“I Am a Buy-and-Holder in Every Respect But One. I Incorporate Into the Buy-and-Hold Strategy Shiller’s Nobel-Prize-Winning Finding That Valuations Affect Long-Term Returns.”

Set forth below is the text of a comment that I recently put to a discussion thread for another blog entry at this site:

Rob

What exactly is your investing strategy? Are you sitting on cash waiting for the next price crash? In TIPs?

Given your concern about valuations, what do you think in a reasonable way to invest now?

I am a Buy-and-Holder in every respect but one. I incorporate into the Buy-and-Hold strategy Shiller’s Nobel-prize-winning finding that valuations affect long-term returns.

I believe strongly that investors should Stay the Course. But in a meaningful way, not in a pointless, self-destructive way. In the days when Buy-and-Hold was being developed, there was a belief among academics that the market was efficient (that is, rational). If that were so, market timing would not be required. Shiller showed the it is investor emotion that is really the driving force behind stock price changes and that the only way to keep irrational exuberance from getting out of control is to always keep investors informed of how high prices diminish the long-term value proposition of stocks and that the only way for an investor to keep his risk profile stable when prices rise is to lower his stock allocation.

Each investor’s life goals and risk tolerance are different. So there is no one answer to your question. But I believe that it makes sense to take the conventional Buy-and-Hold stock allocation recommendation and adjust it 30 percentage points down at times of insanely high stock prices and 30 percentage points up at times of insanely low stock prices. That would put the typical investor at 30 percent stocks today. I would put the remainder in something fluid because you want to be able to move it into stocks if prices drop to insanely low levels, as they have in previous Buy-and-Hold crises. If the CAPE drops to 8, the most likely 10-year annualized return rises to 15 percent real.

TIPS, IBonds and Certificates of Deposit are all good choices. Cash is not just a holding place. It is an asset choice of great strategic value in a world in which the Buy-and-Hold “strategy” is being pushed relentlessly and causing an insanely dangerous bull market.

Rob