Set forth below is the text of a comment that I recently posted to another blog entry at this site:
Super post, Canuck. I relate to everything you say here.
Shiller published his research showing that valuations affect long-term returns in 1981. If valuations affect long-term returns, the risk of stock investing increases each time valuations increase. Buy-and-Holders recommend staying at the same stock allocation at all times. That means that your risk profile is usually wrong. You are in most circumstances taking on either more risk or less risk than is appropriate for an investor in your circumstances. Getting your risk profile wrong is ALWAYS going to hurt you. It can NEVER be a plus.
Say that a 60 percent stock allocation is right for you when valuations are at moderate levels. If you stay at 60 percent stocks when valuations are high, you are hurting yourself — your stock allocation is wildly off the mark. Your stock allocation is also wildly off the mark when valuations are low — again you are hurting yourself.
The stock allocation you choose is the most important factor determining whether you will be successful in the long term. If you are willing to adjust your stock allocation as conditions change, it’s pretty easy to insure good long-term results. But if you refuse to change your stock allocation (that is, if you practice Buy-and-Hold), you insure that your stock allocation will be wrong two-thirds of the time.
If you choose a stock allocation that is right for you when prices are moderate, you have the wrong allocation two thirds of the time (when prices are low or high). If you choose a stock allocation that is right for you when prices are high, you have the wrong allocation when prices are low or moderate. If you choose a stock allocation that is right for you when prices are low, you have the wrong allocation when prices are moderate or high.
It is IMPOSSIBLE to get your allocation right if you follow a Buy-and-Hold strategy. Because the last 33 years of peer-reviewed research shows that risk is VARIABLE. If risk is variable, you MUST change your allocation in response to big changes in valuations.
Here is the research paper that I prepared with Wade Pfau:
Please look at Table 1 on Page 18.
Look at the Maximum Drawdown section. The Maximum Drawdown is a good measure of risk. It is the greatest loss you ever could suffer following the strategy you employ. The Maximum Drawdown for Buy-and-Holders is 61 percent. For Valuation-Informed Indexers, it is 21 percent. That’s a reduction of about two-thirds. That’s huge! I am not saying this to brag and there are of course hundreds of good and smart people who played a role in helping me and Wade to produce this study, but that is the most important finding in the history of personal finance.
We now know how to reduce investing risk by close to 70 percent. That’s like learning how to cure cancer.
I had several long-time Buy-and-Holders tell me when that study came out that they were so impressed with that finding that they were considering changing strategies for the first time in their lives.
The response of the Buy-and-Hold Mafia was to threaten to send defamatory e-mails to Wade’s employer in an effort to get him fired from his job. Wade is financially responsible for two small children. He agreed to stop doing honest research if the Goons would let him keep his job.
Jack Bogle knows about this. He is okay with what the Goons did. Bill Bernstein knows. He is okay with what the Goons did. Larry Swedroe knows. He is okay with what the Goons did. Rick Ferri knows. He is okay with what the Goons did. The Buy-and-Hold Mafia cannot afford to see this research written up on the front page of the New York Times. The day that it is will be the day Buy-and-Hold dies in a practical sense (Buy-and-Hold died intellectually in 1981, when Shiller publisher his research showing that valuations affect long-term returns).
I wrote to the 30,000 names at the Social Science Research Network site to let them know about this. A good number wrote me back saying that they agree that this is corruption but that they do not feel that they can do anything about it given the brutally abusive practices of the Wall Street Con Men and their Internet Goon Squads. None of us can effectively stand up to the Buy-and-Hold Mafia on our own; we need to unite and insist on enforcement of the U.S. laws against financial fraud to have any chance at bringing these powerful and wealthy and corrupt individuals to justice. If this isn’t the greatest act of financial fraud in the history of the United States, I’d hate to know what is. I think it would be fair to say that this is 500 times worse than anything that Bernie Madoff ever did and Bernie Madoff lives in a prison cell today. I think it would be fair to say that Bernie Madoff is Mother Teresa compared to some of the “individuals” we have seen put up posts in “defense” of Mel Linduaer and John Greaney (and my good friend Jack Bogle).
Here’s a list of comments that Wade made about me and about Valuation-Informed Indexing during the 16 months that we were working together:
There is zero chance that Buy-and-Hold can ever work for a single investor because it is built on a false premise. Prior to 1981, people believed that stock investing risk was STABLE. If stock investing risk was stable, Buy-and-Hold would be the ideal strategy.
What happened is that many powerful people built careers pushing the Buy-and-Hold concept BEFORE we learned from the research that it can never work. Then, when we learned this in 1981, they were embarrassed. They didn’t want to acknowledge the error. They felt that it would hurt their careers. So they ignored Shiller’s findings. And they put pressure on lots of others to not say anything about Shiler’s findings either.
Now we are 33 years down the road and the penalty of ignoring Shiller’s findings has become clear — millions of failed retirements and an economic crisis that may well eventually become the Second Great Depression. The people who didn’t want people to learn these realities back in 1981 really, really, really don’t want them to learn these realities today.
Most of them would like to come clean. There is tons of evidence that they have consciences and would love to find some way to get the word out. But how the heck do you get the word out without lots of people being sent to prison for the greatest act of financial fraud in U.S. history? The Goons don’t like it when I talk about the prison sentences. But my aim is to REDUCE the prison sentences. We can only reduce them by getting the word out and by bringing the economic crisis to an end. Each day that the cover-up continues, we cause more financial ruin and thereby INCREASE the length of the prison sentences of those who have participated in this massive act of financial fraud.
It’s a mess!
But the core reality here is very, very, very positive. We now know how to reduce the risk of stock investing by 70 percent. This is the biggest advance in the history of personal finance. My aim is to get all the nasty stuff behind us and then just concentrate on all the wonderful insights that we have mined over the past 33 years and have not been able to benefit from because we have had to keep it zipped to keep from hurting the feelings of the Buy-and-Holders.
Thank for asking. That was a super question.