I like the book Stocks for the Long Run. It is a book focused on long-term buy-and-hold investing. I think that long-term buy-and-hold investing is where it’s at.
It’s a book that relies on analyses of the historical stock-return data to determine what strategies work best in the long term. Again, I think that that approach is on the one. Valuation-Informed Indexing too is an approach rooted in a study of what the historical stock-return data tells us about how to invest successfully for the long term.
It’s certainly been proven an influential book. Stocks for the Long Run isn’t just a book, really. It’s a phrase that calls to mind a powerful idea. Money magazine published an interview with Jeremy Siegel which described him as “the intellectual godfather of the 1990s bull market” and which said that “his 1994 book Stocks for the Long Run sealed the conventional wisdom that most of us should be in the stock market.”
The powerful idea at the core of Stocks for the Long Run is that stock investing becomes less risky with time. That’s a profound truth, especially for middle-class investors (the investor group most concerned about the risks of owning stocks).
The other side of the story is that Stocks for the Long Run is chock full of analytical errors. There’s a whole big bunch of sloppy thinking in evidence in the pages of this text. The errors have had at least as much of a negative influence on investors as the insights have had a positive one. The same book that helped millions accumulate tubfulls of wealth in the 1990s is in all likelihood going to cause millions to lose tubfulls in the not-too-terribly-distant future. This is a dangerous book.
Stocks for the Long Run is an insightful book. Stocks for the Long Run is an influential book. Stocks for the Long Run is a dangerous book. All three things are so.
This article points out the worst of the analytical errors made in the book so that you can avoid the traps likely to do harm to investors who place their confidence in the book’s highly popular (for now) but also highly dubious “findings” about how stocks perform in the long run.
Dubious Claim #1 (Page 22 of Stocks for the Long Run) — “The superiority of stocks to fixed-income investments over the long run is indisputable.”
Is there something in you that makes you want to question an investing claim that someone puts forward as “indisputable”?
If you classify Treasury Inflation-Protected Securities (TIPS) as fixed-income investments (most think of them as a type of fixed-income investment, although the return provided varies with changes in inflation), Siegel’s claim here is false.
I own 30-year TIPS paying a real return of 3.5 percent. William Bernstein has calculated the expected long-term return of stocks purchased at extremely high prices at 3.5 percent real. An investment class that provides 3.5 percent real without risk is superior to an investment class that provides 3.5 percent real by requiring the investor to take on a good bit of risk.
You cannot buy TIPS paying 3.5 percent real today. But a strong argument can be made that Siegel’s claim remains false. Bernstein’s 3.5 percent number is rooted in an assumption that stocks will remain at the absurdly high prices that apply today indefinitely into the future. Assume that stocks will perform in the future at least somewhat as they always have in the past, and today’s TIPS return beats today’s most likely 10-year stock-return number. Stocks will likely do better going out 20 years, but probably not by enough to make up for the added risk taken on in owning them. It is only when you go 30 years out that stocks purchased at today’s prices appear superior. Few of us own investments solely for what they will do for us 30 years out.
Siegel got it wrong.
Dubious Claim #2 (Page 26 of Stocks for the Long Run) — “For many investors, the most meaningful way to describe risk is by portraying a ‘worst case’ scenario…. The fact that stocks, in contrast to bonds or bills, have never offered investors a negative real holding period return yield over periods of 17 years or more is extremely significant.”
Siegel is here playing the same conjurer’s trick that is employed in conventional-methodology safe withdrawal rate studies. He is right that many of us want to know what can happen to our money in a worst-case scenario. For obvious reasons. It is only by knowing what happens in a worst-case scenario that we can plan for the future (hoping that a worst-case scenario will not turn up but structuring our plans so that we can “get by” even if one does). However, the analytical approach employed by Siegel does not reveal how stocks will do in a worst-case scenario.
The approach he follows is to look at all 20-year holding periods in the historical record and refer to the one yielding the worst result for stockholders as the “worst case.” It is of course accurate to say that this is the worst case historically. But Siegel makes clear that the purpose of his analysis is to inform investors as to what is the worst-case scenario that they are likely to face in the future. This he does not do.
There have been few times in the historical record in which stocks have been at the valuation levels that apply today. Stocks have historically performed far worse at times of high valuations than they have at times of low or moderate valuations. Siegel errs in concluding that it is “extremely significant” that stocks have never provided a negative real return over 17 years. The primary reason why that is so is that there have been so few cases in the historical record in which stocks have been as overpriced as they are today. With so few tests of the 17-year rule for purchases made at these valuations (which are the only sorts of valuations at which the 17-year rule is exposed to a serious test), this finding is little more than an historical curiosity.
Siegel’s core point — that stocks become far less risky when held for long time-periods — is important and true. He exaggerates the extent to which this is so by placing too much confidence in the results obtained in the tiny number of cases in which stocks have been at today’s price levels. The impressive thing is not that there has never been a negative return over a 17-year time-period. The impressive thing is that, with so few relevant cases on record, stock investors have already been placed in circumstances in which they had to wait 17 years for a positive return. That’s disturbing news indeed for those going with high stock allocations today.
There’s a good chance that the 17-year rule will be broken sometime around the Year 2017. A regression analysis of the historical stock-return data reports that the worst-case 20-year return for those buying stocks at today’s prices is a negative 1.4 percent. There was a greater than 20 percent chance of a negative return over 20 years for those who invested in S&P stocks in January 2000. At that time, the most likely return over 20 years was only 1 percent real.
Jeremy Siegel got it wrong.
Dubious Claim #3 (Page 30 of Stocks for the Long Run) — “There is no compelling reason for long-term investors to significantly reduce their stockholdings, no matter how high the market seems.”
I’d bet $7.25 that Jeremy Siegel lives to eat those words.
Buy-and-hold investing is what works. There is no worse mistake you can make than to sell when prices are low. The investor who maintains the same stock allocation when prices are sky-high as he does when prices are at low or moderate levels all but insures that he will be forced to sell when prices are low. Siegel here is dooming many of his readers to failed buy-and-hold strategies.
The average price drop that we have seen on the three earlier occasions when prices got to the la-la land levels where they reside today is 68 percent. For an investor with a 30 percent stock allocation, that’s an overall portfolio loss of about 20 percent. Some middle-class investors might be able to take a hit of that size without selling. Few can take a hit much bigger than that without selling.
Is Siegel arguing that we should never go with stock allocations of greater than 30 percent? Surely not. At moderate valuations, the historical stock-return data can be used to make a case for a stock allocation of as high as 75 percent (I tentatively recommend a stock allocation of about 50 percent at times of moderate valuations). To limit your stock allocation to 30 percent at all times would be to leave large amounts of money on the table.
However, to go higher than 30 percent at times of high valuations would be to take on a big risk of selling when prices are down, the worst thing you can do. Investors should be lowering their stock allocations when prices go sky-high.
Siegel got it wrong.
Dubious Claim #4 (Page 30 of Stocks for the Long Run) — “If investors can identify peaks and troughs in the market, they can outperform the buy-and-hold investor. But, needless to say, few investors can do this.”
Siegel does not believe in long-term timing. But it is the same historical stock-return data that he uses to find supports for the things he believes in shows that long-term timing (unlike short-term timing) works.
One reason why long-term timing works is that there is no need for the long-term timer to “identify peaks and troughs.” Who cares what the peak is? Who cares what the trough is? That is the sort of thing that concerns (and trips up) short-term timers.
My sense from his words here is that Jeremy Siegel has never seriously examined the long-term timing option. If that is so, he should not be making the sort of statement that he makes above. Many investors have been misled by this sort of claim, and, in the event that stocks perform in the future anything at all as they always have in the past, many will be hurt in days to come by the misunderstanding of the realities that it encourages.
Jeremy Siegel got it wrong.
Dubious Claim #5 (Page 30 of Stocks for the Long Run) — “As difficult as it is to sell when stock prices are high and everyone is optimistic, it is more difficult to buy at market bottoms.”
Siegel is here suggesting that those who go with high stock allocations when prices are high will be able to avoid selling when there is a big price drop, but that those who took money out of stocks in anticipation of the wonderful value propositions that will open to them when prices fall will be so shook up by the price drop that they will be paralyzed into not following through with their plans.
Someone is going to be buying stocks when prices fall hard, right? There’s a buyer and a seller for every transaction.
Who is more likely to buy — the investor who has been wiped out by the price drop or the investor who has experienced only a small hit because he acted on what he learned from the historical stock-return data about how valuations affect long-term returns? The question should answer itself. When those who ignore valuations are anxious to sell, those who pay attention to valuations will be excited to buy. Not buying when prices are too high is the best indicator of an ability to buy when prices are outstanding.
Jeremy Siegel got it wrong.
Dubious Claim #6 (Page 37 of Stocks for the Long Run) — “Based on the historical returns on stocks and bonds…conservative investors should have nearly 90 percent of their portfolio in stocks, while moderate and aggressive investors should have over 100 percent in equity. This allocation can be achieved by borrowing or leveraging an all-stock portfolio.”
And I hear on discussion boards from time to time that my investing advice is “loony and irrational”!
I mentioned above that 68 percent is the size of the average loss experienced on the three earlier occasions when we traveled to today’s la-la land valuation levels (this article was written in December 2006). Do you want to know how Siegel gets his super-duper calculator to generate “findings” like those quoted above? He assumes that no one sells when he or she experiences a 68 percent price drop!
Do you know anyone who would not sell stocks after experiencing a 68 percent price drop? Neither do I. My strong hunch is that neither does Siegel.
He didn’t let that stop him from writing the words quoted above, however. Siegel spent many, many years engaged in schoolbook learning. Every now and again, it shows.
Jeremy Siegel got it wrong.
Dubious Claim #7 (Page 81 of Stocks for the Long Run) — “To imply that these historical yardsticks [the reference is to valuation assessment tools] constitute the “right” or “fair” value for stocks also implies that the historical returns to equity have been “right” or “fair” to the shareholder. But since stock returns have far exceeded the returns on other financial assets, such a conclusion might not be justified. Higher valuations could occur as investors correctly recognize the superior returns on stocks.”
The four most dangerous words you will ever hear from an investing analyst are — “It’s different this time.”
Every time prices get out of hand, you can count on someone coming forward to tell us not to be concerned because it’s going to turn out different this time.
Every time that there are large numbers of investors who conclude that it’s going to turn out different this time, it ends up turning out the same as all the other times (with many of those investors swearing off stocks for life as a result of the “surprise” hit they endure).
One good thing you can generally say about academics is that they aren’t trying to sell you anything. In this passage, Siegel sounds to me less like an academic and more like a stock salesman.
Could it be different this time? Sure, anything could happen.
When I was a kid, I used to listen to Phillies games during an era in which they regularly lost close to 100 games per season. I used to imagine when they were only two or three runs down in the ninth that there was a good chance that Cookie Rojas would get a walk and that Johnny Callison would hit a line-drive single and that Richie Allen would put one over the wall. I would reassure myself: “It just might turn out different this time!”
I was twelve years old.
Jeremy Siegel got it wrong.
Dubious Claim #8 — (Page 192 of Stocks for the Long Run) — “When reviewing the causes of major market movements, it is sobering to realize that less than one-quarter can be associated with a news event of major political or economic import.”
This claim is true enough on its face. However, it appears that Siegel’s point in putting forward these words is to lead his readers to believe that stock returns are unpredictable. Stock returns are not unpredictable. Stocks returns are backed by the earnings of the underlying companies. U.S. companies have been generating profits large enough to support an annualized real return of about 6.5 percent real for a long time now. When the annualized return goes well above that for a substantial stretch of time (as it did in the 1980s and 1990s), look out below in the years that follow!
Siegel is right that it is a waste of time trying to figure out the causes of short-term price changes. He is wrong to suggest that we cannot understand the cause of long-term returns. If you are willing to assume that the U.S. economy will remain in the future roughly as productive as it has been in the past, you are able to predict (with a reasonable degree of accuracy) your long-term return from any of the various starting-point valuation levels.
Jeremy Siegel got it right, but put forward an unwarranted suggestion that understanding where long-term stock returns come from is a hopeless endeavor.
Dubious Claim #9 (Page 182 of Stocks for the Long Run) — “Individuals have a deep psychological need to find fundamental explanations for why the market is doing what it is doing. It is very discomforting for many to learn that most movements in the market are random and do not have any identifiable cause or reason.”
For good reason.
You betcha we feel a “deep psychological need” to understand why stocks behave the way they do. It’s our life savings that we put at risk when we invest in stocks. It sure would be nice to know why stock prices rise in crazy ways at some times and drop in crazy ways at other times.
Siegel is dismissive of investors’ desire to understand why stocks behave in the seemingly crazy ways they do. He wants us to accept his claims that stocks are always best and stop trying to figure out why.
That would be a terrible mistake for us to make.
The trick to successful investing is holding stocks for the long run. Only those who are confident in their investing choices can pull it off. Only those who understand how stock investing works can count on having the required amount of confidence when their strategies are not working out as they hoped.
Confidence matters. Understanding is the foundation of a lasting confidence.
Siegel got it wrong.
Dubious Claim #10 (Page 272 of Stocks for the Long Run) — “Most of us have no chance of being as good as the average in any pursuit where others practice and hone their skills for many, many hours. But we can be as good as the average investor with no practice at all.”
The average investor doesn’t obtain the sorts of long-term returns that Siegel points to in his book. Most of the long-term numbers presented in his book are mythical long-term numbers for most middle-class investors. To obtain those sorts of returns, you need to become a long-term buy-and-hold investor. It ain’t easy to do. It’s hard to do. Siegel doesn’t come close to revealing to us what it takes.
Siegel discusses a lot of numbers in his book. The numbers are important. Emotions are more important. Siegel discusses emotions hardly at all.
Siegel’s book is a product of the longest and strongest bull market in the history of the United States. It focuses on the easy side of stock investing — the numbers side. It all but ignores the hard side of stock investing — the emotions side.
Siegel got the focus wrong.
The Money article linked to above states that: “Stocks for the Long Run sealed the conventional wisdom that most of us should be in the stock market.” Let’s unseal it!
Let’s build on the genuine insights put forward in this book while avoiding the dangerous traps its sets for those of us seeking to become buy-and-hold investors not just on paper but in the real world too. Let’s build on what Jeremy Siegel got right while helping to enhance the middle-class investor’s gravely flawed understanding of the many important points that Stocks for the Long Run got wrong.