Or, “How Pop enraged some of his readers.”
This is a guest post by Rob Bennett, who writes about value investing at PassionSaving.com. But let’s get real, that kind of standard introduction isn’t enough for somebody the likes of Rob. In fact, I’m fairly sure a certain number of you spit out your morning coffee when you saw that badly colored avatar at the top of the post (colored by me, by the way).
For those of you unfamiliar with Rob, he’s a regular on pretty much every personal finance blog that mentions investing and hasn’t banned him. He’s made it his crusade to up end buy-and-hold investing in favor of value-oriented strategies. But so far, it’s been done in such an odd way (blog comments that are longer than articles, a conspiratorial tone, oddly capitalized words as if he were writing in the Bible) that many bloggers, commenters, and passive readers simply hate the guy.
It’s reached the point that he has at least one discussion board devoted entirely to making fun of him. Ironically, his detractors, who have spent hours writing posts about Rob, don’t seem to see that their zeal has made them seem equally insane. Rob keeps giving them material. They keep giving him attention. And the fire burns on.
But lest I discredit Rob before he’s begun, let me back up by saying that many of Rob’s arguments in favor of value investing actually make a lot of sense—in a way that should make any rational buy-and-holder uncomfortable. This is Rob, edited. Only what I see as his best arguments against buy-and-hold made it in here. And in the end, I’m sticking with my original argument, for all the behavioral reasons I listed in that post.
Enjoy. Or claw your eyes out. But trust me, it’s worth questioning your assumptions every once in a while.
Buy-and-hold masks investing risk
When I argue that investors need to change their stock allocations in response to changes in valuations, people often say it’s not possible with the tools we have today to know precisely how much of an allocation shift is best. This is so. The tools we have today are far more effective than most people realize. But they’re not perfect. It’s entirely possible that investors following valuation-informed strategies will make mistakes.
But what of it?
There are no perfect investing strategies available to us. And we need to do something with our money. So we simply have to accept that, whatever path we choose, there’s going to be some risk of making mistakes.
I believe that the reason why this concern evidences itself so often is that the popularity of buy-and-hold causes many investors to hold it to a lower standard than alternative strategies. Human psychology is such that things that are popular seem safe (this is why “As Seen on TV!†is an effective marketing slogan). Logic, however, doesn’t support the idea that sticking to the same stock allocation at all times is somehow safer than making reasonable efforts to shift your allocation effectively in response to dramatic price swings.
To understand why, I think it might help to consider how safe driving an automobile down the highway would be if we decided on the speed we were going to travel in the way in which many investors decide on their stock allocations. Say that you read a book entitled “Driving for the Long Run†and became convinced as a result of the arguments set forth in it that the thing to do is always to remain at a single speed regardless of the driving conditions you faced in various circumstances.
Perhaps you would decide on a driving speed of 65 miles per hour. That would work well on sunny days. But what would happen the first time you happened to be out on the highway during a snowstorm? The rational drivers would slow down to 10 or 20 miles per hour, but you would stick defiantly to 65, likely killing yourself and a good number of others. Staying the course at the other extreme, or even picking a middle ground, would be just as insane.
The same can be said of going with the same stock allocation at all stock valuation levels. You can tell whether stocks are expensive or a bargain by looking at the market’s price divided by the average of the past 10 years of earnings (P/E10). Using 10 year’s worth of earnings for the P/E rather than the usual one year smooths out unusual drops or bubbles in earnings.
Stock returns for the subsequent 10 years show a strong correlation to where the P/E10 was in year one. In 1982, for example, an analysis of the historical stock-return data shows that the most likely annualized 10-year return for stocks would have been 15 percent after inflation.
The same analysis would have estimated that stocks purchased in the year 2000 would lose one percent per year after inflation.
What one stock allocation percentage makes sense both when the long-term return is likely going to be 15 percent real and when the long-term return is likely going to be a negative 1 percent real? There is none. Elect a Buy-and-Hold strategy and you insure that sooner or later you will be going with a stock allocation that is wildly wrong for you.
Many of today’s investors think of Buy-and-Hold as a neutral choice. The thought is — I really am not sure of precisely how much I need to change my allocation, so perhaps I had better just stick with the neutral choice of leaving it where it is. No! The neutral choice is to remain at the same risk level at all times. Since the risk associated with stock investing is greater at times of high valuations, you must lower your stock allocation at such times to Stay the Course in a meaningful way. It is better to make the effort to change your allocation properly and get it a little wrong than to fail to make the effort and end up with a stock allocation wildly off the mark of what is proper for someone with your risk tolerance.
Part of the reason for the popularity of Buy-and-Hold is that many think of it as a safe choice. The apparent safety of this choice is illusory. You don’t want to be driving 65 miles per hour during a heavy snowfall. And you don’t want to be going with a 65 percent stock allocation when valuations are such that someone with your risk tolerance should not be going with a stock allocation of any more than 10 percent or 2o percent.
Buy-and-Hold does not diminish risk. It masks risks. That’s why I view Buy-and-Hold as the most dangerous investing strategy of them all.
{ 62 comments… read them below or add one }
Fantastic job, Pop!
That image reminds me of the poster that was included in the first volume of Dylan’s Greatest Hits. I’ve always been a 60s guy at heart!
Rob
love every single letter on your blog, pop!.. and this time rob, too!
but the image… it got me all worried all of a sudden.
There was a little back-and-forth in the comments regarding whether or not Rob should apologize for writing something on his own blog about how I accepted and then rejected this guest post (which turned out to not be true). I deleted it because I find that whole debate uninteresting and irrelevant. Actually, I’m getting kind of bored just writing this comment.
Rob wrote: “Part of the reason for the popularity of Buy-and-Hold is that many think of it as a safe choice. The apparent safety of this choice is illusory. You don’t want to be driving 65 miles per hour during a heavy snowfall. And you don’t want to be going with a 65 percent stock allocation when valuations are such that someone with your risk tolerance should not be going with a stock allocation of any more than 10 percent or 2o percent.
Buy-and-Hold does not diminish risk. It masks risks. That’s why I view Buy-and-Hold as the most dangerous investing strategy of them all.”
A dangerous buy-and-hold fund with 65% stocks like Vanguard Wellington fund returned 6.69% annualized for the 10-year period ending Mar 31, 2010.
http://finance.yahoo.com/q/pm?s=VWELX+Performance
By the way, I don’t know where Rob gets the idea that buy-and-hold is a “safe choice” or without risk. It appears to me that Rob makes liberal use of setting up strawmen for which to knock down.
Schroeder
A dangerous buy-and-hold fund with 65% stocks like Vanguard Wellington fund returned 6.69% annualized for the 10-year period ending Mar 31, 2010.
[Cut - not relevant to the discussion. - Pop
The numbers you are citing are not the numbers that apply for real live people who invested in that fund, Schroeder. They are the numbers that apply for the fund itself. Those are very different things. A fund can show great returns even when most investors in that fund have done poorly. The reason why is that investors tend to buy in at high prices and sell out at low prices. In some circumstances it is only a tiny fraction of the number of investors in a fund who receive the return obtained on paper by the fund itself.
Look at what happened in The Great Depression. Stock prices fell by 90 percent nominal, 80 percent real. How many of those who were invested in the U.S. market remained fully invested after seeing a drop in the value of their portfolios of 80 percent real? The answer is -- a number closely approaching zero.
The number remaining fully invested on this fourth try at seeing whether Buy-and-Hold can work in the real world is likely to be even smaller. We went far, far beyond the level of overvaluation that caused the Great Depression this time. So the price drop that follows the insane price years is likely to be greater. That means that the returns obtained by real live living and breathing investors will be even less.
It's what happens to investors that matters, Schroeder. The pretty charts that show only what happens to funds are put before you for marketing purposes. They help sell overpriced stocks. They don't help you pay the electricity bill when it gets cold outside.
[Cut -- let's keep this to a discussion of buy-and-hold, not to a discussion of what might happen if buy-and-hold is espoused less often by the media.]
Rob
I don’t know where Rob gets the idea that buy-and-hold is a “safe choice†or without risk. It appears to me that Rob makes liberal use of setting up strawmen for which to knock down.
Buy-and-Hold has long been promoted as a prudent approach to investing. It is not that. It is the most reckless approach imaginable. I do not say that it is that by intent. I say that it has become that because of the unwillingness of the “experts” in The Stock-Selling Industry to acknowledge their mistakes after those mistakes were brought to their attention.
One of the key principles of Buy-and-Hold is that you stick with your plan no matter what. If the plan makes sense, that is a sound principle. But what if you refuse to acknowledge errors when they are brought to your attention? In that event, the plan you are sticking with does not make sense. In that event, the worst possible thing you could do would be to vow to stick with that plan no matter what.
Buy-and-Holders were wrong to invest so heavily in stocks during the years when they were insanely overpriced (1996 through 2008). They have paid a price for that mistake. But they have not yet paid the full price they are likely to pay. This is the fourth time that large numbers of people have elected to go with a Buy-and-Hold strategy (all suffered disaster on the three earlier occasions). If stocks perform in coming days as they did in the wake of the three earlier trips to insane price levels, we still have a 60 percent price drop ahead of us. How are the numbers going to look on the pretty charts after another 60 percent price drop, Schroeder?
If you are going to advise people to stick with a strategy no matter what, you had better make darn sure that the strategy is likely to work in the long term. Buy-and-Hold has never worked in the long term, any more than buying cars without taking price into consideration could ever work in the long term. Ignoring price when buying something is never a good idea.
It is not that Buy-and-Holders face some risk. It is that Buy-and-Hold is the riskiest of all strategies imaginable. It is high prices that make stocks risky (stocks have never performed poorly in the long run starting from a time of low or moderate prices) and the Buy-and-Hold concept teaches investors to ignore price when buying stocks. A risk you ignore is a risk with far more power to destroy you than a risk of which you are aware.
Rob
Rob, I’m allowing people to disagree with you. I’m just not allowing blanket putdowns, a discussion of your sanity or of activity at that message board or any other board. If those guys want to show up to debate your argument on the merits, they can go for it. So far, it’s meant two comments through (and one was borderline) and four deleted.
If those guys want to show up to debate your argument on the merits, they can go for it. So far, it’s meant two comments through (and one was borderline) and four deleted.
Okay. I allow them to post at my site too so long as the comments are on the merits. They do bring out good points that we all need to consider together. The key is holding them to some sort of standard so that they are not able to intimidate lots of other good people with sincere questions from participating. It appears to me that you are drawing a line that helps us take things to a better place. So — Thanks!
Rob
I have a question, but first some quotes from Rob’s site:
“Indexers know that Passive Investing can never work in the real world.â€
http://www.passionsaving.com/indexing.html
The two threads that J.D. was trying to shut down (he was successful) were entitled “Why buy and hold can never work†and….
“You asked two good substantive questions during our e-mail exchanges: (1) Why is it that I say that Passive can never work even though you can identify many people for whom it HAS worked?â€
…most of us are staking our retirements on an approach that our common sense tells us can never work. This is a news story that I need to report.
Rob:
1) I have personally used Passive Investing, and retired after 35 working years to a comfortable early retirment at 50 years old.
2) Many others have as well. In fact, I challenge anyone to produce a single retirement failure whose failure was ascribed to “Passive Investing”
So Rob the question is simple: What evidence can you produce for your outlandish claims?
[Cut -- Doesn't add to the discussion.]
anyone who did buy and hold got the returns.
It’s not responsible to promote strategies that none of the humans can follow, Ed. It’s the humans that matter! It’s the humans who we should be trying to help out!
There are many genius idea present in the Buy-and-Hold Package. That is the great irony here. One of the genius ideas is the idea that people should invest for the long term. That one is pure gold.
The reason why I object so strongly to the idea of ignoring price is that ignoring price makes it impossible in the real world for long-term investing to work. On the one hand we are telling people to focus on the long term. On the other we are advising them to follow a strategy (ignoring price when setting their allocation) that makes successful long-term investing impossible in a practical sense.
I am saying that we should just let people know what works. If you are willing to take price into consideration when buying stocks, then long-term investing success becomes a realistic goal. I would very much like to see that happen for everybody (including my many Buy-and-Holder friends).
We are all on the same side, Ed. We are all trying to work together to figure out what really works.
Rob
Nothing you could tell people about valuations can counter the fact that the world might actually be coming apart the next time valuations are low.
I don’t agree, Ed.
Anyone who invests for the long term accepts the risk that the world might come apart sometime during his or her investing lifetime. If you are a long-term investor, you would be just as concerned about the chance that the world might come apart within 30 years in 2000 as you were in 2009. The possibility that the world might come apart during your investing lifetime is a constant. You consider it when making your plan and then you move forward.
It’s not low valuations that make the world fall apart, as you suggest in the words above. It is high valuations that cause the world to fall apart. Stocks were overvalued to the tune of $12 trillion in 2000. Do you think that happened because of the massive promotion of valuation-informed strategies? Obviously not. It was the massive promotion of the idea that investors don’t need to change their allocations when stocks become insanely overpriced (Buy-and-Hold) that caused that $12 trillion of overvaluation. It is because as a society we have tolerated the promotion of Buy-and-Hold while prohibiting questioning of it that we are today living through an economic crisis.
Remember, Ed, those who understand valuations were going with stock allocations of 10 percent or 20 percent at the time of the crash. Their losses were tiny. They had no problem whatsoever investing in stocks for the short time-period when prices were reasonable. It’s the Buy-and-Holders who were “surprised” by the crash and who felt that they could not afford to invest in stocks when they finally became available at reasonable prices for a time.
Buy-and-Hold causes investors to overinvest in stocks at the times when they are most dangerous and to underinvest in stocks at the times when they offer truly amazing long-term returns. It always has you doing the wrong thing. That’s because it ignores the most important factor, the price at which the stocks you are buying are selling at the time you buy them. Valuation-Informed Indexing is the opposite of Buy-and-Hold in every possible way. That is why it produces such great long-term results.
Rob
Warren Buffet recommends an Index Fund for most investors and his favorite holding time is “foreverâ€.
And he always take a great deal of time determining whether the investment represents a strong value proposition before he puts his money down on the table. When you buy something that represents a strong value proposition, time is on your side.
When you buy regardless of price, there are going to be times when you purchase something that represents a horrible long-term value proposition (this was the case for those buying index funds from 1996 through 2008). In that circumstance, time is very much not on your side.
Buffett is advocating the thing that always works (go with a strong value proposition and stick to it until it pays off). Bogle is advocating the thing that never works (go with a horrible value proposition and stick with it until it brings you to ruin).
I am advocating that we add the Buffett imperative (consider the value proposition represented by your investment choices) to the simple approach put forward by Bogle. There is all the difference in the world between an investing strategy that never works for the long-term investor and one that always works for the long-term investor. I believe that those middle-class investors who would like to learn about what works (they number in the millions) should be permitted to do so regardless of any embarrassment that honest posting would cause for the “experts” who have advocated Buy-and-Hold over the past 30 years.
[Cut -- I've cut out the Graham discussion. At this point, I've had to do so much cutting that I can't remember why.]
Rob
I have personally used PAssive Investing, and retired after 35 working years to a comfortable early retirment at 50 years old.
If you stayed at the same stock allocation for that 35-year time-period, you greatly reduced your return while dramatically increasing the amount of risk you were taking on in your portfolio by doing so, Ready to Learn. If you had been willing to follow a more rational strategy, you could have retired at age 45 rather than at age 50. A strategy that delays the day you achieve financial freedom by five years cannot be said to have “worked,” according to any reasonable understanding of the word.
I challenge anyone to produce a single retirement failure whose failure was ascribed to “PAssive Investingâ€
It’s hard to see how there could be more than a tiny number of retirement failures properly ascribed to anything else, Ready to Learn. There has never yet been a time when stocks performed poorly starting from a time of low or moderate valuations. So long as you are willing to lower your stock allocation when prices go to insanely high levels, any halfway reasonable retirement plan you go with is going to work out. That of course is not so in the event that you refuse to take valuations into consideration when setting your stock allocation.
Rob
Seems a little contradictory to me.
There are all sorts of puzzlements that we need to learn how to cope with down here in the Valley of Tears, Ed.
I wonder why he hasn’t endorsed you already?
Buffett has endorsed the key principle that valuations affect long-term returns on thousands of occasions.
If you want to know why Buffett does not tell middle-class investors in clear and plain and frank terms that Buy-and-Hold can never work for the long-term investor, please take a look at the Scott Burns column from July 2005 (there’s a link at my site) at which he explains why the investing “experts” have not told us about the analytical errors made in the Old School safe withdrawal rate studies in all the time since they were discovered in May 2002. “It’s information that most people don’t want to hear.” Scott said.
That nails it. Our economic and political systems are headed over a cliff because too many of us cannot work up the grace and courage to let people know about the dangers of a marketing gimmick gone amuck.
Rob
Interesting back and forth…. I’ve seen Rob around in forums and other blog comment sections but haven’t looked in depth into this discussion. Regardless, I’m going to give my impressions of both sides.
Rob, I definitely understand your argument but there are a few things I take issue with.
1. I very rarely see the type of “buy and hold” investing you claim to be the culprit actually recommended. By which I mean investors are recommended to just buy buy buy when prices are high. The most generic advice I see around is to have a certain allocation in stocks based on your age and risk tolerance, this also includes reallocating to those levels once you’ve made or lost money in one of your holdings.
Your writing makes it sound like there is a vast conspiracy where unsuspecting middle – class people with very little sophistication in finance are suckered into buying when stocks are insanely high and selling when they are low.
2. Value investing exists, and is very common. I can go to Yahoo Finance and browse to any stock and two measures that are always on there include the P/E ratio and EPS. You just seem to have a conspiratorial tone that I can easy see putting people off.
Rob, my impression of you overall is one of a conspiratorial crusader. You use a lot of language that I find laughable like “I am shooting straight with you because I believe that somebody has to start shooting straight re this stuff or we are going to see the entire U.S. economic and political system go over a cliff.” It’s hard to take you seriously when you make such blanket statements that I find to be false (after-all it was institutional and “sophisticated” investors who caused the problems in the financial system, not middle class buy and holders).
Having said that, I do think you have a point in that value investing should be taught over buy and hold investing if we can get a simple and solid system for doing so. But your methods seems to be far from effective.
Ed, here are my impressions of your arguments:
1. You point out flaws that you find in Rob’s arguments, which makes sense (given I do the same thing myself).
2. You seem to get flustered quickly and bring up your own absurd arguments. For example, Buffett won’t just suddenly endorse every person who agrees with him, making your “proof” (a lack of endorsement from the man) very ridiculous.
You were making decent points until you went into this realm of absurdity yourself.
Overall it sounds like you two have been going at for awhile it and I’m sure a lot of your stranger arguments reflect that.
Like many people who author a blog, I have a real job. In the course of attending to that real job, more than 40 comments were attached to this post, most of which were Rob and Ed lambasting each other. For the sake of anyone who wants to hear a buy-and-hold debate and isn’t interested in all the vitriolic history those two bring to the table, I deleted more than half of the mostly irrelevant comments and edited down comments that seemed to have relevant information but had weird insults intertwined.
Anyway, Rob and Ed, if you would rather not have your comments appear at all, let me know. Edwin, thanks for bringing some perspective to this whole exchange.
Your writing makes it sound like there is a vast conspiracy where unsuspecting middle – class people with very little sophistication in finance are suckered into buying when stocks are insanely high and selling when they are low.
Thanks for sharing your thoughts, Edwin. Hearing a fresh voice helps me to assess where things stand and I am confident that your comment helped some others form their thoughts as well.
Do I believe in a conspiracy? Yes and no.
I certainly don’t believe that there are any people who got together in a room and said “lets give people bad advice and drive the U.S. economic and political systems over a cliff.” There obviously is zero chance that such a thing happened.
But I do believe that there is an intense institutional interest in The Stock-Selling Industry to keep what we have learned about the effect of valuations on long-term returns bottled up. The reality is that there are thousands of millionaires today who owe their fortunes to their promotion of Buy-and-Hold during a wild bull market. These people believe Buy-and-Hold works. But they shouldn’t. If they studied the academic literature they would know about the holes in the theory. If they encouraged free discussion on the internet, they would over time develop a stronger and stronger grasp of the realities.
I attribute the problem to cognitive dissonance. Shiller’s finding that valuations affect long-term returns is the most important finding in the history of investment research. If valuations affect long-term returns, stock returns are predictable for those willing to look at valuations when setting their allocations. If stock returns are predictable, we can lower risk and increase returns by adjusting our stock allocations in response to price changes. All sorts of amazing possibilities open up once you learn that overvaluation is a real phenomenon. Stock investing can never be again what it was before Shiller published his research. His contributions are even more important than Bogle’s (and that’s saying something).
The “conspiracy” is a conspiracy to ignore or downplay Shiller’s findings, to just keep promoting the same old ideas in a new era. Again, the people promoting Buy-and-Hold follow it themselves. They are sincere to that extent. But the entire society is affected by their unwillingness to follow where the research leads. We all need to work to change this, in my view.
No one should abandon Buy-and-Hold who still believes in it. But everyone (Buy-and-Holders included) should favor civil and warm and reasoned and friendly discussion of the realities of stock investing. If we open up the discussions, we will work it all out in one way or another. Once the Ban on Honest Posting is lifted, the problem is solved, so far as I am concerned. I come from a journalism background. So I find the Ban on Honest Posting positively shocking. It is so much counter to everything that our nation stands for that I truly find it incredible that there is even one person who supports or tolerates the ban. I strongly oppose it.
I do indeed believe that Buy-and-Hold is the primary cause of the economic crisis and that the economic crisis is doing serious damage to the trust that middle-class people have in their economic and political leaders. If you are interested in hearing my full argument re that one, I invite you to take a look at a Google Knol that I wrote entitled “The Bull Market Caused the Economic Crisis.” My personal view is that it is the best piece of writing that I ever put forward. I think of it as my Blood on the Tracks.
http://knol.google.com/k/rob-bennett/the-bull-market-caused-the-economic/1y5zzbysw7pgd/3#
Rob
Rob,
In response to Schroeder’s point about Wellington’s performance, you said:
“The numbers you are citing are not the numbers that apply for real live people who invested in that fund, Schroeder. They are the numbers that apply for the fund itself. Those are very different things. A fund can show great returns even when most investors in that fund have done poorly.”
Of course you are correct. Happily, places like Morningstar report not just fund returns, but investor returns as well, illustrating just what investors in the fund have earned, on average, over a period of time. As you’ll see at the link below, over the past 15 years Wellington has earned an avg. annual return of 9.3%. Wellington fund’s investors have earned 8.6%. This period, of course, covers two tremendous bear markets, so I’m finding a hard time reconciling this performance with your claim that “buy and hold can never work.” It would appear that Wellington investors did just fine during this period. Can you comment?
Also, let’s accept your thesis at face value, and agree that when stock prices reach an agreed upon high valuation level, investors should sell. That begs the obvious question: To whom are they selling?
Thanks.
http://performance.morningstar.com/fund/performance-return.action?symbol=VWELX&country=USA
The most generic advice I see around is to have a certain allocation in stocks based on your age and risk tolerance, this also includes reallocating to those levels once you’ve made or lost money in one of your holdings.
We agree that that is the standard Buy-and-Hold advice, Edwin. I find this advice reckless in the extreme. There’s a two-step process to my thinking on this one.
Step One is to understand that investors have the power in the short term to set stock prices wherever they want them to be. If we all wanted to retire early, we could agree to set stock prices at 10 times their current value. We of course would be believing in a fantasy to think that we really possessed the assets needed to retire just because we played this silly game. But the reality is that we do possess this power. There are implications that follow from that.
The most important implication is that we all are tempted by our Get Rich Quick impulse (we are all born with one) to send stock prices up. In this respect the stock market is different from every other market on earth. In all other markets, buyers of the good or service being offered for sale favor low prices. With stock, buyers as well as sellers favor ever higher prices. Is that a conspiracy? Not in the conventional understanding of the term. But it is a conspiracy of interests that has alarming consequences for stock investing.
What it means is that prices are always at risk of shooting to the moon. That is the entire risk of stock investing. There has never yet in U.S. history been a time when stocks provided a poor long-term return starting from moderate or low prices. So stocks are essentially a risk-free asset class except when they are overvalued. But because of our Get Rich Quick impulse and our ability to send prices to the moon, overvaluation is an ever-present possibility.
It follows that the key to keeping the market functioning is resisting the Get Rich Quick impulse. We need to teach people that overvaluation is bad for the entire society (we have seen an economic crisis on every occasion when stocks went to double fair value and not once when that was not the case). There is an easy way available to us to do this. Just let people know the consequences of buying overpriced stocks (always a disaster, there’s not one exception in the record going back to 1870) and you have solved the overvaluation problem. Investors who know the realities are naturally going to lower their allocations once prices get out of hand. The sales pull prices back to fair value. The market is self-regulating so long as investors have some means to access the information they need to invest effectively.
So what does Buy-and-Hold teach? That investors do not need to lower their stock allocations when prices go to insanely dangerous levels. The one thing that can destroy a market and all the investors in it is the key teaching of this “strategy.” You truly cannot make this sort of thing up!
Encouraging people to stick with high stock allocations when prices are where they were from 1996 through 2008 is like encouraging people to drive drunk. The risks are just off the charts. So why do this? And why ban discussion of what the academic research has been saying? Why is it so important to Buy-and-Holders that investors not learn the realities?
My view is that these questions answer themselves. You don’t see this level of defensiveness among people who are confident in their strategies. If there were any Buy-and-Holders who possessed true confidence, we would hear them speaking up in opposition to the Ban on Honest Posting, no? How many do we hear speaking up? Not John Bogle. Not Bill Bernstein. Not Scott Burns. Not Jonathan Clements.
Yes, I have learned important things from all those individuals and I feel respect and affection for each of them. But it is a stone cold fact that none of them has spoken up. And I think that tells us something very important about the level of confidence that they feel in this “idea.” I put the word “idea” in quotes because the thought that this might be the first time in history when valuations would not affect long-term returns is not really an idea but really just an emotional impulse.
Buy-and-Hold was born out of a desire to root investing advice in the academic literature and the historical data. I think we need to get back to that. The first step is launching a national debate on what we have learned through the research of the past 30 years and how that should change our understanding of how stock investing works in the real world.
Rob
Value investing exists, and is very common. I can go to Yahoo Finance and browse to any stock and two measures that are always on there include the P/E ratio and EPS.
Why do you think it is that valuations are not taken into consideration in safe withdrawal rate studies, Edwin?
I put a post to a Motley Fool board on May 13, 2002, pointing out that the valuation level that applies on the day a retirement begins is the most important factor determining whether that retirement is going to survive or not. My finding has been confirmed by numerous big-name experts in the years since, including Buy-and-Hold advocates like Bill Bernstein and Larry Swedroe. Yet not one of the SWR studies has been corrected in the eight years since. My retirement calculator page is the only place on the internet where people can get accurate retirement planning guidance today and discussion of my calculator (“The Retirement Risk Evaluator”) is prohibited at most discussion boards and personal finance blogs. Huh?
Whether you use the word “conspiracy” or not is immaterial, in my view. That is just flat-out wrong. There are going to be millions of people suffering failed retirements in days to come because of the demonstrably false claims made in these “studies.” This alarms me greatly, Edwin.
And this is not just an investing problem or just an economic problem. It is a political problem. A political system that cannot protect middle-class people who are doing all they can to learn how to plan their retirements effectively but who cannot gain access to the information they need to do so because there is a gang of thugs who will not permit honest posting on this topic anywhere on the internet is a political system that is broken in very, very serious ways.
Scott Burns told us why the newspapers and magazines and web sites don’t provide us with the accurate SWR numbers. “It’s information that most people don’t want to hear,” he said.
Investors have become so emotional in recent decades that they can no longer even bear to hear accurate retirement numbers reported to them. And what investing model is it that caused investors to become so self-destructively emotional?
It is the investing model that I oppose that did this. You know the one.
I want my retirement to succeed. So I use accurate numbers when planning. I want the retirements of my friends on the internet to succeed. So I give them accurate numbers when they ask. What a terrible, terrible, terrible person I am! No wonder I am banned at every major investing board and personal finance blog. Like Morningstar.com says, I am “Inflammatory!” Like the Financial WebRing Forum says, I am “Irritating!” Like Bogleheads.org says, I am “Disruptive!”
I’d rather be known as all those things and not be able to talk to all of the thousands of friends I have made at the various boards and blogs than try to go to sleep at night knowing that I engaged in deliberate deception re the numbers that my friends are going to be using to plan their retirements. I don’t get paid enough for this gig to make it worth selling out my friends.
That’s my sincere take re this aspect of the question, in any event. People matter. And personal integrity matters. Even in investing discussions!
Rob
I’ve read through your knol post and have a reply for it, but given how long it’s going to be, I’m going to respond to it and discuss the concepts of buy and hold and value investing in an article. I hope to finish it up tomorrow so I’ll post a link + abbreviated version here.
Pop, on second thought since this has been sliced and diced so badly, I would prefer it if my remaining comments were removed. Thank you.
I’m going to respond to it and discuss the concepts of buy and hold and value investing in an article.
That’s fantastic, Edwin. That’s precisely the right way to handle it.
I already know that you are going to disagree with me on important points. You know what? That’s wonderful! It’s wonderful for you because you honestly do not share my views. It’s wonderful for me because it is only by being challenged by good and smart people that I learn. And it is wonderful for your readers because they will be hearing about some new ideas from a person they trust. It’s a win/win/win/win/win.
Do I think that there might be a few of your readers who will be led by your words to check out my Knol and who might find my take more persuasive than yours? I think it’s possible that there might be one or two. But I would, wouldn’t I? Maybe I’m wrong. Maybe I’m crazy. In that case, no one will fall for my gibberish and there’s no harm done, right?
But if there is something to what I say, it’s important that people be able to hear the message and decide for themselves. That’s free speech. That’s one of the core principles on which we built our nation. People should be able to hear both sides. It’s a very simple idea and a very important idea and we are always making a mistake when we take it the other day.
I very much look forward to hearing what you have to say, Edwin. I applaud you in advance of reading your words because the most important thing is not what you say but that you possess the confidence in Buy-and-Hold to be able to say something meaningful about these matters. That makes the Buy-and-Holders look a lot better than they come off looking when people play it the other way.
And that’s a very, very good thing for all of us. Buy-and-Holders are not the enemy. Buy-and-Holders are our friends and our neighbors and our co-workers and our fellow community members. Buy-and-Holders are us! We allneed to post honestly. That of course includes the Buy-and-Holders, who are good and smart people to which we all should feel gratitude and respect and affection.
You’ve brought a good bit of cheer to my morning, Edwin. I hope that some other bloggers follow your lead. You are doing this the right way by not backing down from what you truly believe but by standing up for what you truly believe in a positive and constructive and life-affirming manner. I am impressed and encouraged — and happy for all of us!
Rob
As you’ll see at the link below, over the past 15 years Wellington has earned an avg. annual return of 9.3%. Wellington fund’s investors have earned 8.6%. This period, of course, covers two tremendous bear markets, so I’m finding a hard time reconciling this performance with your claim that “buy and hold can never work.†It would appear that Wellington investors did just fine during this period. Can you comment?
Both of your questions are excellent ones, Sid.
You need to distinguish secular bear markets from small and temporary price drops. Taking the former into consideration is critical to long-term investing success. The latter are best ignored. Only the long term is predictable, never the short term.
There have been two huge advances in our understanding of how stock investing works over the past 50 years. The first is the one attributed to Fama and Malkeil and Bogle and the other Buy-and-Holders. Their insight is that short-term timing never works. This is indeed huge. Please never let it be said that Rob Bennett told you otherwise.
The second huge insight is the one developed by Yale Professor Robert Shiller, who showed us that valuations affect long-term returns and that long-term timing thus always works and is indeed required for long-term success. What we need to do to move forward is to combine the two powerful insights into one fully-informed investing model. That’s Valuation-Informed Indexing. That’s what I recommend.
We were at insanely high prices for the entire time-period from January 1996 through September 2008. You should have been at a low stock allocation (perhaps 20 percent) for that entire time-period. We were at moderate prices for a short time after the crash and now are back at dangerous but not quite insane prices.
You are saying that there were two bear markets that stock investors came through successfully during this time-period. I am saying that you are looking at the short-term and not the long-term. Please forget about how many times prices went up and how many times prices went down. What matters is the long term. That is determined by the value proposition you obtained when you purchased your stocks.
If you purchased at bad prices, you obtained a poor value proposition. Once you make the purchase, that’s locked in stone. There’s nothing that can ever change it. You made a mistake and you are just going to have to live with it. If prices go up for a time, that doesn’t change a mistake into a good move. Similarly, if you buy stocks at a good price and they happen to do down for a bit, that doesn’t change a good move into a mistake. Buy good value propositions and you will always end up ahead in the long run. It’s a lock. Buying good value propositions is like being the house in a gambling casino. The odds are so much on your side that you simply cannot lose in the long run.
Stocks obviously have a good record over the past 15 years. You are taking comfort in that. I say that you are wrong to do so. What matters is the long run. Adjust a purchase of stocks made in 1996 for the stock crash that we are going to see in coming years and that purchase ends up being a bad decision — just as could have been predicted by anyone who looked at the prices that applied for stocks at the time.
If you go back further than that, you will have some good value propositions from the pre-1996 period mixed in with the poor value propositions for the time-period from 1996 through 2008. The rule that I am putting forward — that stocks always perform well when priced well and always perform poorly when priced poorly — always holds. There is not one exception in the historical record. I think people have a hard time accepting it because it is just such good news. People find it too good to be true. I’m sorry to be the bearer of wonderfully exciting news, but it happens to be true. Stock prices are highly predictable in the long run. We have to let that good news in.
There’s only one brief time-period in the last three decades in which Buy-and-Hold outperformed Valuation-Informed Indexing. That’s the time-period from 1996 through 2000. Buy-and-Hold will indeed beat VII when investors become dangerously irrational. But look at the risk you are taking on by investing in stocks at such a time. The crash we saw in 2008 could have happened in 1996. Once stocks get to such price levels, the risk of a crash is ever-present. Is it worth taking on such extreme risk just to insure that you don’t “miss out” on a few years of irrationality? I say “no.” It takes many years of investing to recover from such crashes.
When I say that Buy-and-Hold never works, I am not saying that it never provides good returns for short time-periods. Buy-and-Hold provided wonderful returns for the entire time-period from 1982 through 2000. The problem is that Buy-and-Hold does not tell you when to lower your stock allocation. The Buy-and-Holders who enjoyed great returns from 1982 through 2000 were still heavy in stocks in 2002 and 2006 and 2008 and 2010. They are now behind the Valuation-Informed Indexers and they will be falling a lot farther behind with the next crash and then still a lot farther behind yet after you count the loss of many years of compounding on all those losses.
For what purpose do we insist on doing this to ourselves?
We know how to predict stock returns. Why the heck not do it? What is the downside? That is the question I ask over and over and over again and to which I feel that I never get any sort of reasonable answer. When we didn’t know that long-term returns were predictable, it made all the sense in the world to follow a Buy-and-Hold strategy. But we now know better. Why not move forward? Where would we be today if the people who came up with the idea of riding horses could never admit that car travel is more convenient and insisted that all the car companies be shut down so that people could not learn about this “dangerous” new way to get about.
There are no differing “sides” to this question. We are all on the same side. We all want to invest as effectively as possible. Why don’t we begin talking over the possibilities amongst ourselves and see what we come up with together? Everybody benefits. It’s not even possible to imagine any potential downside.
Rob
let’s accept your thesis at face value, and agree that when stock prices reach an agreed upon high valuation level, investors should sell. That begs the obvious question: To whom are they selling?
They are selling to other investors.
The selling brings prices down. That’s the important thing. Those of us who are long-term investors should always want stocks to be priced at fair value, never too high and never too low. We should be asking ourselves — What can we do to make fair-value pricing a reality?
The answer is that we need to inform investors about the dangers of overpriced stocks. Once people understand that stocks offer a poor long-term value proposition when overpriced, no one is going to be willing to buy overpriced stocks. That’s what we want! If no one will buy at the high prices, the price will drop. Then we are back at fair value. Then stocks offer a great long-term value proposition again.
The mistake that the Buy-and-Holders made was in thinking that the market could set prices properly without investors having some way to obtain access to the information they need to invest effectively. The market really does want to be efficient! And it is to every single investor’s benefit for the market to become efficient. But it does not happen by magic. For the market to become efficient, we need to be willing to provide investors with tools like The Stock-Return Predictor. Once investors know the dangers of high-priced stocks, they will naturally stay away from them. The result? No more high-priced stocks! Everybody wins!
We are caught in a vicious circle. I want to open the internet up to honest posting so that investors can begin investing effectively. The Buy-and-Holders fear this because letting people know what works means letting them know that we didn’t always know it all. But the rational given for Buy-and-Hold is that the market is efficient! And the market cannot become efficient until we open the internet up to honest posting!
It goes around and around and around. Going around and around benefits no one. We all are on the same side. We all want to bring the economic crisis to an end. We all want to protect our political system from further damage. We all want to learn how to invest effectively. We all want to have enough money to be able to retire at a reasonable age.
It’s all just sitting there for us. We need a few brave people to work up the courage to pick it up. That’s all it would take at this point. It might take five brave people. Heaven help us all!
Rob
Thanks for the responses, Rob. If you don’t mind, I’d like to flesh both of these out a little bit.
First, regarding the returns earned by Wellington’s investors, let’s consider the ten-year numbers. At the start of the period, the market was just off its all-time high. Over the subsequent ten years, the fund earned 6.7%, and its investors earned 6.1%. The overall market during this time, as we all know, was flat.
You seemed to dismiss the similarly impressive 15 year investor returns because they don’t take into account “the stock crash that we are going to see in coming years.”
I confess I’m not sure how to respond to that, because you’re right, they only reflect the past 15 years. They don’t reflect any crash that the future holds. Nor do they reflect the climate problems Al Gore foresees, the terrorist attacks Bin Laden predicts, the historic bull market my brother-in-law is predicting, or the meteorite crash that some dude on the internet is convinced will happen.
Regardless of that the future holds, the historical data do not lie. And they show that Wellington investors earned rather impressive returns during historically tumultuous markets. (Indeed, I’m sure that the very long-term returns show a similar pattern.) I’m afraid that if someone is able to examine those returns and stand by the statement that “buy and hold investing can never work,” we’re dealing with different definitions of the word “work.” Further, I would need to see the returns earned during the same period by the proposed alternative. Absent that, it’s just words.
Next, regarding buyers and sellers in markets. Market indexes, of course, are made up of thousands of individual stocks. And individuals (or their managers) choosing to buy this stock and sell another represent the vast majority of all transactions.
For the sake of argument, let’s say that everyone should sell upon reaching an agreed upon index valuation level. At that point, as always, that index is composed of stocks which are undervalued, and others that are overvalued.
My question is, how to you propose to separate the former from the latter? Further, how to you plan on convincing the owners of the latter that those stocks are overvalued, and that they should accept a lower price for that stock? If their analysis led them to believe that company X was a good value at $50, what would convince them to abandon that view when you’re offering to buy it for $30?
Thanks in advance for your answers.
I’m afraid that if someone is able to examine those returns and stand by the statement that “buy and hold investing can never work,†we’re dealing with different definitions of the word “work.â€
You’re right, Sid. You are making an important point. We are speaking different languages. The Buy-and-Hold Investor and the Valuation-Informed Indexing Investor start their thinking from entirely different places and thus their thinking ends up in entirely different places.
Something that Buy-and-Holders do over and over again is to look backward to see whether their investments have done well or poorly. I see this as a mistake. The proper way is to look forward. The advantage of looking forward is that, when you determine that the investment option you are considering is a bad choice, you still have time to do something about it. When the Buy-and-Holder finally finds out that he has made a bad choice it is too late to take effective steps.
Whether your investment choice is a good one or not is determined on the day you make it, Sid, not later. I know that this is a big change from the conventional way of thinking about things. All the same, I believe this. It is very exciting news. I want everyone to know. I want to help people by spreading this good news.
You are under the impression that it is not possible to know on the day you make your investment choice whether it is a good choice or not. I believe that the only reason why you feel that way is that you have been taken in by Buy-and-Hold thinking. The reality is that it is easy to know.
U.S. stocks have been providing an average long-term return of 6.5 real for 140 years now. The odds are strong that the average long-term future return is going to be something in that neighborhood. That’s the first thing you need to know.
The only other thing you need to know is the valuation level that applies. If you buy when the price is higher than fair value, you obviously are not going to get the average return, right? So you need to adjust for that. Make the adjustment and you know your neighborhood return. It’s that simple.
You are making it complicated by looking at what crazy Mister Market dishes out and taking those numbers seriously. Oh, look, crazy Mister Market is happy today, my choice was wonderful! Oh, look crazy Miter Market is now sad, my choice was terrible! That sort of thing will drive you crazy over time!
I am suggesting that you leave all that nonsense behind. We can come up with 17 different ways of determining whether your choices were good or bad by cherry-picking different time-periods to look at and by letting crazy Mister Market’s mood swings influence our thinking on the matter. Or we can just play it straight, look at the value proposition you obtained on the day you entered the investment and know forevermore whether you made a good choice or not.
I advocate the latter approach, Sid. Determine when you buy whether your investment choice is a good one or not. Make lots of good ones! That’s it! That’s the secret! It’s so incredibly easy and enriching for those not hung up in the Buy-and-Hold mind games.
Rob
Further, I would need to see the returns earned during the same period by the proposed alternative.
No! This is where we are in disagreement, Sid.
I do not care how my investments do over any one particular time–period. It matters precisely zero to me. I do not care!
All I care about is how they do over the long run. Looking at price is always going to cause my risk-adjusted long-term return to go up. It is not even possible for the rational human mind (at least not mine!) to imagine a circumstance in which it could be otherwise. If anyone is able to come up with a circumstance in which looking at price could end up being a bad thing, I’ll reconsider. As of this moment, my mind is not able even to imagine a circumstance in which looking at price could be a bad thing.
I acknowledge that those who do not look at price can do better over short periods of time. There are many cases in the historical record in which this has happened. I give you this one, Sid. There is no dispute.
What I dispute is the idea that ignoring price could ever work in the long run. Never once has this happened. It is my belief that it is not even a possibility. My view is that Buy-and-Holders are looking for a perpetual motion machine, something that possesses some sort of emotional appeal but which can never exist in the concrete world.
I truly do not see how taking price into consideration could ever be a negative, Sid. I do not. That’s what I always take price into consideration when making my investment choices.
Our disagreement goes right to the root. It’s fundamental. That’s why these discussions have been so difficult. People have a hard time getting their head around an entirely new concept. It’s an entirely simple concept, there is nothing the least bit complex about this. But it is as different from the Buy-and-Hold concept as day is different from night.
Valuation-Informed Indexing is the opposite of Buy-and-Hold. You can’t appreciate it using the way of thinking that you have become accustomed to using in all the years you have been believing in Buy-and-Hold. You need to give all that up for the new ideas to gain passage into your consciousness. Then — watch out!
Rob
At that point, as always, that index is composed of stocks which are undervalued, and others that are overvalued.
We don’t know this to be so, Sid. My guess (I do not have a dogmatic take) is that it is not so.
Stocks are probably priced properly in relation to each other. I say that because there are mechanisms that would prevent relative mispricing from remaining in effect for long.
Say that Company A is wildly overpriced compared to Company B. Analysts who study these things could detect the problem and set up arbitrage transactions that would permit them to profit handsomely from the inevitable closing of the gap. The efforts of these people would cause the mispricing to disappear. I have doubts as to whether relative mispricings can remain in effect for long.
A showing that relative mispricings are not possible is not a showing that mispricing of the entire market is not possible. This is one of the key mistakes that was made by the academics who came up with the Efficient Market Theory (the intellectual framework for Buy-and-Hold). It could be that Company A is priced properly in comparison to Company B but that both Company A and Company B (and, indeed, the entire market) are priced at three times fair value.
There is no arbitrage transaction that prevents mispricing of the entire market. I wish there was! I would be a rich man today if there was! LEAPS are the closest thing we have. But the costs associated with LEAPS are huge and they only go out about two years. That’s not nearly enough. If we had a LEAPS-like investing choice that went out 10 years, the overvaluation problem would be solved. Then, every time prices got out of hand, people like me would buy the 10-year LEAPS as a way to profit from the mispricing and that would cure the mispricing.
I vote for retroactive adoption of 10-year LEAPS. Everyone knows that I saw this crash coming years in advance. I want my big payday!!!
You’re asking great questions, Sid.
Rob
If their analysis led them to believe that company X was a good value at $50, what would convince them to abandon that view when you’re offering to buy it for $30?
This is another super question.
You give the game away with your use of the word “analysis,” Sid. Do you see how you are presuming rationality? “Analysis” is something that rational people do, yes? You are presuming that rationality applies to a significant extent to stock investing. That’s what gets you totally on the wrong path.
Now, I acknowledged that there’s rationality when it comes to relative pricing in my preceding post. So I don’t say that rationality does not come into the picture. We profit from being rational investors. So there is an incentive to be rational. So rationality does indeed come into play when circumstances are right. The trouble is that we do not permit rationality in the consideration of the overall market price.
That is a shocking statement. To back it up, I am going to need to do something that Pop is not going to like. I am going to need to refer to Forbidden Subjects. I will attempt to do so in a gentle and non-upsetting (at least not too much!) manner.
You”ve heard me talk about something I call “The Ban on Honest Posting,” right? That’s not intended to be merely a reference to discussion-board bannings of Rob Bennett. It is a much bigger phenomenon. I have an article in my files in which Shiller said in an interview that he has never told us all that he truly believes about stock investing because he fears that , if he did, he would be perceived as “unprofessional.”
Do you appreciate the implications? Shiller has tenure! He’s written a best-selling book! He’s widely respected! He teaches at Yale! And he doesn’t dare to talk straight on stock investing! Something very, very, very strange is going on. Something is not right.
There is a Social Taboo that applies to block us all from telling the truth about stock investing. It is viewed as “rude” to let people know at a time when their portfolio statement says that their net worth is $300,000 that their true net worth is $100,000. It is not done.
I have done it. I have violated the taboo. In public! On the internet! That’s what the entire Great Safe Withdrawal Debate is all about.
I believe that this taboo needs to be violated and overcome. I believe that we are going to advance in incredible ways from the rush of amazing investing insights that are going to be developed once this taboo is rejected. I believe that we are on the threshold of The Golden Age of Middle-Class Investing. I believe that our free market economy is going to roar forward in ways people cannot imagine today if we survive this economic crisis.
The Taboo presumably served a purpose in earlier times. We wouldn’t have adopted it without good reason. It has outlived its usefulness. It is now killing us. We need to let it go.
That’s going to change everything. Every book on investing is going to need to be rewritten. Every calculator is going to need to be reformulated. Every strategy is going to need to be redeveloped. We are going to see huge changes in this field.
This is good news. The changes will be enriching ones. Lots of people today feel threatened by the prospect of these changes. I wish they would try to get over that. There are going to be lots of opportunities to go around on the other side. Fortunes are going to be made. Empires are going to be built. Hundreds of new web sites and blogs are going to come into existence and become the biggest sites and blogs on the internet.
It’s all good. There is nothing bad that comes of this,. It is just a little scary at the moment to some of us because humans by nature worry about what change is going to bring. Ours is a dynamic society. The dynamism is indeed scary at times. But it is also often very enriching for most of us.
The short answer to your question is that the analyses that are being done today don’t incorporate consideration of the valuations question. Only a small number of the “experts” understands even the ABCs of stock investing because only a small number get what it means to say that valuations affect long-term returns. So we cannot take the analysis being done today too seriously.
It is important work. I am not trying to make fun. I am saying that the analysis done needs to change to reflect Shiller’s findings. After that step is taken, the analyses will begin to make some sense. As of this moment, it is not serious work any more than the Old School safe withdrawal rate studies are serious work. Buy-and-Hold and all that goes with it was discredited by Shiller’s finding that valuations affect long-term returns.
Rob
Thanks for the responses, Rob. In regards to the returns earned by Wellington fund investors, you said “Something that Buy-and-Holders do over and over again is to look backward to see whether their investments have done well or poorly. I see this as a mistake. The proper way is to look forward.â€
My point was that ten years ago, a Wellington fund investor bought at one of the highest valuation levels in the history of the stock market. History has shown that ten years later, those investors have displayed the fortitude to hold onto that investment through the market’s many ups and downs, and in turn have earned very solid returns.
The point I made about the future (which you did not address) was that it’s unknown. You feel strongly a crash is in the near future. Perhaps it is, perhaps it isn’t. What I do know is that history is littered with investors who failed because the future did not match their expectations. On the other hand, history — including the recent history depicted by the experience of Wellington fund investors — has also shown that investors who have enough humility to know that anything can happen in the stock market, and in response choose a prudent asset allocation that’s bought and held for the long-term, have been rather richly rewarded for that humility.
You write that investors should take valuations into consideration. That’s fine. So let’s take the next step. What valuations? For what indexes? What’s too high? How much should be sold? What should be done with that money? When should the process reverse? Simply, how would an investor implement your plan if they chose to do so?
Secondly, how has that strategy fared over the long-term? You seem to dismiss my question about the performance of your strategy over ten years. Fine. The returns earned by buy and hold investors over very long periods of time are well-documented. If you’re offering a better alternative, I would think the first order of business would be to detail just how an investor following your prescribed methodology would have performed in the past. That’s far from a proof of what it might do in the future, of course. But I think most investors would expect that to be one of the first questions answered.
Given your passion for this, I’m sure you have answers to the above, and I thank you in advance for providing them.
Finally, two points on the over- and undervaluation of stocks. You appear to believe that if an index is overvalued (using whatever definition you choose), then all stocks within it are overvalued. Really? To counter that claim, I can point to hundreds of individual stocks at any given moment in history that time has demonstrated were undervalued relative to their future performance over the very long-term. What evidence do you have to support your claim?
And in answering my question about investor analysis of stocks, you wrote that “the analyses that are being done today don’t incorporate consideration of the valuations question.†Are you claiming that in the stock market today — which is dominated by professional investors — the vast majority of those professionals are not taking the price of the stocks they’re buying and selling into consideration? That’s such a surprising statement that I’m certain I’m misunderstanding it. But if I am not, what do you believe they are basing their investment decisions on?
Again, thanks for your answers.
The point I made about the future (which you did not address) was that it’s unknown.
I’ve been at this for eight years, Sid. You are asking the best questions that anyone has asked in those eight years. We are in total disagreement on just about every point. But what is wonderful about your questions is that they get right to the heart of what that disagreement is about. You are raising clarifying questions. I hope that there are a good number of people who are listening in and who will be helped by hearing the questions you have raised (and perhaps even a bit by my responses!).
I addressed your point about the future, Sid. I suspect that you just find my response so amazing that you are not quite able to process it. You are saying that the future is unknown. I am saying that’s wrong, the future is known. That’s why Buy-and-Hold and Valuation-Informed Indexing are opposite models. One starts with a premise that the future is unknown and develops strategies based on that premise. One starts with a premise that the future is known and develops strategies based on that premise. Not surprisingly, going with opposite premises leads to very different takes on just about every question that comes up.
Why do you think the future is unknown?
U.S. stocks have provided the same average long-term return (starting from fair-value prices) for as far back as we have records (1870). Do you have some reason to believe that it’s all going to be dramatically different this time? If not, why would you view the future as unknown? Is it not the neutral position to expect stocks to perform at least somewhat as they always have in the past? I do not understand why you (or anyone) would assume dramatic changes.
My belief is that the future is known. I believe that U.S. stocks will continue to provide an average long-term return of something in the neighborhood of 6.5 percent real. It of course follows that the return for stocks purchased at times of insane overvaluation will continue to be far, far less than that. That’s why I tell people that Buy-and-Hold is dangerous. If you go at a time of insanely high prices with the stock allocation that makes sense at a time of fair-value prices for someone of your risk tolerance (as Buy-and-Hold teaches you should), you are going to suffer a wipeout. I view this as a bad thing.
If you were to convince me that the future return on stocks is entirely unknown, I would not even consider investing my retirement money in stocks, Sid. If your return is entirely unknown, you are gambling.
One of the things that I like most about index investing is that it offers a highly predictable long-term return for those open to taking valuations into consideration when setting their stock allocations. I love it that the future is known. I see it as being as strange as all get-out that some people react negatively to the reality (in my eyes!) that future index returns can be known in advance just by looking at valuations. I view it as a plus to know my future return, not a minus.
You and I are looking through opposite ends of the telescope, Sid. I sure hope that the end that I am looking through is the proper end!
Rob
You feel strongly a crash is in the near future. Perhaps it is, perhaps it isn’t.
Again, we are coming at this from very different mindsets. Your suggestion here is that there is no way to know when a crash is coming. You are 100 percent right about Buy-and-Holders. I do not know any Buy-and-Holders who knew that the crash was coming. Perhaps that’s a tautology. I suppose that if you knew a crash was coming you would not have been a Buy-and-Holder.
But I know of lots of people who knew that a crash was coming. There’s one distinguishing characteristic of all these people. The follow valuation-informed strategies. Shiller knew that a crash was coming. Arnott knew. Asness knew. Smithers knew. Easterling knew. Russell knew. I knew.
How did this group get to be so gosh-darn smart?
We came to understand that valuations affect long-term returns and explored the insights of that reality, Sid. That’s all it takes. You can know what’s coming up ahead too if you care to. All you have to do is to come on over to the dark side. It’s okay! Really! It’s fun (and profitable!) knowing what’s coming up ahead!
You don’t know whether a crash is coming or not because you don’t want to know, Sid. What you want is to stick with your high stock allocation. If you let in what you are capable of knowing about the future, that nixes the high stock allocation idea. So you don’t want to know.
You lack of knowledge on this point is emotional in nature. I do not say that as a personal dig. You obviously are in good company. There are millions of smart and good people who do not believe that it is possible to know when a crash is coming. That’s because they have come to believe in the Buy-and-Hold Model.
This is one of the reasons why I do not like this model, Sid. It blinds us to all sorts of important knowledge. I am a reporter, not an investing expert. I got into the field because I am curious by nature; I like to know stuff. So the idea of blinding myself to important knowledge rubs my fur the wrong way. It makes me nuts that Buy-and-Hold does this to people.
I am telling you this so that you might develop a better idea of where I am coming from. I didn’t just wake up one morning and say “Hey, I know what I’ll do, I’ll become the most severe critic on Planet Earth of the most popular investing strategy on Planet Earth, that’s sure to help my writing career!” I came to dislike Buy-and-Hold more and more and more as I learned more and more and more about it. I ultimately came to discover (at least I think I did!) that it does all sorts of things to humans and other living things that in my view are really, really bad.
I don’t think it was the intent of the people who developed the model to do these bad things. I think it was a mistake. Still, the bottom line is that I strongly believe that Buy-and-Hold has caused a great deal of human misery.
Rob
What I do know is that history is littered with investors who failed because the future did not match their expectations.
How Rob Bennett would change this sentence:
“What I do know is that history is littered with investors who failed to do what is needed to form realistic expectations about the future.”
Rob
investors who have enough humility to know that anything can happen in the stock market
I would change this one to:
“Investors who take comfort in the fantasy that perhaps this time stocks will perform in ways in which they never have before.”
There’s nothing humble in the thought that all the rules have been turned upside down because you have a desire that that be the case, Sid. Valuations have always affected long-term returns. The humble position is to accept that that is going to continue to be the case, not to assert that it certainly will not be the case.
Rob
how would an investor implement your plan if they chose to do so?
My “plan” (it’s not a plan, it’s just common sense) is that investors would buy stocks in the same way they buy carrots and computers and comic books and cameras. They should look at the price to determine whether the purchase represents a good value proposition or not.
It couldn’t be any more simple, Sid. You are looking for some complication that just does not exist.
I have recorded 200 podcasts that are available at my web site. Each is over one-hour in length. I commented on one that, if I were to tell people all that they need to know how to invest effectively, I could do the job on a single one-hour podcast. So why didn’t I do that? Why did I waste my time recording 200 when a single podcast could get the job done?
The other 199 podcasts are to explain to people why Buy-and-Hold does not work. That’s the hard part. That’s the complicated part.
Investing in the age of index funds is a piece of cake. There is absolutely nothing to it. You take five minutes to go to The Stock-Return Predictor to see whether the long-term value proposition for stocks is better or worse than the long-term value proposition for things like IBonds and CDs and you set your allocation accordingly. You’re done! You can now realistically expect to be able to retire five years sooner than the millions following Buy-and-Hold “strategies”!
The hard part is tuning out all the noise that comes to us from the “experts” promoting Buy-and-Hold. It took me 199 hours of recordings to help my readers cope with all that stuff.
Again, I don’t say that this was done with a bad motive. It was a mistake! Had Shiller published his research in 1971 rather than in 1981, we would have been spared all this. Unfortunately, Shiller’s research came out after millions had been spent promoting Buy-and-Hold and after thousands of “experts” had gotten their egos wrapped up in the contention that Buy-and-Hold works and all this sort of thing.
I am not the cause of that, Sid. History is the cause,. Blame it on God. Or on Evolution. Or on your whipping boy of choice. I had nothing to do with it. I am a mild-mannered reporter who happened to post accurate safe withdrawal rate numbers on a web site and saw the roof cave in on a discussion-board community that I had had lots of great times with and had come to respect and love. So I have done what I could to help those people (and all others in similar circumstances) out. That’s my story.
I don’t have a scheme. I don’t have a plan. I just say that we should buy stocks in the same way we buy everything else that is offered for sale in this Valley of Tears. We should look at the price that applies before putting money on the table.
That’s it. That’s the entire deal in a nutshell. It shouldn’t be controversial. If it were not for the millions that have been spent promoting Buy-and-Hold, it would not be. But because of those millions we have this problem of needing to persuade the “experts” who have been promoting Buy-and-Hold for many years now to say The Three Magic Words before we will be permitted to discuss with each other on the internet what Shiller’s research tells us about what really works for the long-term investor.
Oh my!
Rob
Secondly, how has that strategy fared over the long-term?
Leaving your common sense turned on when making investing decisions has produced far higher returns at far less risk for the entire history of the U.S. stock market, going back to 1870.
The way it is, Sid.
You can learn about all the details by putting the four calculators available at my site to work. Unlike all calculators developed under the Buy-and-Hold Model, they include adjustments for valuations.
It makes a difference.
Rob
The returns earned by buy and hold investors over very long periods of time are well-documented.
This is wrong. They are not documented at all, Sid.
What the “documents” you are referring to here invariably do is to tell us how certain funds performed. What matters is how the investors in the funds did. This is not at all the same thing.
In the crash that followed from the massive promotion of the Buy-and-Hold “idea” in the 1920s we saw stock prices drop by 80 percent real. How many middle-class investors do you think held through that? Can we agree that it was a number closely approaching zero?
We went to valuation levels far, far higher this time. So the number who hold in the real world is again going to be a number closely approaching zero.
It’s all an elaborate fantasy, Sid. Investing strategies that sooner or later bring ruin to every investor who follows them are not good strategies. The only brake on rising prices that we possess is the common-sense understanding that we must lower our stock allocations when prices get too high. Buy-and-Hold cancels out that common-sense understanding and replaces it with a mountain of mumbo-jumbo rationalizations. It’s like taking the brakes out of a car. Sooner or later a car without brakes is going to crash and all in the car are going to get killed.
It’s a funny way to run a railroad. It is in the interests of every investor alive for stock prices always to be at fair value. We should be working together to achieve that goal. It’s easy! All we need to do is to let people know what the entire historical record says about the effect of valuations on long-term returns. Al Gore has already invented the internet! This should not be so hard to pull off.
I know, I know. This plan would require asking all the “experts” who have been promoting Buy-and–Hold for years to learn how to say The Three Hardest Words to Pronounce in the Entire English Language. I get that part loud and clear.
Is there anything else that is holding us back at this point?
Rob
If you’re offering a better alternative, I would think the first order of business would be to detail just how an investor following your prescribed methodology would have performed in the past.
I would think that the first order of business would be to open the internet to honest posting on safe withdrawal rates and other important investment-related topics, Sid. That’s what thousands of people at the boards and blogs have requested and what the rules of every board and blog provide for. Open the internet to honest posting and you will have hundreds of good and smart people answering all your questions, Sid.
And in a few months the hundreds will grow to thousands. And then tens of thouands. And then millions. And the next thing you know is you look up and the economic crisis is over and we are all enjoying The Golden Age of Middle-Class Investing together.
It works for me!
Rob
You appear to believe that if an index is overvalued (using whatever definition you choose), then all stocks within it are overvalued. Really?
Really.
To counter that claim, I can point to hundreds of individual stocks at any given moment in history that time has demonstrated were undervalued relative to their future performance over the very long-term. What evidence do you have to support your claim?
I answered that in my earlier comment, Syd.
The phrase “undervalued relative to their future performance” is gibberish. All you are saying with that phrase is that the price went up. A showing that the price went up is not a showing that the price was not initially too high. It could be that the price went up because the company came out with a new hit product. There is nothing at all strange about an individual company’s price shooting up from an overvalued level after the company puts out a hit product.
If the market as a whole is overvalued by a factor of three, how could the individual companies within it not also be overvalued? The market is the collection of all the companies within it.
Rob
Are you claiming that in the stock market today — which is dominated by professional investors — the vast majority of those professionals are not taking the price of the stocks they’re buying and selling into consideration? That’s such a surprising statement that I’m certain I’m misunderstanding it.
I’m full of surprises, Syd. I’m famous for it.
But if I am not, what do you believe they are basing their investment decisions on?
They’re going by what they learned in Investing School, Syd. They teach Buy-and-Hold in Investing School today.
It’s a conspiracy! (That’s a joke.)
Rob
Thanks again for your answers, Rob. You write of your knowledge of what the future holds. I’m well aware of what stocks have earned in the past, and I’m also well aware of their tendency to revert to their long-term mean over time. Where you and I differ seems to be in our belief that the future is somehow guaranteed to mirror the past. I don’t know why anyone would believe that to be so. We’re looking at just one series of returns, during which our country grew from an emerging market to the richest nation in the history of mankind. Unless the series of events that produced those returns are guaranteed to repeat (which is impossible, of course), I find it difficult to believe that the future is guaranteed to mirror the past. It’s akin to saying that because Treasury bonds have provided a 6% annual return in the past, they’re guaranteed to provide a 6% return in the future, which I’m sure you would agree is ridiculous.
My approach, and the buy and hold philosophy, is best summarized by Pascal’s wager, which says that it’s not enough to consider the probabilities of what you believe will happen in the future. You must also consider the consequences of being wrong. Giving both their proper due would lead a rational investor to an allocation that would allow them to reap the rewards if future stock returns are as generous as they have been in the past, while providing protection should they fall short.
You again made a distinction between the returns earned by fund investors versus the returns reported by the funds themselves. But when I provide evidence that both have been generous in the past, you dismiss it. What I believe you’re missing, Rob, is that investing is a zero-sum game. For every investor that you believe has earned horrible returns because of their approach, another has earned outsized returns. It’s impossible, in other words, for investors as a group to have earned 5% over the long-term while the market was earning 10%. For every investor who foolishly bailed at the wrong time, another bought at the right time. So I’m curious how you reconcile this fact with your belief that investors as a group have earned inferior returns — relative to the market or the funds they owned — over time.
Secondly, I remain curios to see the details of your alternative to buy and hold. How are you determining the market’s value? Which market? When are stocks supposed to be bought, and when are they supposed to be sold? What other asset classes are investors utilizing when they’re not investing in stocks? And, as I said earlier, how has such a system performed in the past? Instead of pointing me to a calculator on a website, can’t you just tell me what such a strategy has earned over the long term, so that I can compare it to the alternatives? As I said, that would seem to be a rather straightforward request of someone proposing a new approach to investing.
Returning once more to the valuation of individual stocks within an index, I refer you to the link below, which lists the best performing stocks of the past decade. I’m curious to know the basis for your claim that all of them were overvalued as of 1999. When Panera Bread was selling for $3.88 — on its way to growing by 1600% over the next ten years — why was wrong to have purchased that security at that point? Can you show me any evidence that what you’re claiming regarding the relationship between individual stocks and the overall market is true?
Also, you said that an overvalued stock may provide wonderful returns going forward due to innovations and changes that are unforeseen at the time. Of course that’s true. If that’s true for an individual stock, why could it not be true for the market overall? A market that looks overvalued when interest rates, for instance, are 8% takes on a decidedly different look when rates are 1%. How does your system account for such externalities?
Finally (thank heavens ïŠ), regarding your statement that asset managers today do not take price into consideration when buying and selling stocks because they learned buy and hold in investment school: the market’s turnover is nearly 300% annually. Is that what you call buy and hold investing? If they’re not making their decisions based upon a security’s price, what are they using? Again, what evidence do you have to back up this claim?
Thanks again in advance for your answers to these questions, Rob. You’ve made a number of very counter-intuitive claims, and I’m very curious to see how you substantiate them.
http://www.huffingtonpost.com/2010/01/03/best-performing-stocks-of_n_409739.html
Where you and I differ seems to be in our belief that the future is somehow guaranteed to mirror the past. I don’t know why anyone would believe that to be so.
The word “guaranteed” is your word, Syd. It doesn’t help anyone for you to play word games.
What is the alternative to presuming that stocks will perform in the future at least somewhat as they always have in the past? Presuming that they will not perform in the future somewhat as they always have in the past?
We all have to invest our money, Syd. We have a choice of going with the high probability option (that valuations will continue to affect long-term returns and that we thus must adjust our allocations in response to price changes to keep our risk levels roughly constant) or the low probability option (that this will be the first time that letting our risk profiles get wildly out of whack will work). I prefer having the odds on my side.
Rob
What I believe you’re missing, Rob, is that investing is a zero-sum game. For every investor that you believe has earned horrible returns because of their approach, another has earned outsized returns.
This is another case in which you have asked a fantastic question, Syd. Again, you are highlighting with this question (and with your take on it) the contrast between Buy-and-Hold and Valuation-Informed Indexing.
I do not view investing as a zero-sum game.
If valuations are held steady (if enough people follow Valuation-Informed Indexing, stock valuations will always be held at fair value, there will never again be either bull markets or bear markets), stocks will provide a return of 6.5 percent real without volatility. Price volatility is what makes stocks risky. So what we are saying here is that VII permits investors to earn the same great returns that have always been earned through investing in stocks at far less risk. Reducing risk is not “zero.”
We are now suffering an economic crisis caused by the relentless promotion of Buy-and-Hold (and by the silencing of voices that have tried to help us all out by speaking out in opposition to Buy-and-Hold). That economic crisis has caused millions of failed businesses, millions of failed retirements, and millions of failed marriages. All that goes away when we abandon Buy-and-Hold for VII.
Stock investing is not a zero-sum game (you are quite right, though, that the Buy-and-Hold model posits it as such). Stock investing is wonderful for the entire society when prices are kept reasonable. Stock investing destroys economies that permit prices to get out of control. Buy-and-Hold encourages price volatility by telling investors that there is no need to change their stock allocations when prices rise to insanely dangerous levels. VII protects us from price volatility by letting investors know that they lower their returns and increase their risk by failing to adjust their allocations in response to price changes.
This is another reason why I do not favor Buy-and-Hold Investing. It is one of the big ones. We all lose when too many of us invest irrationally. The stock market is a national resource, like the parks or the lakes and streams. We should not let proponents of Get Rich Quick investing schemes pollute it.
Yes, the language is strong, but it needs to be strong for me to make the point that needs to be made here — the relentless promotion of irrational investing strategies causes great human suffering. We need to start caring not only about our only retirements but about the pain caused to our neighbors and co-workers and friends and fellow citizens when they become unable to obtain the information they need to be able to learn how to invest effectively. I oppose the Ban on Honest Posting that is obviously required to keep the Buy-and-Hold Model afloat.
Rob
It’s impossible, in other words, for investors as a group to have earned 5% over the long-term while the market was earning 10%.
Here are Shiller’s words:
“It is a serious mistake for public figures to acquiesce in the stock market valuations we have seen recently, to remain silent about the implications of such high valuations, and to leave all commentary to the market analysts who specialize in the nearly impossible task of forecasting the market over the short term and who share interests with investment banks or brokerage firms. The valuation of the stock market is an important national — indeed international — issue. All of our plans for the future, as individuals and as a society, hinge on our perceived wealth, and plans can be thrown into disarray if much of that wealth evaporates tomorrow. The tendency of speculative bubbles to grow and then contract can make for very uneven distribution of income. It may even cause many of us, at times, to question the very viability of our capitalist and free market institutions.”
There have been several big-name “experts” who, during the course of our discussions have indicated that, while they advocate Buy-and-Hold in the public comments that can be heard by middle-class investors, they share with their paying clients at least some of what we have learned about investing through the academic research of the past 30 years. Those who were told that it was okay to keep their stock allocations high during times of insanely high prices obviously are going to end up with overall returns of far less than the 6.5 percent real average return, perhaps 2 or 3 percent. The other group is much smaller (perhaps 10 percent of the population of investors and with a far higher percentage of total stock ownership). So I think it might be fair to speculate that the wealthy investors in this group might be earning returns of between 10 and 20 percent.
Is that your idea of “zero sum”? That the group that can afford to pay for advice learns the realities and is thereby able to earn returns of 10 to 20 percent per year while the group that presumes that the “experts” on blogs and websites and in newspapers are shooting straight end up with perhaps 2 percent or 3 percent? That’s not my idea of “zero sum.” That’s my idea of an obscenity.
If the wealthier investors earned the higher returns, that would be a very different story. That’s not the case here. Thousands of middle-class investors have expressed a desire to be able to hear about the realities. If the web sites and blogs honored the promises they make to their readers in their published rules, these people would be able to earn good returns. They have tried to learn what they can. They have been denied this knowledge despite promises made by the owners of the web sites to protect them from the sorts of tactics that have been employed by representatives of the The Stock-Selling Industry to keep this information from them. I believe it was Will Rogers who said that some people rob you with a gun and some people rob you with a fountain pen and the ones who rob you with a fountain pen are the more cold-hearted group.
You are right that the overall return is 6.5 percent real. That applies either way. But I don’t consider it “zero sum” to cause one group to get 90 percent of the gains when all put their money at risk. And that sort of inequality has very serious effects on our economic and political systems. People today are growing angry with their political leaders for having failed to address this matter for many years. Properly so! Dealing with this sort of situation is a political leader’s job. How much is that anger going to grow after the next crash? In what state will our political system be at that point?
One of our earlier tests of the Buy-and-Hold “idea” led to The Great Depression. Was that a “zero sum game” in your eyes, Syd? Have you read stories about the human suffering that millions endured during The Great Depression?
You hit a nerve with this one, Syd.
Rob
For every investor who foolishly bailed at the wrong time, another bought at the right time.
One of the ones who “foolishly bailed at the wrong time” is Bill Bengin, the author of one of the Old School safe withdrawal rate studies. You call the millions of middle-class investors who are suffering “foolish.” Do you call Bill Bengin “foolish”? I call both Bengin and the millions of suffering middle-class investors “human.” I think of those who caused this suffering with their arrogant pridefulness the true fools. There’s no fool bigger than the fool who keeps doing the wrong thing because he would rather do that than admit having made a mistake.
Another one of the ones who came within a whisker of “bailing at the wrong time” was Taylor Larimore, co-author of the book The Bogleheads Guide to Investing. Taylor participated in vicious smear campaigns to block community members at the Vanguard Diehards board from hearing about the realities of stock investing. But the first time his Buy-and-Hold advice was tested in a serious way, he announced that he had all along has a “Plan B” in his pocket that he never mentioned in his book and that he intended to go to a zero stock allocation in the event that prices feel any further (as they likely will in days to come).
People are suffering greatly, Syd. They were foolish in one way — they presumed that the investing “experts” were shooting straight with them. Your idea that it is the victims of this “strategy” who are the “fools” is an insult to millions of good, hard-working people. I bet that many of those people have more compassion for others in their little fingers than all of those who have posted in “defense” of the Ban on Honest Posting added together.
Those people don’t make multi-million dollar salaries, as do the “experts” who promote Buy-and-Hold and Who May Not Be Questioned About the Validity of the Investing Strategies They Recommend. They matter all the same.
My sincere take.
Rob
I’m curious how you reconcile this fact with your belief that investors as a group have earned inferior returns — relative to the market or the funds they owned — over time.
Another factor is that a free market economy is not able to continue to function when millions are being spent to promote Buy-and-Hold and when it is not possible for the other side of the story to be told in public. The “invisible hand” of the free market is supposed to reward companies that do a good job of meeting consumer desires and punish those who do a poor job. Buy-and-Hold teaches investors to treat the wildly inflated numbers on their portfolio statements as if they were real. This causes people to spend on products and services that they would not spend on if they knew the true value of their stock portfolios at all times. An unfair edge is given to sellers of luxury goods and services for the length of one of the insane bull markets brought on by the promotion of Buy-and-Hold investing ideas.
This effect is no small thing. Buy-and-Hold resulted in $12 trillion worth of funny money floating through our economy in early 2000.
Also, all of the money that is being spent on stimulus programs to revive an economy demolished by the relentless promotion of Buy-and-Hold is money that could have been put to far more productive uses if our economic and political leaders had taken effective action sometime within the first three decades of the publication of the research showing that valuations affect long-term returns.
Rob
Instead of pointing me to a calculator on a website,
If you have a serious interest in learning the answer to your questions, you will take the five minutes it would take to learn how to use the calculator, Syd. You could have learned the answers to all your questions less time than it took you to write that post.
Rob
that would seem to be a rather straightforward request of someone proposing a new approach to investing.
There is nothing new about the idea of applying human reason to the investing project, Syd. People have been following rational investing strategies since the first market opened for business.
People have also been following emotional strategies since the first market opened for business.
The way to know which one is popular at a given time is to look at the valuation level that applies. Rational Investing produces reasonable prices. Buy-and-Hold produces what we have seen from 1996 forward.
Buy-and-Hold will collapse without my needing to push it. Logic demands its collapse. My job is to provide people with materials that will help them manage the transition from the most emotional investing era we have yet seen to what I hope will be the most rational investing era we have yet seen. These are dark days But it’s always darkest before the dawn.
Rob
When Panera Bread was selling for $3.88 — on its way to growing by 1600% over the next ten years — why was wrong to have purchased that security at that point?
This is another good question.
If you knew that Panera was going to go up that much, there was obviously nothing wrong at all with buying it.
Did you know?
There are always going to be some companies that shoot to the moon during a given time-period. There are lots of companies.
The fact that a company shoots to the moon doesn’t show that its stock was not overvalued at the earlier price. Panera shot to the moon because its business improved, not because of a valuation change.
When you buy an index, you get all the companies that shoot to the moon and all the companies that collapse mixed in together. So this aspect of the investing project — the success or failure of the business — is neutralized. Indexers don’t need to worry about this sort of thing.
The only thing that indexers need to worry about is valuations. Mixing in different businesses does not take away the need to insure that you obtain a good value proposition for your investing dollar.
Rob