Valuations matter. It’s not a controversial statement. I think it should be. If the market were efficient (which it would need to be for Buy-and-Hold to be a good strategy), valuations would not matter at all. There was a fellow who posted by the name of “SalaryGuru” at a number of discussion boards at which I participated, who often made the case that valuations do not matter at all. I respected him for that. I didn’t agree with him; I believe that valuations matter a great deal. But I admired him for his intellectual integrity. Buy-and-Holders should not be paying any attention to valuations whatsoever. SalaryGuru was a true believer and had the courage to publicly make the case for his beliefs when they were challenged.

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SalaryGuru was the exception, however. Most Buy-and-Holders acknowledge that valuations matter. The most commonly expressed view about valuations that I hear from Buy-and-Holders is that investors should expect lower returns on a going-forward basis at times when valuations are high. Few Buy-and-Holders will say that investors should lower their stock allocations at such times. But most will say that it makes sense to anticipate somewhat lower returns at such times.

This is why I am not a Buy-and-Holder. My thought is that each asset class available to an investor should be considered in relation to all the other options. All else being equal, stocks are less appealing at times when the expected return provided is smaller. So an investor who determined that his stock allocation should be 80 percent at a time when he expected stocks to offer a long-term average return of 6.5 percent real should be going with a stock allocation of something less than that at a time when valuations have risen enough to cause him to expect a long-term average return of a good bit less than that. The lowering of the return changes the risk/reward trade-off. The investor seeking to keep his risk profile roughly stable over time MUST lower his stock allocation at times of sky-high valuations to have any hope whatsoever of achieving that goal.