Set forth below is the text of an e-mail that I sent on January 18, 2010, to New York Times Columnist Paul Krugman:
Mr. Krugman:
I was struck by a reader comment to one of your recent articles re The Efficient Market Hypothesis that this theory “seems harder to kill than the undead.” I believe that there is more going on here than the typical reluctance of academics to acknowledge that better theories have come along to replace earlier ones.
I would be grateful if you would give a look to a Google Knol that I have written entitled “Why Buy-and-Hold Investing Can Never Work.” If the market is NOT efficient in the short term but IS efficient in the long term, it seems to me that Buy and-Hold is the WORST possible strategy. If the market is always in the process of moving in the direction of fair price, ignoring price when setting one’s stock allocation is a horrible mistake. Stocks were overvalued by about $12 trillion at the top of the bubble. This means that middle-class investors are in the process of losing that much of their life savings and that the reason why they are losing it is that The Stock Selling Industry has been pushing the Buy-and-Hold mantra so aggressively and for so long.
I believe that political pressure is going to be required to force the “experts” in The Stock-Selling Industry to acknowledge their error or this discredited theory is going to cause a mass loss of confidence in our economic and political systems.
I would love to hear any thoughts you have in reaction to the Google Knol (either positive or negative, of course).
Rob Bennett
http:.//arichlife.passionsaving.com
Regarding today’s passion, are you seriously comparing yourself to Rosa Parks?
Yes.
The internet is where Americans go today to learn about important issues that affect their lives. I believe that we all have a right to post honestly on safe withdrawal rates and on all other topics.
When we post dishonestly to appease internet Goons, we degrade ourselves. We also degrade the Goons. Dishonest posting engaged in as a means of avoiding threats of physical violence and other intimidation tactics is bad news all the way around, in my assessment.
There’s a reason why the published rules of every site I have posted at protect those who post honestly from internet predators. These sites could not win the confidence of their readers if they did not provide such protections. The site owners who make these promises should honor the promises they make to the people who build their communities.
This is all my sincere take, JCL. I do not believe that any of this would generate any “controversy” whatsoever if the “experts” in The Stock Selling Industry had acknowledged back in 1981 that Shiller’s research showing that valuations affect long-term returns meant that the odds of Buy-and-Hold ever working in the real world are precisely zero. It was the unwillingness among these “experts” to promptly say the three magic words “I” and “Was” and “Wrong” that caused all the trouble.
Now we all have the responsibility to do what we can to rebuild our economic and political systems. It cannot be done without honest posting on the reckless and irresponsible decision of The Stock Selling Industry to continue promoting Buy-and-Hold for 30 years after the academic research showing that it could not work was published. The first step is insisting (not asking!) that our right to post honestly on important investing topics be given recognition at all investing discussion boards and blogs.
Rob
Hi Rob,
Having read a great deal of your writing, I’m well familiar with your approach to investing. Given that, there is one aspect of your approach that I’ve never seen you address (my apologies if I’ve overlooked it).
That is, if buy and hold is widely eschewed in favor of your approach, just who would investors be selling their securities to?
Thanks for asking an insightful question, Curious.
If everyone followed a Valuation-Informed Indexing strategy, stocks could never become overvalued or undervalued. Thus, there would never be any need for anyone to increase or lower his or her stock allocation.
There would of course still be sales and buys. People would want to cash in to raise money to start businesses and things like that. And people would lower their stock allocations when they reached retirement age. On the other side of the equation, people would reach a point at which they started saving and would buy stocks. The two sides would balance out, just as they do in any market.
Think about the car market. There are always just enough buyers and just enough sellers, no? How does that happen? It’s the magic of a market that makes it happen. This is what markets DO — they balance things out so that there are just as many buyers as there are sellers. The balancing-out process is accomplished through changes in price. The problem with Buy-and-Hold is that it makes it impossible for the market to perform the balancing-out process by removing price considerations from the minds of most investors.
The problem today is that we are encouraging people to invest irrationally and thereby making the stock market disfunctional. The market WANTS to set prices properly. But millions of people have been taught to ignore prices when buying stocks. Can you imagine how messed up the car market would become if we taught people buying cars never to take price into consideration when making their purchases? What a disaster that would be!
What we should all want is for the stock market to be as rational as possible. There should be buys and sells but only for rational reasons. Today, many people are buying even when buying makes no sense for them (because the price of stocks has gone so high that owning stocks is too risky for someone in their circumstances). A rational market is a good thing for every single investor. It means less volatility, more stability, less risk and higher returns (because investors are not frightened into selling at the wrong time because of price crashes).
Price crashes are caused by the promotion of irrational strategies. The market wants to set prices properly. When investors have become so irrational in their investing strategies that there is no possible means to correct prices except through a crash, we get a crash. We should not blame the market for crashes. We force crashes by teaching millions to follow Buy-and-Hold strategies.
I hope that I have answered your question, Curious. If I have not, I hope you will come back with a follow-up question. You are hitting on something of considerable significance, in my assessment. You’re stretching my mind and my hope is that you are stretching the minds of others listening in to our conversation as well.
Rob
As this falls off the page, I might be shouting into the darkness, but here goes.
Regarding your points, I should first point out that, with two major car manufacturers filing for bankruptcy recently, you might rethink your illustration for depicting just how well supply and demand mesh. Further, in your world of no volatility, what purpose would there be for anyone to lower their stock allocation upon reaching retirement? Why would I turn down a stable 6.5% return in exchange for a bond paying 4%? That’s the height of irrationality.
And in your comments, I think you make the error of confusing the small segment of investors who buy “the market” via total market index funds (approximately 15% of all shareholders) with the vastly larger segment who own (and, most often, trade) the smaller components of the market. And in this world, the market works just as you would expect it to. For every purchaser who believes that Google is a wonderful bargain at $542/share, there is another who’s happy to sell it, believing that their capital is put to better use elsewhere. And when no sellers (or buyers) at that price are available, the price adjusts up (or down), so the market clears.
As to whether the price on each of the thousands of individual stocks that compose the market is “proper” at any given moment in time: how can one possibly know, without the benefit of hindsight? When, for instance, the S&P was selling at more than 30x earnings, there were any number of individual stocks within the index that the passage of time showed were undervalued. Likewise, when it was selling for 10x earnings in the late-70s, there were any number of issues that history showed were overvalued.
Jos. A Banks, for instance, was up nearly 3500% for the 2000s. How would you presume to convince a prescient owner of this stock in 1999 to sell his stock for a price that you deem more “rational”? Precisely what would that price be? And how would you determine it?
When the new blog entry comes up for today, I’ll put up a note letting people know about your fine comment and provide them a link to use to come see it, Curious. Perhaps that will help insure that at least a few of our fellow community members will be able to tap into your insights.
I will offer a response to your comment at the new blog entry (the one dated January 28, 2010).
I hope that we hear from you again.
Rob