I recently posted an article to the “Valuation-Informed Indexing” section of the site entitled The True Cause of the Current Financial Crisis Is Buy-and-Hold Investing.

Juicy Excerpt #1: We feel a great short-term temptation to set prices insanely high. But we ultimately are governed by the long-term economic necessity that prices reflect fair value. It’s the tension between the short-term desire for high prices and the long-term requirement of fair-value prices that causes all stock crashes. If prices never get too out of control, the tension can be resolved through modest price drops. But when the idea that price doesn’t matter (Buy-and-Hold Investing or Passive Investing) catches on, prices go so high that a crash becomes an inevitability.

Juicy Excerpt #2: Once we get to insanely high stock prices, stocks must crash if the market is to continue to function. Stock crashes cause massive losses of wealth. Massive losses of wealth cause consumers to cut back their spending dramatically. Dramatic spending cutbacks cause businesses to fail. Business failures cause millions to lose their jobs.

Juicy Excerpt #3: Teaching investors to ignore the prices of the stocks they buy sets in motion a chain of events that sooner or later inevitably produces an economic crisis. Persuading millions to follow a buy-and-hold strategy is the financial-world equivalent of persuading millions to remove the brakes from their cars. Cars without brakes always crash. So do economies in which all price discipline has been removed from the stock market.

Juicy Excerpt #4: Most of those cited as “experts” on investing have ties to The Stock-Selling Industry. All industries like to see their customers buy as much of their product as possible and at all times and prices. Buy-and-Hold Investing has brought in millions to The Stock-Selling Industry.

Juicy Excerpt #5: We are suffering from what the economists call a “Tragedy of the Commons” problem. No one benefits from our failure to inform investors of what really works. The economic crisis hurts us all. But each individual blogger fears that he will lose links and annoy those of his readers who still believe in Buy-and-Hold Investing if he points out that the experts have been giving wildly dangerous advice for years now, and each “expert” fears that he will lose the confidence of his clients if he “tells.”

Juicy Excerpt #6: The academic researchers learned in the 1960s that short-term timing does not work; that is, it is not possible to predict effectively what the stock return will be over the next year or so. There are two possible explanations for this reality. One is that the market does such a good job at setting prices that it is not possible for any investor to reliably do a better job. The second is that the market does such a poor job at setting prices, at least in the short term, that the best that any investor engaged in short-term timing can do is take guesses as to where prices will be in the next year or so.The academic researchers took a guess that the first explanation was the one that applied. 

Juicy Excerpt #7: Shiller’s findings are entirely consistent with the second explanation. Shiller showed that valuations affect long-term returns. If the market does a poor job of setting prices in the short-term but a good job of setting prices in the long term, it would follow that returns would be poor starting from times of high valuations and that returns would be good starting from times of low valuations. Prices can go just about anywhere in the short term. But they are always in the process of moving to fair value.

Juicy Excerpt #8: The prudent way to invest is to assume that stocks will perform in the future at least somewhat as they always have in the past. Buy-and-Hold Investing is the longest of long shots. We should not be advising millions of middle-class investors to take the longest of long shots with their retirement money, in my assessment. At the very least, we should be cautioning those who elect to invest passively that the historical data offers little support for their choice.

Juicy Excerpt #9: Think of the Passive Investing Era as the time-period when the majority of investing experts drove drunk or got addicted to cigarettes or dated people obviously not right for them. We need to put aside the idea that there is a rational explanation for all human behavior. It’s not so. It’s holding us back. It’s become dangerous for us to continue to entertain this excessively rationalistic (and not even a little bit rational!) fantasy.

Juicy Excerpt #10: John Bogle is a whole big bunch smarter than Rob Bennett in an I.Q. sense. But Rob Bennett has been placed in circumstances that have permitted him to zoom past John Bogle in his understanding of what works in stock investing.

Juicy Excerpt#11: There was a time when millions of people believed that the earth was flat. There was a time when millions of people believed that the earth revolved around the sun. There was a time when millions of people believed that man would never walk on the moon.

Juicy Excerpt #12: The reckless promotion of Buy-and-Hold Investing has been an anchor on economic growth for so long now that it is hard to overestimate how good we could have it if we made the shift to a more realistic approach. Rational Investing (the investing model proposed as an alternative to Passive Investing in a number of articles and podcasts at this site) is such an advance that making the shift from Passive to Rational may well provide the lift to middle-class spirits (and pocketbooks!) needed to escape today’s economic and political crisis.

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