Buy-and-Hold is a price-indifferent strategy.

That’s a criticism. That’s a complaint. That’s a condemnation.

Most people don’t see it that way. Buy-and-Holders would not object to hearing their strategy described as price-indifferent. That’s a problem.

Shiller’s book is titled “Irrational Exuberance.” The first word of the term gives the game away. Irrational exuberance is not a good thing. As bad as it is, we all should be united in trying to put an end to it whenever it appears. You put an end to irrational exuberance by noticing when prices get too high and by uniting as a nation of people to pull them back down to reasonable levels. Um – hello, advocates of price-indifferent strategies!

Coping With The Irrational Exuberance Phenomenon

Stocks are a super investment class in theory. The businesses of this nation have historically created enough wealth for the owners of those businesses to enjoy an average annual return of 6.5 percent real. Sign me up!

However, there’s one aspect of the stock buying experience that is not so super. It’s all that darn price volatility. It’s scary. Every 40 years or so, we see a price drop so severe that millions of people lose a large portion of their accumulated savings of a lifetime.

The collective losses are big enough to bring on a recession and in one case even a Great Depression. If only stocks didn’t behave in such crazy ways!

There is nothing inherent in the nature of stocks that requires that they behave in such crazy ways. Shiller’s research shows that it is the owners of the stocks that behave in crazy ways, It is the owners that become irrationally exuberant. That’s the source of all the craziness.

So, once we learn how to cope with the irrational exuberance phenomenon, we have this stock investing thing licked. And it’s not terribly hard to figure out what we need to do. We need to stop being price indifferent!

Think of overvalued stocks as the cancer of the personal finance world. What would you say about a doctor who told you that he was indifferent to cancer, that he sometimes discovered it in his patients but that he did not tell them because he was concerned that it might make them feel bad.

Cancer is not something that we ignore, it is something that we cut out quickly. So it should be with irrational exuberance. Price indifference is not the way.

Bidding Stock Prices Up

Humans are always going to want to bid stock prices up above their fair-price level. Why wouldn’t they? Bidding stock prices up is like granting yourself a raise. What’s the downside?

The downside is that stock prices that are bid up because of irrational exuberance do not stay bid up. Stock gains that result from increases in economic productivity stay bid up. Those gains are real. It’s fine to be indifferent to those. In fact, we should be overjoyed and grateful about those. Those gains (gains of 6.5 percent real per year) are the gains that make stocks such a wonderful asset class.

But the irrational exuberance gains (gains of more than 6.5 percent real per year, gains that cause the CAPE value to go above 17) are a snare and a delusion. Those gains cause you to believe that you are richer than you really are.

You might spend more than you can afford to spend. You might save less than you need to save. You might retire earlier than you would want to retire if you were aware of the realities. Irrational exuberance gains eventually go “Poof!” and, when they do, millions of people suffer an ocean of misery. We could all do without those sorts of gains.

It wouldn’t be hard to bring those sorts of gains to a full and complete stop. Most people want to get good value for their money. We have 42 years of peer-reviewed research showing that stocks are just not as good a deal when they are overpriced as they are when they are properly priced. What if we told people just how big a difference there is in the value proposition of stocks when they are priced improperly?

The most likely annualized return for stocks when they are priced as they were in 1982 is 15 percent real. When stocks are priced as they were in 2000, the number is a negative 1 percent real. Do you think that telling people that would get the point across?

I do too.

People would not remain price indifferent for long once we told them what the research says, would they?

Good.

Price indifferent stock-investment strategies are stupid stock-investment strategies.To say that a stock investment strategy is price indifferent is an accusation, an insult, a warning.

Buy-and-Hold is a price-indifferent stock investment strategy.

Rob’s bio is here.