I say controversial things about stock investing.
Most people believe that following a Buy-and-Hold strategy is the way to go. I do not. Buy-and-Hold is rooted in the research of University of Chicago Economics Professor Eugene Fama. I advocate Valuation-Informed Indexing, the investing strategy rooted in the research of Yale Economics Professor Robert Shiller. Shiller’s ideas represent a “revolutionary” (Shiller’s word) departure from the conventional wisdom of today.
The big change is that Buy-and-Holders think they are engaging in a neutral act when they rebalance their portfolios. Vanguard Founder John Bogle says that investors should aim to “Stay the Course.” Staying at the same stock allocation is staying the course, in the eyes of the Buy-and-Holders.
Valuation-Informed Indexers see it as dangerous move for an investor to stay at the same stock allocation at all times. We believe that valuations affects long-term returns. So stocks are far more risky and offer far lower returns when priced high than they do when they are priced low. It is our view that investors MUST change their stock allocations in response to big valuation shifts to have any hope of staying the course in a meaningful way. Investors who rebalance rather than change their stock allocations are permitting their risk profiles to get wildly out of whack by doing so.
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It is my view that all of the research in this field supports the Valuation-Informed Indexers and that none of it supports the Buy-and-Holders. I do not mean for that claim to be taken as an insult. I view the Buy-and-Holders as good and smart people. My take is that the reason why the Buy-and-Holders believe that the research says something very different from what it really does say is that they made a mistake in the early days that caused their fundamental beliefs about how stock investing works to get seriously off track.
To understand what happened, you need to appreciate the history.
The first point that needs to be made is that the Buy-and-Holders were pioneers. It is common practice today for investment analysts to root their claims in research and data. That was not the case in the days before the publication of A Random Walk Down Wall Street (the book that popularized the Buy-and-Hold concept). In the old days, most investing advice consisted of subjective impressions. We all owe the Buy-and-Holders a debt of gratitude for taking investment analysis out of the dark ages and imposing the accountability that comes with turning the study of investing into a sort of science.
There is a reason why few people long to be pioneers. Pioneering is dangerous. Pioneers often return to camp with arrows piercing all sorts of sensitive body parts.
The Buy-and-Holders got important things wrong because those who go first often get important things wrong. We didn’t know it all back in the early 1970s. Research on all of the important questions had not yet been completed in the days when Buy-and-Hold was being developed. So the Buy-and-Holders were forced to take some guesses, and the research that has been done in the 40 years since has shown some of those guesses to have been dangerously off the proper path.
The big mistake was the finding of the Buy-and-Holders that timing doesn’t work.
That one is partly true. I rank the partial truth as the second most important insight in the history of investing analysis. It really is so that short-term timing doesn’t work and it was an important advance for the Buy-and-Holders to discover this.
Unfortunately, the research showing that short-term timing never works was done at a time when we did not know how important it is to distinguish short-term timing from long-term timing. Shiller taught us the importance of that distinction with research he published in 1981. At the time Buy-and-Hold was being developed, the finding that short-term timing doesn’t work was interpreted as a finding that timing doesn’t work, period. That’s why most of today’s investment advisors fail to stress the importance of long-term timing, which ALWAYS works and which reduce the risk of stock investing by 80 percent while dramatically increasing long-term returns.
Is Shiller’s work a rejection of Fama’s work?
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Most Buy-and-Holders see it that way. Most Buy-and-Holders become defensive when the 30 years of research confirming Shiller’s findings is mentioned. I think that’s unfortunate. My view is that Valuation-Informed Indexing represents a combination of the critical insights of the Buy-and-Holders and the critical correction added by Shiller. I think of Valuation-Informed Indexing as a new approach to Buy-and-Hold Investing, a sort of Buy-and-Hold 2.0.
The Buy-and-Holders made a mistake. That mistake has cost a lot of people a lot of money. That mistake has caused a lot of confusion about how stock investing works both among experts and among regular investors. That mistake has brought on an economic crisis.
Still, the full reality is that our understanding of all areas of life endeavor is achieved in building-block style. We learned a great deal when the Buy-and-Holders showed us that short-term timing doesn’t work. Shiller would probably never have achieved his advances had the Buy-and-Holders not laid the foundation for them with their own breakthroughs.
The Buy-and-Holders think that acknowledging their mistake will cause them to lose “credit” for explaining how stock investing works. I don’t think that’s right. I think that that acknowledgement of the mistake will permit us to take the genuine insights of the Buy-and-Holders to places we have never been able to take them before. I believe that we will someday look back at the day when the Buy-and-Holders acknowledge their error as one of the most important and exciting days in the history of the core Buy-and-Hold project — to learn the truth about how stock investing works.
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