By robbennett. Originally published at ValueWalk.
The Buy-and-Hold “idea” is an absurdity.
I know that many people will find that a provocative and offensive and probably ill-informed statement. But it is my sincere assessment.
Price discipline is essential to the proper functioning of every market that has ever existed. In the stock market, price discipline is achieved through the practice of market timing (lowering one’e stock allocation when stock valuations get too high and increasing it when they get too low). Yet the Buy-and-Holders say that market timing doesn’t work or isn’t required. That claim brings this strategy into conflict with what common sense says must be so.
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Market Timing Doesn’t Work
Incredibly, there is no evidence either that market timing doesn’t work or is not required. Given how often they have heard the claim that market timing doesn’t work, most people assume that there must be a mountain of evidence supporting the claim. But there is not. There is a good bit of evidence showing that short-term market timing (guessing when price shifts will take place) doesn’t work. But showing that one particular form of market timing doesn’t work is not at all the same thing as showing that all forms of market timing are dubious. Saying that is like saying that, because drunk driving is dangerous, driving in general should be outlawed.
How did we get here? How did we get so mixed up in our views about so basic a question as whether market timing (price discipline!) is required when buying stocks?
I am a big believer in turning to the most obvious explanation of a puzzle as the one most likely to be the one that applies. Why don’t we know how stock investing works? We don’t need to look into nefarious possibilities. We don’t know because we don’t know. Humankind did not come to this planet with an instruction book detailing how stock investing works. Some people noticed that short-term timing doesn’t work and, not knowing anything else about the subject, jumped to the conclusion that timing in general is a bad idea.
The problem is what happened after that. The same lack of an instruction manual applies in all fields of human endeavor. But stock investing is a field in which large amounts of money are at risk. So the procedure that applies in other fields – mistakes are discovered over time and then corrected so that knowledge increases gradually over time – does not apply. With stock investing, the feeling is that it would be too horrible to admit a mistake. So this mistake about a fundamental reality – whether market timing is required – has remained uncorrected for 40 years since the research was published showing that there is zero chance that the old understanding is correct (Shiller published research showing that valuations affect long-term returns in 1981).
The Buy-and-Hold Idea
Today, it is not just the mistake that embarrasses the “experts.” It is also the cover-up of the mistake. And the cover-up of the cover-up. As time goes on, the case in favor of market timing grows stronger and stronger. Yet the resistance to acknowledging and correcting the mistake also grows stronger and stronger. What would have been a relatively easy matter in 1981 looks like a mountain of complication to Buy-and-Holders who consider coming clean today.
Market timing is essentially the pressure valve for the stock market system. When a little irrational exuberance accumulates in the pipes, the proper thing to do is to apply a little market timing to deal with the issue before the problem gets out of hand. When large numbers of investors have come to believe that market timing is not required, the irrational exuberance and the pressure both grow and grow until – very bad things happen.
This will change, I believe. Following the next price crash, people will reflect on what we have done to ourselves by putting our confidence in the absurd idea that there might be one market in which price discipline is not absolutely required and we will get about the business of getting better investment advice out to millions. I know from talking to people in this field that there are a good number of experts who would like to get about the business of correcting the horrible error that has caused so much human misery over the years.
When we look back at what happened, I hope that we will all appreciate that the Buy-and-Holders who made the mistake also offered many amazing, positive contributions. The only ones who don’t make any mistakes are the ones who never try to accomplish anything of importance. The Buy-and-Holders tried to do important stuff and in many respects succeeded in their efforts. My guess is that Shiller might not have performed his research showing that valuations affect long-term returns had the idea not first caught on that the market is efficient. Shiller discredited that idea because it needed to be discredited. It was by coming up with the failed understanding that the Buy-and-Holders initiated a process which in time helped us all to appreciate the realities.
Rob’s bio is here.
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