Most people will react to the question I pose in the headline with puzzlement. Buy-and-Hold is an investing strategy. It has nothing to do with politics. It’s not liberal OR conservative.
I don’t think that’s right.
Buy-and-Hold is not, as is popularly believed, the product of disinterested research. It is the product of ideology. To understand why the conventional investing wisdom of today is what it is, you need to consider where Buy-and-Hold came from. It wasn’t that a bunch of researchers sat in a room and discovered things. The people who developed the Buy-and-Hold concept went into the room with fixed beliefs already in their heads and the questions they elected to research were heavily influenced by those beliefs.
Buy-and-Hold is the product of Adam Smith economics, or Classical Economics, or Rational Man economics. This is the economic theory generally associated with conservatives today. Most of today’s liberals favor Keynesianism. Keynesianism is more in tune with Valuation-Informed Indexing, the investing model that I would like to see supplant Buy-and-Hold as the dominant model.
Classical economics is logic-based. This is the model that was dominant prior to the Great Depression. The government played a far smaller role in national affairs than it does today. That’s because the thinking was that private entities can make perfectly good decisions as to how to spend money and any money spent by government represents money that cannot be spent by private entities. Government spending was viewed as proper only when it was directed to purposes that could not be served by private entities, such as the financing of a war effort.
That all makes sense, no?
It does make sense. Unfortunately, that’s the trouble with it. It makes TOO much sense.
Keynesianism was a reaction to the failure of Classical economics in the Great Depression. Keynes argued that the Depression was more an emotional phenomenon than a logical one. People were improperly fearful of spending money. To get things going again, government had to step in and pick up the spending slack, whether it made sense or not. Getting out of the Depression was so important that logic had to be pushed aside for a time.
Keynesianism became the dominant economic model. But, when it came time to develop the first research-based investment strategy, Classical economic ideas made a comeback. Buy-and-Hold is pure logic. Think what you are being told when you are told that there is no need to time the market. You are being told that you can’t outsmart the market. Why? Because the market is rational, because the market is logical.
There’s now 30 years of academic research showing that this is not so. It turns out that it is true that you can’t outsmart the market in the short term. Short-term timing does not work, just as the Buy-and-Holders claim. But long-term timing ALWAYS works. There has never in 140 years of stock market history been an exception to the rule. Investors who lower their stock allocations at times of high valuations and increase their stock allocations at times of low valuations earn far higher returns while taking on dramatically reduced risk.
We are today living through a replay of the Great Depression. An excessively logical approach to economic analysis brought on the nightmare of the 1930s. Smart people moved on to a different set of economic ideas. But then other smart people who had not yet given up on Classical economics applied those ideas to stock investing and brought on a Second Great Depression. Humans!
Please don’t get the idea that I am a Keynesian. I am conservative in my political and economic thinking. I don’t believe that Keynesianism as it is practiced today works. Government spending did help people regain confidence in the economy in the 1930s and thereby helped us out of the Depression. But in recent years politicians have become so addicted to Keynesian stimulus programs that we have turned to them when they were not needed and thereby created a deficit problem which renders the stimulus programs ineffective when they ARE needed (people are not spending in response to the Obama stimulus bills because they are too scared about the deficit problem to have confidence in the fix).
I don’t favor the Classical economic model as I want to see Valuation-Informed Indexing replace Buy-and-Hold. And I don’t favor the Keynesian economic model because I believe that it no longer does the job of restoring the public’s willingness to spend following an economic collapse. What do I believe might work?
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My hope is that today’s economic crisis will cause the liberals and conservatives to stop yelling at each other long enough to listen to the good points coming from the other side. The Keynesians are right that we have to consider the emotional realities of both economics and stock investing. The Classical economists are being bullheaded not to acknowledge that Keynes was hitting on something important and true.
But a Keynesian stimulus can only be effective if used sparingly. When there is a new stimulus every two years, there is no stimulus at all, just a lot of wasteful spending.
The Buy-and-Holders came close to getting it right. Their idea of rooting an investing strategy in the academic research was a huge advance. Now they need to acknowledge the errors in their first-draft approach that were revealed by the last 30 years of research.
The market wants to be efficient. The market wants to get prices right. But it cannot do the job without our help. The market tells us how far off prices are by telling us when valuations have gone too high. We need to encourage investors to lower their allocations when prices get too high (to practice market timing!) to restore price discipline to the market.
The market collapsed because our relentless promotion of Buy-and-Hold strategies removed all vestiges of price discipline. And the collapse of the market caused a broad economic collapse. We are still learning how both economics and investing work. We need to be less prideful and more open to the learning experiences that help us grow and prosper and thrive.