An Important Purpose of Investment Research Is to Reveal Unpopular Truths

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I’ve spent the last 19 years of my life making the case against Buy-and-Hold. It started with safe withdrawal rates. Given Shiller’s finding that valuations affect long-term returns, it did not seem possible to me that the safe withdrawal rate is always the same number (the Buy-and-Holders say that it is always 4 percent). After I witnessed the heated reactions of Buy-and-Holders to my assertions that the safe withdrawal rate is a number that changes with changes in valuations, my concerns spread to many other areas. If the safe withdrawal rate changes as much as the historical return data indicates (it is 9.0 percent when stocks are priced as they were in 1982 and 1.6 percent when stocks are priced as they were in 2000), the core idea of the Buy-and-Hold Model — that market timing is not required — seems more than a little dubious. If the value proposition of stocks changes that dramatically, investors seeking to keep their risk profile constant over time must engage in market timing.

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Q2 2021 hedge fund letters, conferences and more

Losing Confidence In Buy-and-Hold

It took me a long time to lose confidence in Buy-and-Hold. But I am well over it today. In my efforts to figure out why so many Buy-and-Holders are resistant to challenges to the strategy, I find it helpful to think back on how I came to think so highly of it. I remember the days before I became a Buy-and-Holder and can recall clearly the attraction of the strategy — it was the claim that the ideas being advanced by advocates of this strategy are rooted in peer-reviewed research.

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There are two reasons why that is important. One, stock investing is obviously an important subject. We have our retirement money riding on what we do. We all want our retirement plans to work. We want to be going on more than someone’s opinion. Requiring that an opinion be backed by research gives us something objective to look to to confirm the legitimacy of the opinion.

Two, the investment advice field is a money field. Those who offer investment advice inevitably face temptations to tell us things that make us like them rather than the things that we need to hear to achieve good long-term results. Requiring that an expert’s opinion be rooted in research imposes a discipline that ensures that the advice offered will be more than a marketing spiel.

Once I heard that Buy-and-Hold is the stock investment strategy for those who want science on their side when deciding what to do with their money, I knew that I had found my home. I believe that most of the people who still follow Buy-and-Hold strategies today have confidence in the strategy for similar reasons.

Market Timing

I am of course disillusioned. I believe that the people who developed the Buy-and-Hold strategy sincerely intended to craft a research-based strategy. And I believe that they achieved the goal to which they aspired to a considerable extent. All of the ideas that the Buy-and-Holders advance check out, in my assessment. Except one. The idea that market timing is not required (or doesn’t work!) just doesn’t make sense. It is through market timing that stock investors engage in price discipline when buying stocks. Price discipline is the magic by which all markets work. Take market timing out of the mix and stock investing is like driving a car without brakes.

As I say, I don’t believe that the Buy-and-Holders knew this when the strategy was being developed in the 1960s. But surely they are aware of Shiller’s research showing that valuations affect long-term returns. If that’s so, then the value proposition of stocks is not constant but variable. So market timing is required. Why has this critically important research finding (Shiller has been awarded a Nobel prize for his work) not been incorporated into the mix of Buy-and-Hold foundational insights?

There is more than one explanation. One big one is that the Buy-and-Holders are suffering cognitive dissonance re Shiller’s work. They really thought that they had come up with the answer and Shiller’s research turned their understanding upside down. Another is that we are now at the tail end of the longest and strongest bull market in U.S. history. To the Buy-and-Holders, the crazy prices that we have seen in recent decades is evidence that they hit the target with their strategy. Shiller’s research is hard to process.

Revealing Unpopular Truths

The biggest problem, though, is that the Buy-and-Holders are not entirely sincere in their belief in the power of research. They do believe in research. It is clear to me that that is so. But one element of the scientific mindset is always to question, never to fall into the trap of believing that you have it all figured out. The Buy-and-Holders have fallen into the trap of believing that they have it all figured out. They no longer are open to questioning of their claim that market timing doesn’t work. The Buy-and-Holders of today disdain the recent research.

Shiller’s research is disconcerting. If he is right that price increases beyond those supported by the median CAPE value of 16 represent irrational exuberance rather than real and lasting economic gains, more than half of today’s market value is cotton-candy fluff fated soon to be blown away in the wind. That translates into millions of failed retirements and hundreds of thousands of failed businesses when the next price crash subtracts trillions of dollars of consumer buying power from our economic system. And of course the mountain of irrational exuberance was fueled by the popularity of the idea that market timing (price discipline!) is not required for stock investors.

We all want to believe that the numbers in our portfolio statement are real. The Buy-and-Holders tell us that that is so. The recent research tells a very different story. We need to adjust those numbers for the effect of irrational exuberance. Telling that side of the story is a very bad idea from a marketing standpoint. Buy-and-Hold has been transformed into the opposite of what it was intended to be at its inception. An important purpose of research is to reveal unpopular truths that otherwise would be ignored. The Buy-and-Holders need to get back to where they once belonged.

Rob’s bio is here