How We Ruined Our Economy – And How We Can Rebuild It

Beyond Buy-and-Hold

By Rob Bennett

Our economy is a mess.

<img class="alignright" src="http://www.favstocks.com/wp-content/uploads/cache/2010/08/e58bb-3051500551-b1fc3d3fe0-m.jpg" alt="" /Lots of people have expressed shock over what has happened. But there’s one group that is not even a little bit surprised. That’s the group that figured out a good number of years ago that the Buy-and-Hold Investing Model makes no sense. This group predicted the economic crisis a good number of years before it took place. This is the group that I think we should be listening to in trying to figure out how we can rebuild.

The premise of this new column (you’ll see it in this space each Wednesday morning) is that Buy-and-Hold has failed. Each column entry will examine a different principle of Buy-and-Hold Investing, explain why we now know that things don’t work in the way that the Buy-and-Holders say they do, and describe what those of us who believe in the Valuation-Informed Indexing Model (the alternative to Buy-and-Hold) believe instead.

The focus of this first column entry is — How Buy-and-Hold caused the economic crisis and how switching from Buy-and-Hold to Valuation-Informed Indexing will bring about a recovery.

The development of the Buy-and-Hold Model represented a huge advance in our understanding of how stock investing works. In earlier days, most investing analysis was rooted in subjectivity. One expert said one thing, another said another thing, and there was really no way for non-experts to know what to believe.

The pioneers of the Buy-and-Hold Model changed that by rooting their investing strategies in academic research and in the historical stock-return data. They made investing analysis objective. We all owe them our gratitude for doing so. We are going to be seeing huge economic growth in future years as a result of the courage and intelligence it took for them to take that step.

Unfortunately, the First Draft effort at developing an objective approach to investing contained a few eensy, teensy analytical boo boos. Humans! Whatchagonnado?

Where it all started

The mistake that ruined the pie was the one made by Chicago University Economist Eugene Fama. Fama believed that the market is automatically efficient. That means that investors, acting in their self interest, always set stock prices roughly where they ought to be