexing (a strategy that posits that market timing is essential for investors seeking to keep their risk profile constant over time) and that precisely 0 percent of the evidence available to us today supports Buy-and-Hold (because the idea that market timing is not required is rooted only in an assumption, not in peer-reviewed research findings). I believe that. But there’s one significant problem with the claim. 100 percent of the evidence available to us today is not all that much evidence.
The research that is done in this field makes use of return data going back to 1870. That sounds like a lot of data. But bull/bear cycles can take 40 years or even a bit longer to play out. So the full reality is that we only have data from three complete cycles and one near-complete cycle to guide us. That’s not very much. It is entirely possible that there are possible return scenarios that do not appear in the record solely because the record is not yet big enough. Something could happen starting today that we have never seen before.
Another plus for Buy-and-Hold is that it is simple. I am a big believer in keeping stock investment strategies simple. For a strategy to work, the investors following it have to execute it properly. Permitting even a little complexity diminishes the odds that most will be able to pull it off. Buy-and-Hold is exceedingly simple – stay at the same stock allocation at all times. I think that there is such a thing as being too simple. But I acknowledge that Buy-and-Hold is as simple as it gets and as a general rule that is a good thing.
Buy-and-Hold puts the focus on stocks. Stocks are an amazing asset class and Buy-and-Holders are always heavily invested in that amazing asset class. I don’t believe that that is always the best choice. But given the compelling value proposition of stocks, it’s a good default position. Being heavily invested in stocks is usually going to pay off and there are many circumstances in which it will pay off very well indeed.
What Causes A Change In Stock Prices
Buy-and-Hold makes intuitive sense. Buy-and-Holders believe that it is economic developments that cause stock price changes because investors act in their self-interest in response to developments that change the long-term value proposition of their investment. I don’t think that’s quite so. I believe that non-rational behavioral factors play a big role. But it sure does seem like investors would want to make rational investment choices given that it is their financial future that is at risk if they fail to do so. Why do so many people believe in the Buy-and-Hold story?. It’s a naturally believable story.
Buy-and-Hold is a mechanical strategy. Following it permits investors to tune out the “noise” of people offering advice related to current developments in the market. I like that about Buy-and-Hold. Valuation-Informed Indexing is mechanical too. It’s just that the mechanics are a bit different because valuations/emotions are taken into account as well as nominal prices. But the fact that Buy-and-Hold is mechanical is a solid selling point.
Buy-and-Hold is a seemingly humble strategy. How many times have you heard Buy-and-Holders say “you can’t beat the market”? It sounds like Buy-and-Holders are trying to recognize their limitations. The flaw in that line of thinking from the standpoint of someone who believes in valuation-informed strategies is that sometimes the market as a whole goes so nuts that you can beat it and should want to. But humility is a super-power in the investing realm. The Buy-and-Holders are at least aiming in the right direction.
Avoiding Price Crashes
Price crashes are rare. The big flaw in Buy-and-Hold is that it facilitates price crashes (market timing is the thing that helps us avoid price crashes and Buy-and-Holders disdain it) and one price crash can set an investor back for many years. But price crashes don’t turn up all that often. Shiller was warning of a price crash in 1996. We didn’t see one until 2008. And that price drop did not remain in place for very long. Starting in late 2009, we have seen high prices for another 12 years. Some would say that a strategy that works well for such long stretches of time delivers the goods.
Many smart people believe in Buy-and-Hold. I have gotten into discussions/arguments with thousands of Buy-and-Holders over the years. I can never recall encountering a dumb one.
Returns on safe asset classes are often very poor. This is the biggest reason why most investors are drawn to Buy-and-Hold strategies. I believe that there are circumstances in which it is better to give up on obtaining good returns for a time in exchange for being protected from suffering terrible losses. But the returns on most non-stock asset classes are just not good enough to finance an age-65 retirement. So a strategy that keeps one’s money in stocks cannot be dismissed out of hand.
We will return you to your normal programming next week.
Rob’s bio is here.
