Current Research

Current Research A

Fundamental Breakthroughs associated with TIPS

Latest update: June 16, 2005.
Current Research A

Current Research B

Keeping In Tune with the Human Element

Updated August 21, 2005.
Current Research B

Current Research C

True Buy-and-Hold Investing

Dated: September 12, 2005.

I received this letter from Rob Bennett of www.PassionSaving.com . It has opened up several new areas of research.

An immediate, but insufficient, response to this letter would have been to scale P/E10 and nothing else.

Our answers about True Buy-and-Hold Investing are different from the traditional: grit your teeth and hang on.
True Buy-and-Hold Investing Letter

John:

As you know, I am a big believer in Buy-and-Hold Investing. I believe that middle-class investors seeking financial freedom early in life generally should aim to follow a Buy-and-Hold investing strategy.

As you also know, I am a big skeptic re the conventional approach to Buy-and-Hold Investing. The conventional approach is to calculate the benefits that flow from use of a Buy-and-Hold strategy and then ASSUME that any investor referring to himself as a Buy-and-Hold investor will obtain these benefits. I find this approach to be naive in the extreme.

The reality is that only a small percentage of the universe of investors who refer to themselves as Buy-and-Hold investors will in the real world enjoy the benefits that flow from following this investing approach for a long period of time. If what has always happened in the past is a valid indicator of what it likely to happen in the future, most of the investors who today refer to themselves as Buy-and-Hold investors will abandon the Buy-and-Hold approach when stock prices revert to more moderate levels.

I believe that the key to successful Buy-and-Hold investing is developing a firm understanding of what the historical stock-return data say about what sorts of long-term returns stocks are likely to provide for purchases made from a variety of starting-point valuation levels. Thus, my interest in safe withdrawal rate (SWR) analysis, particularly the analytically valid approach to SWR analysis you put forward at this site.

One of the things that I like about analytically valid SWR research is that it helps the middle-class investor seeking to follow a Buy-and-Hold strategy to do so. When stock prices go up, the investor feels pressures to increase his stock allocation to levels higher than the levels that are optimal for his hopes of achieving his particular life plan. When stock prices go down, the investor feels pressures to lower his stock allocation to levels lower than the levels that are optimal for his hopes of achieving his particular life plan. An analytically valid SWR analysis works COUNTER to these pressures, thereby helping the investor stick with the investment allocation most likely to cause him to achieve his most important life goals.

The core problem with stocks is that one can not trust the current selling price to serve as an accurate indicator of the intrinsic value of the investment. There are times when the selling price is about at fair value, there are times when the selling price is far above fair value, and there are times when the selling price is far below fair value. An investor needs to plan to achieve his goals. But how can he plan when he doesn't have at his disposal a number giving an accurate assessment of the monetary value of his stock investments?

Most investors don't even try to come up with accurate assessments of the values of their stock investments--they just use the newspaper-reported prices. The historical stock-return data show that these numbers are often far off the mark. Using la-la land numbers obviously does great harm to the efforts of aspiring early retirees to plan their retirements and to assess how well their retirement plans are doing after they have handed in their resignations.

SWR analysis comes to the rescue. Each time that stocks become more overvalued, the SWR goes DOWN. Thus, the investor's excitement over seeing a higher value assigned to his stock investment is tempered by an understanding that the long-term returns he will receive from that investment has been diminished. Each time that stocks become more undervalued, the SWR goes UP. Thus, the investor's dismay over seeing a lower value assigned to his stock investment is tempered by an understanding that the long-term returns he will receive from that investment has been increased. The mix of positive and negative emotions experienced by the investor provides him an informed understanding of the REALITIES of the extent to which his stock investment is helping him realize his long-term investing goals.

I do not believe that an investor should be using the newspaper prices of his stock investments to determine his net worth. He should be employing SWR analysis to reduce the newspaper-reported price to something closer to reality or to increase the newspaper-reported price to something closer to reality.

My question is--Do we now have enough research completed to permit investors interested in doing so to make use of SWR analysis to assign reasonably accurate valuations to their stock investments?

If I were to purchase $10,000 of an S&P Index Fund today, and the S&P Index were to rise by 30 percent over the next 12 months, would you be able to tell me at the end of the 12 months a number that is a better assessment of the true value of my investment than the number I would get by looking in the newspapers? If the S&P Index were to drop by 50 percent in the following year, would you again be able to give me a more accurate assessment of the value of my investment?

My sense is that, if we presume a holding period of 50 or 60 years, a reasonable assessment would be that the value of the investment would grow by about 6.5 percent real per year regardless of upward or downward swings in newspaper-reported prices. What we need are the numbers that apply for shorter time-periods (10 years, 20 years, 30 years, and 40 years). For example, it might be possible to tell the investor holding his stock investment for 30 years that the real value of his investment at the end of the 30 percent increase and the 50 percent drop is a number between x and y, with a z level of percentage confidence.

I worry, though, that there are complications that I am ignoring in putting forward this layman's understanding of how the intrinsic value of an investment in an index fund changes over time. Do you see complications? How far away do you think we are from the day when we could develop tables letting early retirees and aspiring early retirees assess (to a reasonable degree of accuracy) the true value of their stock investments on a year-by-year basis?

An interesting test of the concept might be to assign annual values to a $10,000 S&P index purchase made on January 1, 1996, for each of the years from 1996 through 2005. The newspaper prices have gone wildly up, then down a good bit, and then stable for a bit. My sense is that the intrinsic value changes have been much less volatile. It would be interesting to compare the two numbers for each of the nine years, and consider the extent to which knowing the better-informed valuation assessment would help the investor stick to a long-term Buy-and-Hold investing strategy.

I believe that knowing the true value of what you own is key to development and maintenance of a Retire Early plan. So I think the idea of developing such tables is an idea of great potential. I also believe that knowing the true value of what one owns is key to developing the ability to stick to a Buy-and-Hold investing strategy for the long term. I see the ultimate big plus of the Valuation-Informed Indexing approach to investing being its ability to help investors become Buy-and-Hold investors not just in theory but on the real true Planet Earth as well.

Rob

Initial Response

I have constructed tables from the equations in You Can't Count on 7% to assist buy-and-hold investors.
Buy-and-Hold Projections

Additional Tables

I have constructed tables with the projected stock market returns in dollars for 1995-2005 at 10, 20 and 30 years, as requested in Rob Bennett's letter.
Buy-and-Hold Dollar Projections

Valuations and Dividend-Based Strategies

Valuations affect Dividend-Based Strategies. Everyone is aware that prices affect yields. They do more.

The change in the speculative return caused by price changes is larger than the change of dividend yields.
Valuations and Dividend-Based Strategies

Dividends and True Buy-and-Hold Investing

Here are some applications of the True Buy-and-Hold concept using dividend-based strategies.
Dividends and True Buy-and-Hold Investing

Have fun.

John Walter Russell
September 12, 2005