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The following is a guest post. The opinions expressed are those of the author.

 

The Buy-and-Hold Myth

The most important article ever published on investing appeared in the Wall Street Journal on October 14, 2010. It was a column by Brett Arends titled “The Market Timing Myth.”

Before I give you a link to the column and quote briefly from it, I want to ask you a question. If you were in the market for a used car, would you go to a dealership without having done any homework and ask the dealer whether the cars he picked out for you was in his expert opinion a good choice?

That’s a bad idea, isn’t it?

The used-car dealer is biased. What you want to do is to check out Edmunds.com, identify the fair price for the car you want and then negotiate with the dealer, taking your business elsewhere if he refuses to meet your demands.

Here’s the link — The Market Timing Myth

The article states: “For years, the investment industry has tried to scare clients into staying full invested in the stock market at all times, no matter how high stocks go… It’s hooey…. They’re leaving out more than half the story…. Anyone who followed the numbers would have avoided the disaster of the 1929 crash, the 1970s or the past decade on Wall Street…. I wonder how many stayed fully invested because their brokers told them you can’t time the market.”

Buy-and-Hold doesn’t work. That’s what he is saying. The harsh way of putting it would be to say “Buy-and-Hold is a lie.” The charitable way of putting it would be to say “Buy-and-Hold is a marketing gimmick.” In any event, those who follow Buy-and-Hold strategies never achieve good results in the long term.

We have 140 years of return data available to us and there has never yet been an exception. Stocks always do well in the long term when purchased at moderate or low prices and stocks always do poorly when purchased at high prices.

But wait.

Everyone supports Buy-and-Hold. The experts support it. Financial journalists support it. Our friends and neighbors and co-workers support it. Most personal finance bloggers support it. All these people cannot be crooked. There must be something to it.

Please read the excerpt from Arends’ column again. There is nothing to it. Buy-and-Hold is a myth. It’s “hooey,” in Arends’ words.

To understand why this myth has become so popular, you need to consider an important respect in which the stock market is different from the used-car market.

In the used-car market, the price of the car being sold is the result of a battle waged between the car seller and the car buyer. The seller wants a high price. The buyer wants a low one. Each side has to give something or risk seeing the negotiation fall through. The end result of the battle is usually a price that is more or less right. The car-selling market works.

It doesn’t work that way in the stock-selling market.

Have you ever heard anyone cheer low stock prices? The magazines love bull markets. So do the experts. So do the bloggers. So do your friends and neighbors and co-workers. So do you.

So the stock market is not really a market. Or, if it is, it is a very unbalanced market. A market in which everyone is pushing for higher prices. A dysfunctional market.

What happens is that stock prices go up and up and up for about 20 years. By that time, the market price is so far off from what it should be that we experience an economic collapse. Then we see 20 years of poor returns. Then we start the cycle over again.

There’s only one way to end this madness. We need to tell people the truth about stock investing. We need to let people know that stocks are a great investment when prices are moderate or low and a horrible investment when prices are high. If people knew that, prices would be self-correcting. Once prices got too high, enough investors would sell their stocks to bring prices back to fair-value levels. We would never again see out-of-control bull markets or the economic crises that inevitably follow from them.

We need people like Arends telling us the straight story. If we all came to learn how stock investing works, we could earn far higher returns while taking on dramatically less risk. We would all be living in Investor Heaven.

I can point you to academic research showing that all I am saying here is so. The data shows that we all could retire five to ten years sooner if only we could bury the Buy-and-Hold Myth 30 feet in the ground, where it can do no further harm to humans and other living things.

Why don’t more experts tell us the straight story?

We get mad at them when they do. We like to pretend that the phony prices that apply for stocks during bull markets are real. When experts tell us how to invest so that we can retire five to ten years sooner, we become enraged at them for popping our fantasy beliefs about stock investing. So not too many dare to do this. Arends is very much an exception.

What’s the answer? We need to let the experts off the hook. We need to let them know that we want to hear the truth from them, even if it hurts a bit to learn that we were taken and that we have done great harm to our financial futures by investing foolishly. It’s only by admitting our mistakes that we can begin to do better.

Buy-and-Hold is a myth. We need to start talking about this harsh and promising reality. it’s harsh because it is a reality that it hurts to accept. But it is promising too because we now know of far safer and more effective investing strategies that we would enrich us all if only we could work up the courage to leave the Buy-and-Hold Myth behind.

 

Rob Bennett developed The Stock-Return Predictor, a stock valuation calculator. His bio is here.