Own Stocks For The Long Run

by Todd Smith on 2010-08-159

Here is a more optimistic view of the state of the stock market by our contributing writer, Todd Smith, CFP. He shares some thoughts on long term investing strategies.

I have been around long enough to have heard many of the arguments for and against the stock market. And, depending on whom you talk to (i.e. real estate folks, bankers, etc.) and when you have the conversation, there is always something as, if not more, effective than investing in the equity markets. How true is that today?

Interestingly, I recently sat down with a banker at a local branch of one of the largest banks in the world. Discussing his career and aspirations (despite me turning a job down there) our talk transitioned to investing. Despite my explanations, brief as they may have been, he remained stuck on the notion that investing in equities was simply akin to sitting at the blackjack table. I am sure the CEO or any management member of his company would be mortified at such ignorance on the part of their employee. So, perhaps I expect more from someone who works in the financial industry even if that is not their particular forte. But honestly, any student of markets should know some indisputable facts about the long-term performance of the stock market. Such as the fact that historically, the stock market has outperformed any other asset class out there — yes, including real estate. This was something much harder for people to grasp when real estate was so “hot” a couple of years ago.

Own Stocks For The Long Run, Says Jeremy Siegel

Don’t want to take my word for it? How about listening to Jeremy Siegel, who’s a financial professor who teaches at Wharton (University of Pennsylvania). Dr. Siegel points out that most investors should think about putting their money in the stock market while having a buy and hold approach. This is pretty much the buy and hold strategy that has caused many a debate in this blog.

Jeremy Siegel first published a book in 1994 entitled “Stocks for the Long Run” and since then, despite the recent unsettling of markets, he has not changed his view. Frankly, it is nice to see and hear of someone that avoids thinking of today, tomorrow, and even next year. And, it’s nice for someone to actually show some hope for the future.

Aren’t there enough doomsday naysayers out there?

He truly is a student of markets and is convinced that while the stock market may have lower returns, long-term it is still one of the best places to be. Recently, he was quoted in the NY Times as saying, “it’s exactly times like this, when bearish sentiment has brought down valuations, that your chance of strong returns in the following years is greatest.” And Professor Siegel has also stated “to the contrary, the future is bright, and the possibility of a double-dip recession ‘minimal’.”

Professor Siegel thinks that “there is every reason to believe that mean reversion will continue” — so the expectation here is that even with the volatility we see in the markets over time, it is expected to yield average real returns (e.g. returns above the rate of inflation) that are more than 6% per year.

Long Term Ownership of Stocks: Historical Findings

In “Stocks for the Long Run”, Dr. Siegel’s analysis of the U.S. stock market covered historical data as far back as 1802 which pointed to the long term superiority of stocks over anything else. Interestingly, “long term” here actually refers to something longer than a couple of decades. If we decide to be a bit myopic and look at asset classes over 20 year periods, you’ll find that government bonds may have the advantage in terms of returns. But beyond that, stocks have done better as per Dr. Siegel’s studies.

He also explains that for those periods when stocks are undervalued (which you can measure via the market’s collective P/E ratio), then it’s much more likely to achieve positive returns in the following years. And if you’re going to apply that to today’s markets, we’re actually in undervalued territory. Do you believe it?

And if these averages hold true, then the market’s prospects should be pretty good. What does this mean? Stocks still have room to grow (again, as of this writing). The report in the NYTimes on this subject now purports that the likelihood of having positive returns via equities now stands between 95% to 100% if you’re looking at a long term timeframe. The claim? How does 11% over the next 2 decades sound?

So what do you think? Sounds too good?

Let’s look at the other side of the equation then. What about the big question: can we tell the future based on the market’s past behavior? Not necessarily, but what frame of reference do we have? Many state that the longer the time frame, the greater the uncertainty. We’re talking here about the possibility of dramatic unforeseen events that can throw a wrench on the markets and which may become more probable the longer the time frame. While this sounds like a decent counterargument, the fact is that all asset classes are subject to the same uncertainties, which evens the playing field for all classes on this particular matter. So in short, given all such exogenous factors and events which can hit all investment categories in virtually the same way, you can still expect stocks to perform better (or so Dr. Siegel says). It’s just as I have always believed, but I do not have the backing of Wharton on my side.

For more on investing in the markets, check out our articles on investing in ETFs and putting money in stocks and mutual funds.

Copyright © 2010 The Digerati Life. All Rights Reserved.

{ 9 comments… read them below or add one }

Echo August 15, 2010 at 3:19 pm

I loved this book when I read it, and while I know it’s hard for some people to believe that in the long run the stock market will continue to out-perform any other asset class, the statistics are hard to ignore.

If anyone has ever sat in the corporate boardroom of a good company, you would know that there are extremely intelligent people out there who will continue to add value to their organizations, which will streamline businesses, increase sales, and continue to drive profits for shareholders. They just won’t accept anything less.

Pop August 15, 2010 at 3:36 pm

Nice post. I think the problem with Siegel’s thesis starts with his data set.

Question one: Is 200 years of stock market returns a lot? Not really. If you look at 20-year returns, you only have ten sets of non-overlapping data to look at.

Question two: Even if you had lots of data, is there reason to think that returns could be “averaged” to reach a probably prediction of the future? Again, no. The U.S. grew from second-rate power to superpower in the last 150 years. Think we’re going to do it again?

Ste August 16, 2010 at 4:42 am

Have to agree with POP. 200 years of stock market returns isn’t a lot. Nice post anyway.

Rob Bennett August 16, 2010 at 5:02 am

My view is that Siegel’s book (“Stocks for the Long Run”) is both one of the most important investing books ever published and one of the most dangerous. Siegel points the way to taking the crazy subjectivity out of stock investing by looking at data. That’s the future. Unfortunately, he is hampered by his belief in the Efficient Market Theory, which causes him to report what the data says inaccurately.

I agree with the statement in the blog entry that Reversion to the Mean remains a reality. Where I disagree is in the suggestion that this is a good thing for people invested in stocks today. Stocks were overvalued by $12 trillion in 2000. We are in the process of seeing that $12 trillion disappear from our economy. That’s why we are in an economic crisis. On the three earlier occasions when we went to insanely high stock prices, Reversion to the Mean didn’t push us only back to fair prices but to prices one-half of fair value. That would mean another 60 percent price drop from where we are today. That would almost certainly put us in the Second Great Depression.

The mistake that we have made is to believe that the price we pay for stocks doesn’t affect the long-term return obtained from them. The entire historical record shows otherwise — price DOES matter. If price matters, we need to stop telling people that Buy-and-Hold is a reasonable strategy, that it is okay to stay at the same stock allocation even when prices go to insanely dangerous levels. There are limits to how much risk most middle-class people can afford to take on and those following Buy-and-Hold strategies have been investing far, far beyond their appropriate risk levels for 15 years now.

Stocks are the best investment class for the middle-class investor. We are going to recover from this crisis, even if it puts us in the Second Great Depression, which looks more and more likely the longer we avoid dealing with the real problems. When we bury Buy-and-Hold 30 feet in the ground, where it can no longer harm anyone, we will be able to restore some price discipline to the market and I believe that we will enter the greatest period of economic growth this country has ever seen. I just wish we could speed up the process of coming to terms with the realities. Each day of delay causes more human misery.


mike August 16, 2010 at 5:49 pm

Siegel not only recommended owning stocks, but he found that a class of stock outperformed: value stocks (he found that the best performing stock of the last 50 years wasn’t high growth IBM, but boring Philip Morris (now Altria)). This is akin to investing how a businessman would buy a company based upon cash flow, moat, margins and historical/future growth rates. Value investing usually comes with a higher level of income through dividends. So, you can make money investing every year no matter what the business cycle.

I have had good success investing this way, particularly throughout this Recession.

Ian Harvey August 17, 2010 at 5:24 am

Absolutely correct! It is a proven fact that the stock market, in the long term, certainly outpaces all other standard type investments.

I have taken this concept one step further over the past 10 years and basically trade options, only, within the stock market. This again, is far more beneficial and profitable then just owning stocks, but once again the risk is always higher if you are not geared correctly to this type of investment.

Still, the situation you had with the bank person and his outlook on the stock market as a blackjack table, the options trading is far less a risk than that as well. I love playing blackjack but it is certainly not a money-maker unless you are extremely lucky!

basicmoneytips.com August 18, 2010 at 4:35 am

Like most, I have become dis-enchanted with the stock market. However, that does not mean I have abondoned my investments in it. I think it needs to be one part of your investment wheel.

If you look at your portfolio today it is probably short of what you think it should be at retirement time. I think you need alternative investments to complement your stock portfolio – maybe rental property or fixed assets like treasuries.

Otherwise I will probably see you when I walk into Walmart in 20 years because you will be the greeter.

Jason August 18, 2010 at 5:03 pm

History shows us that investing in stocks for the long run is a smart move. We just completed the called “lost decade” where stocks closed the decade without valuation. That’s why more and more people are pessimists about the market and are talking about another “lost decade” that will occur again…
For me investing on the long term will always be a smart move. If you know what you’re buying of course. Without proper DD and lots of work, there’s no point in investing.

the neatest little guide to stock market investing August 19, 2010 at 6:44 am

I always buy a stock with a time horizon of six months to three years. for instance I bought citibank when it was dirt cheap, I know that three years from now it may be worth more than ten dollars a share. I bought at $2.50 a share.

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