Set forth below is the text of a comment by a poster named MBTN (his blog is Money By the Numbers) put to the market timing thread at the Free Money Finance board. MBTN does a good job of presenting the pro-Buy-and-Hold position:
Thank you for your response. I think you describe your argument quite well. You are saying that just because the “market value” of a basket of stocks is $600,000 doesn’t mean that they are actually worth $600,000. I agree with that statement. The actual value (meaning the present value of future earnings) is inherently unknowable. It could be $800,000. It could be $200,000. If it is $800,000 then great; you just made an additional $200,000! If it is $200,000 like you said, then it is a disaster waiting to happen.
I think though that the way you frame the debate between buy-and-hold versus market timing doesn’t match with how I see things. Not to say that I am right, just that I see the debate in a different light.
Buy and holder would say that the market value is $600,000 and we don’t know if the true value is really $800,000 or $200,000. The market timer would say that the market value is $600,000 but that number is overvalued and the true value is $200,000. From my way of thinking, it is a matter of thinking whether you know what the true value is or not. My opinion is that you can’t know the true value because it depends upon future events. That is the way that I see the debate being framed.
I agree with you that there is a risk that the market is overvaluing the value of stocks in which case you are in trouble. However, there is no way for people to know right now whether they are overvalued or undervalued. Yes, if they are overvalued, you are going to take a loss. However if you THINK they are overvalued when in point of fact they are undervalued, you are going to take a loss as well in the sense that you will be selling stocks at $600,000 when they are actually worth $800,000. Either way is a bad condition.
The other thing is that Buy and Holder doesn’t mean that you are going to hold 100% in stocks. At least I don’t. A buy and holder should realize that he or she doesn’t know whether stocks are undervalued or overvalued so he or she will allocate assets across many sectors: stocks (large, small, value, growth, international), bonds (long term, short term, government, corporate, junk), real estate, commodities, etc. The reason being is that usually all of these asset classes move in different directions. When stocks are up, bonds are down. When stocks are down, commodities are up, and so forth. Usually if one asset class is overvalued, another is undervalued. That way, no matter what the unknowable future holds, you will not lose your shirt.