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STOCKS FOR THE LONG RUN:
A Guide to Selecting Markets for Long Term Growth
by Jeremy J. Siegel
Reviewed by Frederic G. Marks
How does an investor achieve high returns with low risk? This is the central question for people with serious money to invest, such as retirement savings, proceeds of sale of a business, or an inheritance.
All too frequently, when asked to review someone's investments, we see sizable accounts holding 90% or more in bonds, bond funds, and mortgage backed securities such as GNMAs, a form of bonds. This is the typical portfolio of many sensible, careful people who are averse to risk. It is also a big mistake to invest this way if you are investing for the long term, according to Stocks for the Long Run, by Jeremy Siegel, a professor of finance at the Wharton School of the University of Pennsylvania. Dr. Siegel explains:
[In 1991] began to research the returns on financial assets to determine whether stocks did realize superior returns for the long term investor. My examination into nearly two centuries of financial data reveals [that/ although stocks are certainly riskier than bonds in the short run, over the long run the returns on stocks are so stable that stocks are actually safer than either government bonds or Treasury bills.The constancy of the long-term, after-inflation returns on stocks was truly astounding, while the returns on fixed-income assets posed higher risks for the long term investor. This is because bondholders can never be compensated for unexpected inflation, a factor that cannot be ignored in our world of paper money.
Siegel found that stocks provided returns at least 5% higher than inflation, and higher than cash or bonds in 99.4% of the "rolling" 30-year periods from 1802 through 1992; since 1871 stock returns were higher than cash and bond returns in every rolling 30-year period.
How long does one have to invest so that it is virtually certain one's stock portfolio will do better than cash or bonds? To answer this question Siegel examined all holding periods of 1, 2, 5, 10, 20, and 30 years from 1802-1992. Siegel found that the longer the holding period, the more likely stocks were to perform better than both cash and bonds. The only 30-year periods in which bonds or cash did better than stocks were before 1871. Since 1871 stocks did better than cash or bonds in every one (100%) of the ninety 30-year periods.
Since 1931 there have been a few holding periods of 10 years when stocks did less well than cash or bonds, but even then if the holding period were extended to 11 or 12 years, stocks again surpassed cash and bonds. Thus, for holding periods of 10 to 12 years there is little risk in stocks, compared to bonds or cash; and for holding periods of 20 years or more there is almost always less risk in stocks than in cash and bonds.
Stocks for the Long Run is much more than a compendium of statistics about stocks and bonds. Siegel also (1) explains why stocks do better than bonds, (2) provides a valuable discussion of the economics, politics and psychology of investments, and (3) concludes with practical guidance for the implementation of a sensible investment program built on common stocks.
Professor Siegel explains that stocks do better than bonds and cash because it is more rewarding to own a profitable business than to lend money, which is what bond and cash investors do.
The stock market has been called the world 's greatest casino, . . . but [it] ~s far more than a game of chance. Stocks represent claims on the profits of the world's productive enterprises which provide the goods we consume and which drive growth and innovation .... Although stocks are legally just the residual claim on the firm after all creditors are satisfied, stocks turn out to be much more than that. The returns to equity are the returns to entrepreneurship which motivate production and growth. Perhaps that is why stock returns transcend the radical political, economic, and social changes that have impacted the world over the past two centuries.
Perhaps the most informative chapters in Stocks for the Long Run deal with the economic environment for investment, including the role of money; how the laws of Congress and the operations of the central bank (the Federal Reserve) cause inflation; and how and why stock prices are affected by business cycles, war and peace, and the continuous flow of economic data.
Siegel provides insight about the psychological effects of the 1929 stock market crash and ensuing Great Depression: people overreacted to these events for an entire generation. Until the mid- 1950s the fear of the risk in stocks depressed stock prices to extreme levels of undervaluation and raised bond prices to extreme overvaluation.
Today, however, the events of 1929-41 are only a lesson in a history book for most investors; they ignore the risk of a possible decline in stocks similar to the 1929-32 debacle or the lesser, but still major decline of 1973-74 when the S & P 500 had a negative total return of minus 42% over 21 months. Instead they focus on (1) stocks as a hedge against the risk of inflation, which devastated bond prices and raised interest rates for 30 years (195080), and (2) the bull market returns from stocks since World War II.
However, stock prices now are high in terms of historic parameters of valuation. E.g., the bull market of the 1950s started in mid-1949 when the aggregate cash dividend on stocks in the Dow Jones Industrial Average (DJLA) was 7%, while U.S. Treasury Bonds were paying interest of only 2.5%. Currently, the relative values of stocks and bonds are exactly the reverse of 1949. With the DJIA at 4200 its aggregate cash dividend is only 2.6%, while the interest on long-term Treasury bonds is over 7%.
In 1929 the DJIA peaked at 30.5x its dividends; the bear market of 197374 started when the DJIA peaked at 32.5x its dividends; the 1987 crash followed the DJIA reaching a level 35.8x its dividends; today the DJLA is at an all-time record of 38.4x its dividends.
Therefore, while investors must heed the central message of Stocks for the Long Run, it would be foolish to put all of one's money into the stock market at current prices. Rather, investors should cultivate the discipline of value investing by learning how to identify individual companies of high quality, and by waiting to buy until normal market stock fluctuation brings the prices of individual companies' shares down into the range of good value for the money to be invested. This is the discipline that helped Warren Buffett to become the most successful stock investor on record.
Stocks for the Long Run: A Guide to Selecting Markets for Long Term Growth, by Jeremy J. Siegel. Irwin Professional Publishing (1994), 318 pp. $25.00.
Reprinted with permission from Investment Values, Issue #35, July 1995, 1995, published quarterly by Frederic Marks Capital Management, subscription $25.00. 10573 West Pico Blvd., Box 854, Los Angeles, CA 90064; (310) 558- 3942.
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