10 Years Later: An Investment Strategy Worth Reconsidering
“If everyone else was jumping off a bridge, would you jump off one too?” – my Mom.
And the answer is: probably. Let’s face it, there is a sense of safety in numbers. If more people do something it appears safer. The term for this behavior is social proof (or informal social influence). Take the practice of living near or on an active volcano (Pompei, Hawaii), living close to the coastline in a hurricane path (the Carolinas or the Gulf), areas prone to mudslides (California), or in an area prone to frequent flooding. The more people that live there, the safer we assume it is. In some instances, government intervention has been required to get people to safety or stop them from rebuilding houses that are destined to be destroyed in short order. For decades we have been told that buy-and-hold investing works. Warren Buffett swears by it, traditional investors practice it, and the repetition of this philosophy is held as infallible truth within academic circles. But what if this wasn’t true? What if buy-and-hold is really buy-and-hope?
Crash Course In History
Evidence of the fallacy of social proof can be witnessed nearly a dozen times throughout the last century. Take, for example, the Japanese stock market from 1986 to the winter of 1989. Stock and real estate prices inflated exponentially causing the Nikkei to hit an all-time high of 38,916. There was great debate on whether the market bubble would burst or if it would climb higher to 45,000. To many it was clear that the market had topped out and there was great risk in not preparing for the worst, yet popular trading rhetoric continued to echo the same old tale: buy-and-hold. It’s the best strategy. By the fall of 1990 the Nikkei had fallen below 21,000 (a 46% decrease in 9 short months) and would eventually drop below 8000 over the next 13 years. The years preceding the collapse were known as the Ushina-wareta Jūnen – The Lost Decade. For those who held to the mantra of buy-and-hold, it’s safe to say they were truly lost. As late as September 11, 2018, the Nikkei has only recovered to 22,664.
Hold That Thought
So why do we resist change even when faced with solid evidence? Until the 1500s, the learned elite of society held the view that the earth was the center of the universe. Copernicus (1473-1543) challenged that view and espoused that the earth revolved around the sun. Then, Galileo (1564-1642) championed the Copernican view, presenting tangible evidence that unquestionably elevated this theory into what is now modern science. However, he was met with stalwart resistance and spent the last eight years of his life under house arrest for his heretical views. Looking back at this today, one can’t help but think how ridiculous it was to condemn what we see now as painfully obvious. Imagine what people will think looking back at the concept of buy-and-hold.
What Doesn’t Kill You…
Survivorship bias may have kept the idea of buy-and-hold alive. Survivorship bias is what happens when we hear that someone bought Coke or General Electric in 1959 and held it and exclaimed, “look how well it’s done!” What we don’t hear about is that purchase of Bethlehem Steel, Service Merchandise, Enron or other former Wall Street darlings who are now as extinct as the Dodo bird. The only evidence presented is the evidence that supports the thesis (closely related to “Confirmation Bias” in behavioral economics). That’s why Dow Jones and Standard & Poor’s actively adjust their “passive” indexes. It makes sense. And that is why we believe it makes sense to make periodic adjustments to asset allocation. Asset allocation as a one-time decision is, effectively, a buy-and-hold allocation. No farmer expects an effective yield by simply planting seeds and letting nature take its course. Likewise, buy-and-hold can lead to less fruitful portfolios. Even though many people treat asset allocation as a set-it-and-forget-it decision – a buy-and-hold mentality on asset allocation – that is not enough social proof for me. I won’t jump off that bridge.