Wednesday, 10 February 2010

Warren Buffett's Long-term timing of the market and the Rational Investing Model

I recently posted:

New Investing Idea: The Rational Investing Model is the alternative to the Buy-and-Hold Investing Model

and pleasantly received a reply from the author of the above article:

Rob Bennett said...

This is Rob Bennett, author of the Google Knol on "Why Buy-and-Hold Investing Can Never Work." Thanks for sharing some of the ideas set forth in the Knol with your readers, BullBear. If you or others have questions, I'm happy to help out to the extent that I am able. Rob

My comments:

Thanks Rob for allowing me to share your article in my blog.

Buy and hold strategy is safe for selected stocks.  Those using this strategy should be stock pickers; having only good quality companies in their portfolios and only buying them when their prices are obviously at bargain or fair prices.  Over the short term, the returns will be volatile, but over the long-term the returns on these investments will be predictably positive reflecting their fundamentals.

Though incorporating a long-term market timing based on valuation of the market may increase returns, like any market timing strategy, it may also impacts negatively on the returns too.

However, there are the very few periods when market timing can be usefully employed with a high degree of confidence and conviction.    Those with a good understanding of the valuation of the stock market can  employ this infrequently to their benefit when the valuations of the markets are obvious at the extremes.  Warren Buffett had done this on a few occasions in his very long investing lifetime.  In other periods (the majority of the time), buy and hold for the long term is safe and it works (my personal testimony), but for selected stocks only bought at bargain or fair prices. 

Investors would be impressed that Warren Buffett did make adjustments to his allocations to equities at certain periods during his long investing career.  These adjustments were based on valuations of the stocks and the market.  There were periods his exposure to equities were low when he felt the market was overpriced.  At one stage, he returned cash to all his investors as he could find no value in equities to justify continuing investing their money in stocks.  And there were the few occasions when Warren Buffett saw deep values in stocks and invested heavily, usually at the bottom of bear markets.  Yet, these were the times when other investors were most fearful.

What Warren Buffett did was essentially quite close to what Rob Bennett has written:

The Rational Investing Model encourages investors to take price (valuations) into consideration when setting their stock allocations.

Though we often hear only his "buy and hold forever" mantra, Warren Buffet has in fact been cleverly employing the equivalent of THE RATIONAL INVESTING MODEL, incorporating long-term market timing based on valuation of the market in his allocation of his money to stocks. 

The links below documented these actions by Warren Buffett:

*****Warren Buffett's commonsense approach to valuing the stock market

Buffett's success in gauging market conditions and profiting from them

Buffett: Keeping abreast of market conditions

*****Buffett's Shrinking Portfolio of the 1980s (1)

*****Buffett's shrinking portfolio of the 1980s (2)

Also read:

and this:

A Better Approach to Investing from Rob Bennett of A Rich Life
I'd like to introduce you to a very solid approach to investing from Rob Bennett, author of A Rich Life. His investment approach has been given many names (the one I use for it is dynamic asset allocation). The principles are sound and over the long run, it will serve to reduce overall risk in your portfolio while providing more than adequate returns when compared to static or strategic asset allocation methods. To learn more, read on...


investbullbear said...

Rob Bennett said...

Though we often hear only his "buy and hold forever" mantra, Warren Buffet has in fact been cleverly employing the equivalent of THE RATIONAL INVESTING MODEL, incorporating long-term market timing based on valuation of the market in his allocation of his money to stocks.

That's precisely correct (in my view!), BullBear.

Buffett's Value Investing is the best investing approach. There's only one problem with it. It requires more work than the typical middle-class investor is willing to put into the investing project.

Bogle's Buy-and-Hold has the benefit of simplicity. So it almost offers a means for middle-class investors not willing to do the research that must be done to make the Buffett approach work to participate in the benefits of stock investing. One of my favorite book titles is "How I Almost Made a Million." Adding the word "almost" to a declarative sentence changes the message being conveyed.

Unfortunately, Bogle made a big mistake. He neglected to incorporate a valuations component into the model. As a result, his model in practice is the opposite of Buffett's model. Buffett has people investing in great value propositions and holding them until they pay off. Bogle has people investing in horrible value propositions and refusing to acknowledge the error no matter how much wealth they destroy by doing so.

I recommend a melding of the Buffett and Bogle models. We need the simplicity of Bogle's approach. But it must work in the real world or middle-class investors will reject it after it destroys them. The way to make the Bogle approach workable for regular people is to incorporate a valuations element to it. That's Valuation-Informed Indexing.

Investing can be simple as pie for those who invest in indexes. And indexes can provide solid long-term returns. But none of the magic happens unless you are willing to look at the price of the stocks you are buying before putting money on the table. Holding makes sense when the thing you are holding represents a strong long-term value proposition. When the thing you bought offers a poor long-term value proposition, holding in the face of all the evidence that you have made a terrible mistake is the worst strategy of all.

I recommend Value Investing for the sophisticated investor and Valuation-Informed Indexing for the typical middle-class investor. My take is that Buffett and Bogle go together like chocolate and peanut butter!

February 11, 2010 6:49 AM

I have reposted here in the right forum.

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