Set forth below is the text of a comment that I recently put to the Goon Central board:
I agree it’s entirely possible that the stock market (i.e., the S&P 500 Index) could drop precipitously for any number of “real-world problems, geopolitical turmoil, economic weakness, high unemployment, you name it.” There’s a quote from Tolstoy that sums up precisely the trouble that you are having understanding how stock investing works, Yip. He said (I am paraphrasing): “There is no concept so hard to explain that it cannot be easily taught to the dumbest person alive if he starts out with no knowledge of the subject. But there is also no concept so simple to explain that it can be conveyed to the smartest person in the world if he starts out thinking that he already knows all there is to know about the subject.”
You are not dumb. Neither are any of the other Buy-and-Holders. But you are having a very, very, very hard time understanding some exceedingly simple ideas. Your problem is that your belief in Buy-and-Hold cripples you. All information that tries to get into your mind first passes through a Buy-and-Hold filter. And all of the findings of the peer-reviewed academic research of the past 30 years are instantly rejected without any consideration. You cannot advance in your understanding until you make some effort to turn off that filter and listen to what the last 30 years of research is telling you.
The article says that the 65 percent price drop is a “worst-case scenario.” Huh? What the heck makes it worst case? It is the DEFAULT scenario. To expect anything less than a 65 percent price drop is to expect something we have never seen in 140 years. It is to expect something fantastic and preposterous. Now, that doesn’t mean we cannot see a drop of only 60 percent. That’s close enough to the default scenario that it is for all practical purposes a playing out of the default scenario. But we are just as likely to see a drop of 70 percent as we are to see a drop of only 60 percent. There’s no law that says that deviations from the default can only be in one direction. If you are going to propose that we are going to see some extreme outlier possibility like a loss of only 50 percent, you must in honestly acknowledge that the odds are just as good that we will see an extreme outlier possibility in the other direction, a loss of 80 percent rather than a loss of 65 percent. The default is the most likely scenario, NOT a worst-case scenario. Please try to stop getting that one wrong. It matters.
The real question is why do you keep making this elementary mistake?
There are two reasons, one substantive and one emotional. I talk about the emotional one all the time. You built your retirement plan on a discredited theory and it causes you intense emotional pain to accept that you were fooled. So you resist the message of the last 30 years of academic research. Let’s leave that one aside for now. The people who planted the wrong idea in your head are not bad people or dumb people. How is it that they came to plant the bad idea in your head? Let’s look at that one, the substantive hang-up you face.
The human race was not created knowing all there is to know about stock investing. The Efficient Market concept is a hypothesis. It possesses at least a surface plausibility. And there really is research that appears at first to support it. So many smart and good people bought into the idea. They then constructed an entire model for understanding how stock investing works built on the hypothesis. That’s Buy-and-Hold. The problem we face today is that, if the core principle of your model is wrong, the entire model is wrong. The Buy-and-Holders got the core principle wrong. So they got everything wrong. Not by intention. Inadvertently. But still.
The thing that they got wrong is the idea that long-term timing is not required. There is a perfectly understandable reason why they got it wrong. Long-term timing works only for those invested in index funds. Guess what? Index funds did not exist at the time Fama was doing his research showing that it is not necessary to time the market. Stock investing in those days meant investing in individual companies. Timing does not work for those who invest in individual companies. There is a sense in which Fama was right.
But the statement “timing doesn’t work” is 100 percent wrong. One form of timing — short-term timing — ALWAYS works. ALWAYS. There has never been an exception. There never CAN be an exception. I’ll explain why below. But first I must take the “timing always works” claim one step farther. It is not just that timing always works. It is that timing is always REQUIRED. To engage in long-term timing is to exercise price discipline. It is price discipline that permits markets to perform their magic of setting prices properly. Take price discipline out of a market and you make that market dysfunctional. No market can survive without price discipline. When the Buy-and-Holders told us that we do not need to exercise price discipline, they advanced an attack on our stock market. Which is another way of saying that they advanced an attack on our economic and political system — Millions of middle-class people have their retirement money in the stock market and our economic and political system cannot survive if the stock market is destroyed by the promotion of Buy-and-Hold strategies and all those people lose all their money.
I said that it is not possible to imagine a circumstance in which long-term timing would not work. Why do I say that? Because it follows from the research-based model for understanding how stock investing works. It does not follow from the Buy-and-Hold model. That is certainly so. But the Buy-and-Hold Model has been discredited. Nothing the Buy-and-Hold Model tells us matters any more. Once a model is discredited, it no longer serves the purpose of informing people about how the thing it is a model for works. Buy-and-Hold ideas are today dangerous ideas.
The Buy-and-Hold Model posits that stock prices are determined by economic and political events. That’s why in your comment you refer to geopolitical turmoil and unemployment. If the Buy-and-Hold Model were valid, you would be right to do so. But if the Buy-and-Hold Model has been discredited, you are foolish to do so.
The Buy-and-Hold Model has been discredited. If the market were efficient (this is the core belief of Buy-and-Holders, it is the only possible reason why someone would believe that it is not necessary to take price into consideration when buying stocks), prices would play out in a random walk. No? It is only unanticipated political and economic events that affect prices, under the Buy-and-Hiold Model. Unanticipated events fall in a random pattern. They are not knowable in advance. That is the entire reason why Buy-and-Holders say the market is efficient. But if prices do not fall in a random walk, none of this is so. The Buy-and-Hold Model failed on the day Shiller published his research showing that long-term prices do not play out in a random walk. A somewhat plausible explanation of how the stock market works was discredited by the RETURN DATA.