Investing–The New Rules: The Monster That Ate the U.S. Economy

From little things, big monsters grow

What is the Monster that Ate the U.S. Economy? Where did it come from? What can we do? Rob Bennett has the entire horror story in this week’s Investing–the New Rules.

“From Small Things, Mama, Big Things One Day Come.”

That’s the title of a Bruce Springstein song that was recorded by Dave Edmunds. It’s the line that comes to mind for me when I am asked how it could be that Buy-and-Hold turned into The Monster That Ate the U.S. Economy while no one was looking.

When pointing out the horrors of Buy-and-Hold, I usually point to The Missing $12 Trillion. Stocks were overvalued by $12 trillion in January 2000. Stock prices always revert to the mean in the long run (even John Bogle acknowledges this). So, there was $12 trillion that in 2000 middle-class investors were expecting to be able to use to finance their retirements that was fated to go “Poof!” over the next 10 or 15 years. Stir ingredients briskly and voila! — Economic Crisis Supreme!

How did it get to be $12 trillion? Why didn’t anyone speak up? Surely our economic and political leaders did not want to create a crisis?

They didn’t want to create a crisis. Humans are mess-ups but they are not evil through and through (there are exceptions, but our economic and political leaders follow the general rule, so far as I am able to tell). The sin that the people who should have protected us from the crisis are most guilty of is the sin of rationalization. The pain brought on by the sin of rationalization can be very big but it is often slow-acting.

Consider the alcoholic. He ruins his health. He loses his job. His money is washed down the drain. His wife walks out on him. His kids cannot stand him. Was there ever a moment in which he formed a deliberate intent to cause all this self-destruction? Of course not. The fellow was feeling a little down, he took a few extra drinks for the temporary comfort they brought him and then over time it became a habit.

So it is with Buy-and-Hold and our economic crisis. No one planned to let stocks get overvalued by $12 trillion. The level of overvaluation that was certain to crash our economy just sort of snuck up on us, you know? These things happen from time to time down here in the Valley of Tears.

The two most important discoveries in the history of investing both happened to take place over the past 50 years. The first was the discovery that short-term timing (changing your stock allocation with the expectation of seeing a benefit for doing so within a year or two) doesn’t work. The second was the discovery that long-term timing (changing your stock allocation in response to big price changes with the understanding that you may not see a benefit for doing so for as long as 10 years) always works and is in fact required for those hoping to have any realistic prospect for long-term success. If both of these major discoveries had been discovered at the same time, there never would have been any Buy-and-Hold. We all would have been confirmed Valuation-Informed Indexers dating back to the 1970s, when the insights that followed from the first major discovery were first being popularized.

It didn’t happen that way. The Stock-Selling Industry spent millions promoting Buy-and-Hold in the 1970s. Then this Yale professor fellow came along with his nasty research showing that, while it was partly right (short-term timing really does not work), it was also partly wrong (long-term timing always works and is required). The Stock-Selling Industry wasn’t too keen on the idea of taking out millions in advertising letting everyone know that they had gotten it all horribly wrong. They elected to — keep the second huge discovery under their collective hat, let’s say.

That was 1981. The economic crisis came in 2008. We took our first drink in 1981. The divorce papers were not filed until 27 years down the road. Some spouses are patient souls. Our economy was an awfully strong economy. It took decades to put it in the ground. These things take time.

Buy-and-Hold is a lie (just as the illusion of happiness that being drunk brings is a lie). The $12 trillion that we were planning to use to finance our retirements never existed. It was puffery, sales talk. But the hurt that it brought on was real. Millions of us believed for a time that that money was real. So we spent money that we never would have dreamed of spending had we known the realities. Buy-and-Hold is a lie that destroys entire economies — but only gradually.

In 1981 there was no practical problem. Yes, those who followed the research knew that Buy-and-Hold was nonsense even then or at least they would have known if their minds were working properly (my sense is that most were blinded by the cognitive dissonance that follows from learning that you made so horrible a mistake re so important a matter). But stocks were wildly undervalued in 1981. Telling people to ignore valuations was not going to cause a problem at those prices. So we rationalized keeping the matter quiet.

By 1996 stocks were insanely overvalued. At this point the problem was no longer merely a theoretical one. But what to do? By 1996 the insane price jumps had made many on-paper millionaires. Much of the money they were counting as theirs wasn’t real. But which economic or political leader was going to be the one to spread the news?

It’s like the story of the mice who come up with the idea of putting a bell around the neck of the cat so that forevermore they would know in advance when Mr. Claws was back in town. Great idea. But which mouse is going to be the one to get the job done? That’s always the rub.

Buy-and-Hold eats away at our economic health day by day, week by week, month by month, year by year. It always destroys us in the end. It ha been tried four times in U.S. history. It brought on an economic collapse on the first, second, third and now fourth try. I am beginning to detect a pattern.

But the crisis always comes many years after the day on which the Buy-and-Hold idea (that there is no need for investors to consider valuations when setting their stock allocations) first begins to catch on. And once it does catch on, Buy-and-Hold “logic” is about as easy a thing to stop as a runaway train. We all have a Get Rich Quick impulse lurking within. We all cotton to the idea of money for nothing and the chicks for free.

Will it happen again?

It is my belief that our free-market economy cannot survive another bite at the Buy-and-Hold apple. It’s not just rich people who invest in stocks today and who thus destroy themselves when they commit to the 100 percent emotional investing approach. The middle-class now invests in stocks to finance its retirements. Our system of government won’t be the same if we permit Buy-and-Hold to entirely wipe out the middle class.

So I believe that this fourth economic crisis is going to be the last one caused by the popularity of the Buy-and-Hold idea. I think we are on our way to moving on to something better. I believe that this economic crisis is slowly leading to the dawn of The Golden Age of Middle-Class Investing.

Wish us luck!

by Rob Bennett
images: DBKP file; chicago now

The video of an ABC News interview with Rob is here. His bio is here. And please do not even think of failing to read these Important Cautionary Words.

Back to DBKP Front Page.

Your Ad Here