A Rich Life

The Old Ideas on Saving & Investing Don't Work -- Here's What Does

Podcast #196 — Valuation-Informed Indexing and Buy-and-Hold Are Opposite Strategies

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I’ve posted Podcast #196 to the “RobCasts” section of the site. It’s called Valuation-Informed Indexing and Buy-and-Hold Are Opposite Investing Strategies.

I saw post at the Vanguard Diehards board from a fellow who thought of Valuation-Informed Indexing as a “tweak” to the Buy-and-Hold approach. Oh, no! It’s not a tweak. It’s a totally different head!

“I Don’t Think I’ve Ever Heard Buy-and-Hold Described As a ‘Get Rich Quick’ Scheme Before”

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I described Mike, author of the Quest for Four Pillars blog, as “heroic” in a comment that I put to his blog last Saturday morning.

He banned me from posting further comments on Saturday afternoon.

I didn’t mean it, Mike! I really didn’t mean it! I take it back!

Well, perhaps not.

I certainly do not approve of the ban. As regular readers know, I am the leading critic of the Ban on Honest Internet Posting on safe withdrawal rates and other important investment topics alive on Planet Earth today. I’m a journalist. Bans on honest posting on the numbers that people use to plan their retirements rub my fur the wrong way. Sue me. (I’m kidding, Drip Guy, I’m kidding!)

Here’s the deal.

Mike has long been torn about whether to permit honest posting on investment topics at his board.

He’s a big believer in most of the principles of Buy-and-Hold. I explained to him one time that I was not willing to post dishonestly on a matter that was likely to cause a good number of my friends to suffer failed retirements and asked whether he could see the problem with that. His reply was: “It’s hard to say.” Another time he praised the Canadian Money Forum and I pointed out that they banned honest posting on safe withdrawal rates on the day they opened the forum. He expressed no surprise or concern. On another occasion, he cited the Old School retirement studies at his ABCs of Investing blog and I pointed out that these studies had been discredited by numerous big-name experts years earlier. He deleted my comment and left his endorsement of the discredited studies stand despite the financial harm that it would likely do to readers of his blog.

The other side of the story is that Mike has permitted me to post numerous comments to his Four Pillars blog that point out the realities of stock investing (as revealed by the historical stock-return data and the academic research of the past 30 years) in plain and clear and firm and uncompromising terms. Mike has evidenced the right stuff on numerous occasions. He also has run two Guest Blog Entries that explored the realities in some depth. The one that caused him to adopt the ban was posted last week and was entitled Stock Investing Is a Lot Less Risky Than You Think.

My sense is that Mike really, really, really does not like people discussing the realities of stock investing at his blog; it makes his tummy hurt to learn that ignoring price when buying stocks always brings on financial catastrophe sooner or later. However, Mike also really, really, really (kinda, sorta) believes in freedom of speech. He has probably never had this belief tested to the extent it was when he made a decision to permit honest posting on Buy-and-Hold at his blog and saw the sorts of words that began appearing there as a result.

The final straw came with the posting of last week’s Guest Blog Entry (according to my sense of things — I of course am not able to see into Mike’s mind). Numerous community members expressed a desire to learn more about those yucky (from the perspective of a confirmed Buy-and-Holder) stock investing realities.

A fellow named “Two Cents” said :”At first I thought you were advocating a Buy-and-Hold strategy. I was relieved to read on and discover that that was not the case…. I’m interested in Rob’s strategy. I just haven’t had the time yet to read up on it and wrap my head around it.”

A poster going by the screen-name “Potato” commented: “I don’t think I’ve ever heard Buy-and-Hold described as a Get Rich Quick scheme before”, and linked to the Guest Blog Entry at his own blog.

“Jason” congratulated Mike for hosting an “interesting post and discussion.”  He added that “I am also pleased to see that this is not a Buy-and-Hold forever post.”

Yikes!

It’s one thing to believe in Free Speech when the millions spent by The Stock-Selling Industry promoting Buy-and-Hold have effectively intimidated most of the middle-class investors who see through the gibberish from sharing what they know with others. It’s something else altogether when the gig appears close to being up. At that point this Free Speech business begins looking more than a little threatening to one’s continued ability to pull the wool over one’s own eyes and the eyes of one’s readers.

One of the tricks that has been effectively used against us is the deceptive claim often made that “everyone” accepts that Buy-and-Hold makes sense, that there is some sort of “science” supporting this investing strategy or some sort of “academic research” somewhere that suggests that it might work this time. It gets harder to work these deceptions on people when those who know the realities work up the courage to speak out. And, once a few work up the courage, what’s to stop it from becoming a trend?

Potato’s comment hit it on the head. It’s true that we have rarely heard Buy-and-Hold described as a “Get Rich Quick” scheme in recent decades. Why the heck not?

I think it is fair to say that this “strategy” has the worst track record of any investing “idea” ever concocted by the human mind. It doesn’t take an I.Q. of 140 to see that a model that says that there is no need to change one’s stock allocation when prices go to insane levels is rooted in Get Rich Quick thinking. What other possible explanation is there for such dangerous allocation strategies?

When we get to a point where a large number of people are openly saying what they have suspected but not said about Buy-and-Hold for many years now we will have finally turned the corner on today’s economic crisis. That’s what it is going take — a few caring men and women working up the courage to tell the obvious truths about how we have been destroying both our retirement dreams and our economic system for a good long time now.

Mike was afraid that he was beginning to lose control of his blog community with his posting of that Guest Blog Entry. That’s my take. Buy-and-Hold failed in the academic research nearly 30 years ago. Since the crash, it has more and more come to be seen as failing in the minds of typical middle-class investors (Mike’s readers). And its most fervent advocates sense that, when the fall begins, it is likely to increase in momentum quickly. We are living in the last days of this irrational and degrading and economically destructive “idea.” One good push from an influential name could at this point send it tumbling down the ravine.

I believe that Mike has put himself on the wrong side of the history train with adoption of a Ban on Honest Posting on the Flaws of the Buy-and-Hold Concept at his blog. I also believe that he writes a fine blog and that he really is at least semi-serious in his belief in Free Speech principles. I believe that there will come a day when Mike and I will be working together again to help both Mike and his readers (and me!)  come to a better understanding of the realities of stock investing. Let’s hope so!

I will send Mike a link to this blog entry. In the event that he believes that my report is in any way unfair, I will of course be happy to post his version of events in a follow-up blog entry. I will try to get the Guest Blog Entry placed at another blog. In the event that I am successful, I will post a link to it in a subsequent blog entry here.

Heaven help the boy who won’t reach twenty-one.

Heaven help the man who gave that boy a gun.

Heaven help the people with their backs against the wall.

Oh, heaven help us all!

My First Podcast — Buy-and-Hold Cannot Work

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I’ve created a new section of the site entitled “RobCasts” to house Personal Finance Podcasts that I will be recording in the days and weeks and months and years to come. I’ve also posted the first podcast, which is entitled Buy-and-Hold Cannot Work — Here’s Why.

Today’s Passion: The Buzz section contains an audio recording of a radio interview that I did with Maxine Frost for the Sunday Morning Update program on NewsRadio KEX in Portland. This interview provides a good overview of the money management ideas explored in depth in my book Passion Saving: The Path to Plentiful Free Time and Soul-Satisfying Work.

This Month’s Permanent Portfolio

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The great thing about studying what investors say on discussion boards is that you learn about how things work in practice, not theory.

Investors have been told for 25 years now to follow buy-and-hold strategies. And they say they do. But do they really?

I’ve seen hundreds of comments indicating otherwise. One thing I’ve seen a lot of is a rigid adherence to the idea of buy-and-hold combined with an extremely loose understanding of what it involves in practice.

There are lots of investors out there who in 1999 believed with their entire minds, hearts and souls that owning the S&P500 and the NASDAQ forever was the essence of buy-and-hold. Then the idea became to own just the S&P500 forever. Then it was the S&P and value stocks. Then the S&P and REITS. Then the S&P and small caps. Then the S&P and a global index. Then the S&P and Emerging Markets. The idea seems to be growing of late that maybe it’s best to leave out the S&P altogether and just go with all the other possible slices and dices.

That ain’t buy-and-hold. The idea of buy-and-hold was to stick with a plan long enough to see if it can really pay off. Switching to a different Permanent Portfolio every six months or so doesn’t do the trick.

Investors are kidding themselves. They like the buy-and-hold idea, and for good reason. It is indeed important to stick with a plan long enough to give it a fair test. But the promoters of the buy-and-hold concept did a poor job of pointing out the pressures that those following it will feel to abandon it. As a result, most would-be buy-and-hold investors are unprepared for those pressures and have no idea how to respond to them other than to change their understanding of what constitutes buy-and-hold regularly enough to keep up with their changing desires to own different classes of stocks.

Buy-and-hold is a good idea. But the popular formulation of it is unrealistic. We need a new understanding of how buy-and-hold can work, one that stands a better chance of playing out well in the world of flesh-and-blood investors.

The problem is that buy-and-hold became popular during the longest and strongest bull market in U.S. history. People came to think that you could buy the S&P and forget about it. That of course can never work. When the S&P is selling at reasonable prices, it is a wonderful asset choice. When it is selling at the sorts of prices that apply today, it represents a dubious long-term value proposition.

If we could just say that, we could develop all sorts of strategies for following what are basically buy-and-hold strategies but that are a good bit less rigid than what many of the promoters of the concept have endorsed. Until we develop that freedom, many investors will feel that their hands are tied. It is taboo to change one’s stock allocation or one’s mix of asset classes. But it’s becoming increasingly clear that it is foolhardy not to make some changes in one’s portfolio when the investing environment changes dramatically.

Is it okay to make shifts in the makeup of your portfolio from time to time? Of course. It’s not only okay, it’s pretty much mandatory. None of us knows it all starting out. We learn over time. If we didn’t put what we learned into effect by changing the makeup of our portfolios, there wouldn’t be much point to learning, would there?

We need to be more up front about the changes we make and the reasons why we make them. Many investors have given up on the S&P500 in recent years. For good reason. The S&P is dangerously overvalued. We should learn from our mistaken belief of yesteryear that the S&P would always be as attractive a buy as it was back in the time when it was available at a far more reasonable price.

Buy-and-hold should be a tendency, a goal, a principle. When we make it a dogma, we switch onto the wrong track. We all need to make changes in our portfolio composition and in our stock allocation from time to time. We should discuss those changes openly and thereby learn lessons from the mistakes we made at earlier times.

Today’s Passion: The article entitled Basics of the New Buy-and-Hold provides a groundwork for the development of a new way of implementing this strategy.

I Believe In Buy-and-Hold,
I’m Just Not a Fanatic About It

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We all know what’s good about stocks. Stocks provide great long-term returns.

Is there anything bad about stocks?

There is. The bad thing about stocks is the price volatility. You never know where you stand. One day your net worth is $100,000. If the money is in stocks, the number a year from today might be $130,000 or $70,000. You just don’t know. That’s scary.

The thing that determines whether you will become a successful long-term investor or not is how you deal with the fear caused by price volatility. The most common way of dealing with it is through denial. No one literally denies that prices are volatile. But many block this reality out of their minds. They would as soon draw up a will as develop a strategy to deal with price volatility. They act as if they believe that dealing with the problem will cause bad things to happen to them.

There have been three times in the past when stock prices have been where they are today. The average price drop for those three occasions was 67 percent. What are you going to do if the value of your portfolio is cut by two-thirds? Do you have a plan?

Lots of people say “buy-and-hold is my plan.” I don’t think that works. It’s too pat. Your life is going to change in dramatic way if the value of your portfolio is cut by two-thirds; lose that high a percentage of your accumulated wealth of a lifetime and there are going to be fewer options left open to you in all areas of life endeavor. You really are just not going to let that affect you? Are you sure?

Remember, if things go this time as they have gone all the other times, most other middle-class investors will be abandoning stocks when prices drop. It’s easy to practice buy-and-hold when everyone is saying it’s a good idea. It’s not easy when everyone is saying that the best thing is to abandon stocks. That will be what most people will want to hear when most people are abandoning stocks, and most stock “experts” have made it a longstanding practice to tailor their advice to meet the current desires of most of their listeners.

I don’t think you are going to hold if prices drop by 67 percent or by anything close to it. I don’t say that because I think you are weak. I say that because I don’t think any reasonable person would hold onto an asset that had lost 67 percent of its value. People don’t do things like that, and for a perfectly good reason. Doing things like that is nuts. Who the heck can afford to lose 67 percent of his or her life savings? Who the heck can afford to take that sort of hit and not take some kind of action?

Buy-and-hold does not work. It is not realistic.

At least that’s so of the version of buy-and-hold that has been widely promoted for 25 years now

I propose a new approach to buy-and-hold, one with all of the advantages of the now popular approach but without the terrible failing that it cannot work in the real world.

The problem with the conventional approach to buy-and-hold is that it ignores the way the stock market performs. Stocks are not really one asset class. They are two, two, two asset classes in one.

When stock prices reach extreme highs, stocks are a dangerous asset class. There are always huge wipeouts of middle-class wealth when stock prices reach extreme highs. There are no exceptions in the historical record.

When stock prices are normal or low, there’s not much risk. Stock prices might go down a bit from moderate or low prices. But probably not too much. And, if they do go down a good bit, the price drop is not likely to remain in place for long. At least that’s always been the case in the past. Again, there are no exceptions in the historical record.

Here’s my plan for escaping the worst effects of stock-market volatility: Lower your stock allocation when prices reach extreme levels (like those that apply today). That way you are heavily in stocks most of the time and get to enjoy the wonderful long-term returns generally associated with stocks. But you miss out on those huge price drops characteristic only of stock markets for which prices have been permitted to get out of control.

Make sense?

It makes sense to me.

What doesn’t make sense to me is the negative reaction I sometimes hear to this idea. It is my view that that negative reaction is a signal of defensiveness. It is because investors trying to pull off the conventional approach to buy-and-hold don’t really deep in their hearts believe that it can work that it makes them anxious to hear about other strategies, strategies that could help them if they could chill out a bit and think things through without too much emotion getting in the way.

Do I believe in buy-and-hold? Sure. Stocks rarely get to the sorts of price levels that apply today. So it is going to be a rare event when you are going to need to lower your stock allocation to protect yourself from monster price drops. It makes all the sense in the world to hold your stocks through the moderate ups and downs that apply for investors who buy their stocks at reasonable price levels. When the monster price crashs become a live possibility (probability? certainty?), however, I think it makes all the sense in the world to take a little something off the table until our fellow investors come to their senses and pull stocks back to more reasonable price levels.

It’s just an idea, you know? I think it’s a good one. If you don’t, that’s of course fine. We can of course still be friends. I ask that you not get mad at me because I put the idea forward and that you give the idea some thought if your initial impression is that it might make sense.

Today’s Passion: The Investor’s Scenario Surfer lets you test how you would respond to various return patterns without requiring you to put actual money at stake.