“The Heavy Promotion of the Buy-and-Hold “Strategy” Is Always Going to Cause an Economic Crisis. It Is Impossible That It Ever Would Not.”

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

In your utopia the stock prices can never be rational, as people are still just buying and selling without a thought given to the valuation of the individual companies. The index is weighted. If you had index funds in January 2022 you were holding a whole lot of Apple, Google, Facebook and Tesla. These were overvalued. Outside of my 401k I was holding onto mostly oil and tobacco stocks at the time. Some buy and holders (myself included) have seen their retirement savings increase during this recent bear market. More sophisticated people used options. I believe Bill Gates shorted Tesla. There’s more than one way to skin a cat.

The thing about index funds is they are dumb money whether you just follow a three fund portfolio or if you do VII. When enough people get into it, it can move markets but it’s dumb money either way. Now I’m not saying indexers are dumb. My 401k is in index funds, most people should just use index funds, but it is what it is.

I don’t see how VII could have prevented a financial crisis that was brought on by things unrelated to CAPE valuations. Care to explain in detail?

I see indexing as a huge advance. I don’t think of indedxing money as dumb money at all. An indexer is taking a bet that the U.S. economic system will remain sufficiently productive to support a strong stock return. It’s been doing that for 150 years now. So I think it is smart to believe that it may well continue doing it.

I don;t have any objections to investing in individual stocks. I think it takes a lot of work to get it right. So I would advise people not to do it unless they are sure that they love researching stocks enough for it to pay off. For the average person, I recommend index funds. But for the right person, I think it can make sense to pick individual stocks. I am glad that index funds are now an option.

The heavy promotion of the Buy-and-Hold “strategy” is always going to cause an economic crisis. It is impossible that it ever would not.

In every market that has ever existed, price discipline is the thing that makes the market work. That’s true in the car market, the banana market, the shoelace market and on and on and on. All that Shiller really did was to demonstrate that the way things work in every other market that has ever existed is also the way they work in the stock market. Price discipline/market timing is the thing that keeps the market functional. So long as most investors are engaging in market timing (adjusting their asset allocation as needed to keep their risk profile constant over time), market prices will always be roughly right. When investors start acting as if price doesn’t matter (that is, sticking with the same stock allocation no matter how poor a value proposition stocks come to provide), things go haywire. Stock prices go up and up and there is nothing to bring them down. Since the market eventually must get prices right (that is the core purpose of any market), it eventually crashes them. Which does great harm to our economic system (price crashes take huge amounts of buying power out of the economy).

Buy-and-Holders blame economic developments for price crashes. But the causation is in the opposite direction. It is price crashes that cause economic crises. Price crashes take trillions of dollars of spending power out of the economy. It would be better to just price stocks properly. Then we wouldn’t have either price crashes or the economic crises that follow from them. The hitch in the minds of the Buy-and-Holders is that to price stocks properly we have to encourage market timing. For prices to be set properly, investors need to be willing to act in their own best interest. It is in the best interest of investors to consider the long-term value proposition of stocks before purchasing them. But Buy-and-Holders tell investors that they must never do that, that they must always invest in stocks blindly, that they must never consider how much the current CAPE value affects the long-term value proposition.

Take Buy-and-Hold/Get Rich Quick investing strategies out of the equation and there is not reason to believe that we would have any more of these horrible economic crises. I believe that we would still have modest ups and downs. But nothing like what we have experienced during the days when we did not know how stock investing worked in the real world (the pre-Shiller era). We are really still in the pre-Shiller era today because, while we have his research available to us to help us become better investors, we have not yet as a nation of people given ourselves permission to discuss it at every internet site. Having Shiller’s book available in most public libraries doesn’t do us much goos if we are not all actively discussins its far-reaching implications with our friends and neighbors and co-workers on a daily basis. It is by discussing things that we come to understand them and learn how to apply what we have learned to our daily life choices.

Minimizing the use of Get Rich Quick/Buy-and-Hold investment strategies would stabilize the stock market and thereby would stabilize out economic system as well. And stabilizing our economic system would stabiize our political system to a considerable extent as well. It’s a win/win/win/win/win. I am not able to imagine any possible downside.

Rob