Set forth below is the text of a comment that I recently posted to the discussion thread for an article on Valuation-Informed Indexing appearing at the Invest It Wisely site:
Look at the orange line at the bottom of Fig. 6: it follows the stock line (in black) most of the time, this is just plain buy-and-hold as long as valuations are sane. This strategy is closer to buy-and-hold than to, say, day-trading or stock picking.
I certainly agree that the strategy you suggest (I call it “Valuation-Informed Indexing”) is closer to Buy-and-Hold than it is to day trading or stock picking. I would describe it as a revision to Buy-and-Hold, based on Shiller’s research, which was published several years after the publication of A Random Walk Down Wall Street, the book that Buy-and-Holders cite as their Bible.
There’s only one difference between VII and Buy-and-Hold — Valuation-Informed Indexers make infrequent adjustments to their stock allocation percentages. But that one difference makes a huge difference to the long-term results obtained. VII produces far higher returns at greatly diminished risk. More importantly, it makes the investing project far less stressful. Buy-and-Holders never know what is coming. VIIers always know what’s coming (not precisely, but close enough). That’s huge.
Another huge difference is that Buy-and-Hold causes economic crises that we could avoid if we publicized VII. Since 1900, there have been four times when we have gone to P/E10 values above 25. There have also been four economic crises in that time. Each and every one of them followed the time we hit 25 by a few years. Why? The return to fair value P/E10 levels take a huge amount of spending power out of the economy, causing an economic crisis. The market was overpriced by $12 trillion in 2000. Today’s crisis became inevitable when we let prices rise to the insane levels to which we permitted them to rise in the late 1990s.
Buy-and-hold existed before Fama was even born
There’s a sense in which I agree with you and there is a sense in which I don’t, Mathieu.
The idea of not taking price into consideration when setting one’s stock allocation has been with us since the first market opened for business. I agree with that. I call that approach “Get Rich Quick” and I think it can be fairly said that Buy-and-Hold is just the old Get Rich Quick concept dressed up in modern, pseudo-scientific clothing.
The sense in which I would describe Buy-and-Hold as something new is that Buy-and-Hold purports to be rooted in research. Those promoting Buy-and-Hold strategies often claim that “timing never works.” There is of course precisely zero research showing this to be so. There is research showing that short-term timing never works. But every study of long-term timing shows that it always works. So the statement “timing always works” is every bit as true as the statement “timing never works.”
I think it would be fair to describe Buy-and-Hold as a marketing gimmick. Millions of middle-class investors have been led to believe that long-term timing is not required. They believe that there is some study somewhere showing this. So, when their common sense tells them that they had better lower their stock allocations because prices have risen so high, they ignore that voice on grounds that all the experts say that timing isn’t required. But of course there is no research supporting such a claim. It’s just a means by which stock salesmen persuade people to buy stocks even in circumstances in which stocks offer a poor long-term value proposition.