I think your link is bad….

I just read that paper from Faber a couple weeks ago. You can see my thoughts on it in my reply to Retirement Savior’s bringing it up here.

Regarding Buy and Hold vs. other strategy: something that ties in with trend following (which is my favourite non-predictive investment philosophy) and Buy and Hold is the Buy and Hold Asset Allocation “Timing” by Mebane Faber. It is really worth looking into it as an alternative investment method available for all kinds of traders. It basically identifies when the trend is up in a specific asset class and buys and holds it (the timing is done on a monthly basis and only generates very few trades – hence the resemblance to Buy and Hold – but it gets you out as the trend reverses and could crash).

He has a paper out on his website (a quick google of “Mebane Faber + asset allocation” should do it) and I would recommend you take a look at it.

Cheers
Jez

Thanks for the reading suggestion. I’ll add it to my list.

My own preference of buy & hold indexing is based on:

1. the evidence that there’s a lack of investment professionals who consistently beat the market, and
2. the fact that I have far less resources at my disposal than the pros do.

For me, those are the only two pieces of information I truly need.

Admittedly, I’m fascinated by discussions of the reason for point #1. But regardless of the reason for the phenomenon, the phenomenon is still there, and I’m comfortable investing accordingly. (Or rather, I’m more comfortable investing accordingly than I’d be investing in any way that presupposes a contradictory phenomenon.)

…what dinner parties do you attend? If I used the words “Modern Portfolio Theory” at any of the ones I go to, I don’t think I’d have many people to chat with!

I realize now that my comments were directed at you but I meant them of course as a general question for all of us trying to make sense of this very important question…I know that you are very thoughtful about this stuff.

A few more comments:

[3] I would highly recommend actually reading Mandelbrot’s “The Misbehavior of Markets”. Very, very insightful.

[4] The core reason that most people view Indexing or passive investing as a good “strategy” is because of MPT and The Efficient Market Hypothesis.

Thanks again for the civil discussion…like a great dinner party.

1) One reason I’ve never particularly liked that analogy: Leaning down to check out a bill on the ground hardly incurs any risk. Changing your investment strategy does (or could). That said, be my guest and lean down to check it out if you’d like. As I mentioned, there are several other ways a person could invest that I’d find reasonable. I’m simply not convinced that any of them are better.

2) My copies of Taleb’s books and my notes on Fooled by Randomness. (I couldn’t readily find my notes on Black Swan. I wasn’t as impressed with it as by Fooled, so I don’t reference them very often.) Yes, I watched the Mandelbrot interviews.

3) All I know about it is what Mandelbrot briefly mentioned in said interviews. Do you have any other suggested references?

4) I’m not arguing in favor of market efficiency or any other model of how the markets work. I’m arguing in favor of a strategy. I don’t see buy & hold indexing’s success as being dependent upon market efficiency or MPT.

5) I’m all for looking at alternatives.

Edited to fix the link tag and to clean up my own grammatical sloppiness.

Very well written post. This is what we need more of, people with different views discussing them without going after each other.

A few points:

[1] This conversation reminds me of the story of the university finance professor walking across campus with a student. They came upon a $20 bill on the ground, as the student went to pick it up, the professor said “don’t bother, if it was a real $20 bill someone else would have picked it up long ago”.

I think that it is time that we at least lean down to see if it is real….

[2] Did you actually read Taleb’s book or just what other said about it? Did you watch the Mandlebrot interviews?

[3] If you don’t know about Louis Bachelier’s contribution to MPT you need to. This is really the guy that first has the idea that returns and risk could be modeled in a bell-shape based on his observations or how heat traveled through metal and how molecules move (brownian motion). So the entire foundation is built on what Louis started…it might be worth understanding…

[4] A lot if us hang on to MPT, Buy & Hold, based on the argument that there is nothing better. I am just suggesting that we forget about the solution for a moment and judge the current model on its own merits. Just because you may not have a better model DOES not make the current one correct.

[5] I want to be clear: I am not saying that buy & hold, indexing, or MPT are wrong or dead. I am just suggesting that we look at alternatives, understand the math, and judge them against reality, and maybe at least bend down and look at the $20 bill FOR OURSELVES.

Just a few things I have been thinking about

Great question regarding what makes an investment strategy “better.” My first answer would be “higher expected risk-adjusted returns.” But the more I think about it, the more I realize that’s not a complete answer. I’d also include simplicity. If an investor cannot fully understand a strategy, or finds it to be difficult to implement, he or she is unlikely to execute it properly over an extended period.

As to how much value I place on what other people say: If William Bernstein, for instance, were to write something explaining why he’d given up on buy & hold indexing, it would certainly get my attention, and I’d certainly take a look at his new proposed strategy. But if I wasn’t fully convinced, I’d stick with what I believed in. (I imagine this is analogous to your own situation.)

Regarding the Prudent Man Rule: Maybe there’s something to it that I’m missing, but I’ve never found it to be very useful. It seems to me that everybody will interpret it differently. As I read it, it’s practically a mandate for buy & hold indexing. I’m sure you read it quite differently.

Another strategy which is based on the fact that markets have fat-tails and that you can not predict them (i.e. ) is Trend Following: just notice when a trend starts going up or down, and ride it until it finishes. The majority of the trades will cancel each other out (ie randomness of markets) but the big over-shooting ones (i.e. resulting from Black Swan events) will generate a positive return for the strategy.
You can see on my last blog post for example (quite timely: http://www.automated-trading-system.com/trend-following-wizards/ ) a collection of trend following wizards that have consistently outperformed the market – without doing any prediction at all… Just riding the trend!

-Jez