“Jacob touched on buying without regard to the price.”

In most B&H with rebalancing schemes you have an asset allocation that you want to maintain. With that in place you automatically buy less (and perhaps even sell) the more expensive stocks / asset classes.

“Jacob touched on DCA, which only works in a substantially upward-trending market.”

Actually in an upward trending market DCA is the worst thing you can do and you would be better off putting in all your money in a lump sum at the beginning. DCA works great when there is a lot of variability in the price and spreads the risk of choosing an inopportune time to buy/sell. People who kept DCA’ing over the past crash did great.

“There is no accepted definition of “periodic rebalancing”… is that once a year? Twice a year? When the security is overpriced? Never?”

This is largely because most strategies are relatively insensitive to whether you rebalance 1/year or 2/year etc. This is a good thing.

The thing to remember about B&H / index investing is that it’s never going to be the optimum strategy in hindsight. But we don’t have that advantage when investing — we obviously need to make decisions without seeing the pattern of future returns. When making decisions going forward I haven’t seen any evidence that other approaches gives higher *expected returns* for the individual investor..

2) B&H / indexing. I suspect there is a reason that it’s much harder for one to be convinced that B&H / DCA indexing is unsound from the perspective of investing (which by definition is the expectation of higher comparative returns via either income, appreciation, or both). DCA indexing is an extremely low-cost offering, yes for the investor, but that much more so for the service provider. Conversely, value investing is hard work (in my limited experience). The successful value investors on occasion transmit their wisdom to others, e.g. Graham & Dodd, Graham, Munger, Buffett, Klarman, Dreman, et al. But I don’t believe they really care about being intellectually competitive with a B&H / DCA industry. The DCA industry *enables* the value investing approach, and the aforementioned authors are too busy making lots of money for themselves and their clients to be bothered to defend their ways, possibly even to the point of secret glee that their books are not more widely embraced. Back on the first hand, authors and proponents of B&H / DCA / indexing *do* have a lot to gain by continuing to write books and tout their own ways, because DCA is very easily transmittable and there is a lot to be gained by continuing to harvest the low-hanging fruit of DCA-primed indexing adherents. Thus, I predict that DCA indexing will continue to win the media campaign, while value investing disciples will quietly and happily carry on regardless.

What if I told you could purchase a Muni bond fund that is currently yielding more than 7%? Seems to me that it is a tax free return well above the inflation rate.

And have you seriously looked at dividend growth? There are quite a few dividend payers offering current yields over 3% that have 5 to 10 year (or longer) track records of growing their dividends at a minimum of twice the inflation rate.

My own 20-yrs of investing experience compels me to say that buy-and-hold is sub-optimum, just like index investing. Both are safe techniques for people who don’t want to be bothered with analysis and tracking and are happy with “average” results.

“Science is hypothesis, experiment, verification, repeat and verify. Investing is never like that because the last two steps are missing.”

Well I don’t see the difference between investing research and any other behaviorial science. The last two steps you mention, repeat and verify are done in investing research. Academics regularly see if findings in one period apply to other more independent areas such as other countries and time-periods. Of course these studies are never perfect because one cannot achieve complete independence but that doesn’t mean they provide no support. And of course the best test of reproducibility is to see if going forward we can replicate findings in past studies (we just have to do this on a slow time-scale as we wait for new data to come in).

“Fact is, everything is based on historical data which is really only a single data point.”

This has certainly been a problem of some studies that they treat data from individual years as independent when they are linked. However, I think by now most researchers are well aware of the issue. However, I wouldn’t go so far as to say that investing history can be summed up by one point, my guess (just pulled out of my rear) is that we probably have the equivalent of 1 statistically independent point for 10 years of history.

“Yes, I realize I take a very fundamentalist position here with tons of opposition. It’s like going against the peer reviewed papers that say that the Earth is the center of the universe.”

I’m perfectly willing to drop the idea that B&H / index investing are not the best course of action. But I think doing so without seeing objective evidence (or a strong mathematical argument) is not a well-advised strategy.

“In the previous century this was what people could do. Now, with computers, you can take into account human behavior to a greater extend, hence the emergence of behavioral economics and behavioral finance.”

I think if you are a bigger player there are anomalies in the market that you can take advantage of to obtain excess returns (e.g., look at all the interest in high frequency trading). But these are not feasible options for individual investors once you take into account taxes, trading costs, etc.

“Obviously this stuff can’t be put into a simple equation or a simple theory. However, humans can still understand it intuitively. Those who do are good investors. Not everybody are good investors.”

Warren Buffet is widely regarded as one of the best investors in the world. But even his performance over the past decade is not substantially better (actually it was worse) than what you would achieve with a well diversified asset allocation, buy & hold, rebalancing, and low cost index funds:

http://www.fundadvice.com/articles/investing-basics/ten-years-of-superior-performance-was-no-accident-2.html

What is happening, in a nutshell, is that a particular investing method gets popular and consequentially it is self-reinforcing (we can agree, this is a universal truth). That professors describe this with math (when this presumption is fundamentally wrong) and agree on each others findings doesn’t really mean much.

Yes, I realize I take a very fundamentalist position here with tons of opposition. It’s like going against the peer reviewed papers that say that the Earth is the center of the universe.

Much of the existing literature operates under the presumption than economics is like physics and that people are like particles. In the previous century this was what people could do. Now, with computers, you can take into account human behavior to a greater extend, hence the emergence of behavioral economics and behavioral finance. Obviously this stuff can’t be put into a simple equation or a simple theory. However, humans can still understand it intuitively. Those who do are good investors. Not everybody are good investors.

Anyway … the key point I agree on … index investing is probably the best option for the individual investor — but that’s mainly because most individuals are not investors, rather they are people who spend their savings in the stock market because they expect higher returns.

[The main problem with investing is that anyone can use the tools even with no skills whatsoever. (A five year old can buy a stock, but it takes years and years to understand how to buy the right stock.) It is the money equivalent of the machine gun. If investing was more like the sword, which requires years of practice to be semi-deadly, we probably wouldn't have this discussion. IOW, I think many of these methods for the "individual investor" have been developed simply because investing has become "democratic" (like automatic weapons).]

There is an abundant amount of evidence/studies published in peer reviewed journals that thoroughly go over the statistics and outcomes of B&H / indexing. These overwhelming support B&H / indexing for the individual investor. To give a nod to Sagan, you are making an extraordinary claim in light of that evidence and really need to provide extraordinary evidence to back up your ideas.

Here are some responses to specific comments from various posters:

“I agree that periodic rebalancing [different assets] is better than buy and holding.” No serious financial advisor recommends buy and hold without rebalancing. These are not two separate strategies.

“There were no safe places in 2009.” People who rebalanced from bonds/cash into stocks did very well.

“The main flaw in buy and hold is that one does not stop buying when markets become overvalued.” Rebalancing should prevent buying too much of an overvalued asset. Remember B&H / index investing != buy only S&P 500 index. You typically have a mix of asset classes with B&H and they are usually at different valuation levels.

“I think trying to quantify is a big epistemological mistake because it changes the perception to what can be measured and ignores what can’t be measured.” Quantification and measurement is key to science and reproducible results. If you believe the current measure of risk=volatility has problems (which it does) then suggest a better one.

Many people (including myself) who followed the traditional strategy of buy & hold, index investing, rebalancing and did very well over the past year, past decade. And this is for one of the worst decades for stocks with two big bear markets. If you look at forums like bogleheads / earlyretirement there are many folks who follow this strategy that are back at their peak net worth or even higher.

I agree that periodic rebalancing [different assets] is better than buy and holding. However, this will only work insofar that that strategy hasn’t gotten as popular as “buy and hold yet”. There are things that suggest that this point is close though. There were no safe places in 2009.

I don’t track my performance meticulously (because 1) that would be work 2) Why does it matter when I’m not trying to put it on my resume 3) I wouldn’t learn anything from short term numbers … in 10 years I will know if I’m right with stock picks). I did note though, that compared to the SP500, I did not drop as far from peak to bottom (Mar 2009) AND I’m further up in percentage from bottom to now than the SP500. Honestly, though, I think trying to quantify is a big epistemological mistake because it changes the perception to what can be measured and ignores what can’t be measured. Just consider how risk is considered to be volatility (because that’s easy to calculate) and not chance of loss (because that’s pretty much impossible to calculate). Now that’s just crazy, but yet that’s the way performance is measured. If I optimized for that kind of performance, I might have the a great Sharp ratio, but last year, I likely would have gotten clobbered along with the rest of the market.

I agree buy and hold is dead. Investors put too much emphasis on recent experience. As a 36 year old investor, most of my investing experience occurred in the late nineties bull market and the second smaller bull market that followed. The late nineties bull market lulled us into the buy and hold mentality. Mutual fund firms happily capitalized on this, authors made millions on books that told you how to set automatic payroll deductions to index funds, and it became accepted wisdom. Buy and hold dominated my entire formative period of investment learning and I naively accepted it.

The main flaw in buy and hold is that one does not stop buying when markets become overvalued. Again because of my limited experience in not seeing enough market cycles, I genuinely believed a 17 p/e with a 2% yield and 2.4 p/b for a total market index fund was a reasonable deal. What a joke.

With last year’s change in market circumstances, Vanguard now has value index funds paying more than 3.5% yield. I never believed that was possible before because I had never seen it. The key I believe and I hope to be able to put it into practice is to stop buying index funds once they drop below a 3% yield (Because 3% is what I would like my funds to pay me for early retirement.) I think the psychological difficulty will come when I have to stop buying funds for what could be a couple of years at stretch because I genuinely find pleasure in buying funds.

Also, as another extreme saver, I really appreciate your idea that compound interest will not help extreme savers get to early retirement. Extreme savers must concentrate on building income-producing assets. I don’t think you can stop preaching that enough. One has to think radical thoughts to get to a radical goal.

I agree with your statement: the reason DCA or index investing would make you successful is primarily your discipline in continuously investing. It has nothing to do with the index of stocks as an investment. Logically, the index is only going to increase at about the rate of inflation, unless an equity asset bubble is going on. Now that we had a huge one of those, and it popped and is still deflating, we will have a generation of people who will not be looking to equities as some manna from heaven. I suspect the overall market will do little more than keep pace with inflation in the future.

Now, that is not to say there there are not investments within the equities universe whose *underlying business* will grow faster than than inflation. But that is another story. The stock market as a whole will at best match inflation over the next 10 to 20 years is my assumption going forward.

Very interesting link regarding the long term returns. I thought there was a ~26 year flat market in the USA (1926 ~ 1952 or so), why doesn’t show that show up? Maybe there was deflation? Also I’m surprised that Japan (over the past ~25 years) doesn’t show up when adjusted for inflation.

I haven’t analyzed my earlier retirement funds and their performance, but it is easy to look at the last 4 yr. I have maxed my contributions to my SEP IRA, making the contributions when the money is available and not trying to time the market.

The value of that investment (in a Vanguard target retirement fund) as of October 31 was 24% less than the amount I contributed.

Obviously, I would have been better off putting the money in a money market account and earning whatever piddly interest they pay; however, who knows what will happen to the money I invest over the next 4 yr? If things are truly cheap now, then I will outperform the money market and possibly even recoup the losses from the last 4 yr.

I love your statement that “Investing is the process of spending savings to purchase something of value to increase future returns”. I’ve never thought of investing as spending before.