Jeremy J. Siegel - Stocks for the Long Run 5/E: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies

STOCK RETURNS
Past, Present, and Future

THE VERDICT OF HISTORY

HOW THE ECONOMIC ENVIRONMENT IMPACTS STOCKS

STOCK FLUCTUATIONS IN THE SHORT RUN

BUILDING WEALTH THROUGH STOCKS

The new-era doctrinethat good stocks (or blue chips) were sound investments regardless of how high the price paid for themwas at the bottom only a means of rationalizing under the title of investment the well-nigh universal capitulation to the gambling fever.

BENJAMIN GRAHAM AND DAVID DODD, SECURITY ANALYSIS

Investing in stocks has become a national hobby and a national obsession. To update Marx, it is the religion of the masses.

ROGER LOWENSTEIN, A COMMON MARKET: THE PUBLICS ZEAL TO INVEST

Stocks for the Long Run by Siegel? Yeah, all its good for now is a doorstop.

INVESTOR CALLING INTO CNBC, MARCH, 2009

In the summer of 1929, a journalist named Samuel Crowther interviewed John J. Raskob, a senior financial executive at General Motors, about how the typical individual could build wealth by investing in stocks. In August of that year, Crowther published Raskobs ideas in a Ladies Home Journal article with the audacious title Everybody Ought to Be Rich.

In the interview, Raskob claimed that America was on the verge of a tremendous industrial expansion. He maintained that by putting just $15 per month into good common stocks, investors could expect their wealth to grow steadily to $80,000 over the next 20 years. Such a return24 percent per yearwas unprecedented, but the prospect of effortlessly amassing a great fortune seemed plausible in the atmosphere of the 1920s bull market. Stocks excited investors, and millions put their savings into the market, seeking quick profit.

On September 3, 1929, a few days after Raskobs plan appeared, the Dow Jones Industrial Average hit a historic high of 381.17. Seven weeks later, stocks crashed. The next 34 months saw the most devastating decline in share values in U.S. history.

On July 8, 1932, when the carnage was finally over, the Dow Industrials stood at 41.22. The market value of the worlds greatest corporations had declined an incredible 89 percent. Millions of investors life savings were wiped out, and thousands of investors who had borrowed money to buy stocks were forced into bankruptcy. America was mired in the deepest economic depression in its history.

Raskobs advice was ridiculed and denounced for years to come. It was said to represent the insanity of those who believed that the market could rise forever and the foolishness of those who ignored the tremendous risks in stocks. Senator Arthur Robinson of Indiana publicly held Raskob responsible for the stock crash by urging common people to buy stock at the market peak.

Conventional wisdom holds that Raskobs foolhardy advice epitomizes the mania that periodically overruns Wall Street. But is that verdict fair? The answer is decidedly no. Investing over time in stocks has been a winning strategy whether one starts such an investment plan at a market top or not. If you calculate the value of the portfolio of an investor who followed Raskobs advice in 1929, patiently putting $15 a month into the market, you find that his accumulation exceeded that of someone who placed the same money in Treasury bills after less than 4 years. By 1949 his stock portfolio would have accumulated almost $9,000, a return of 7.86 percent, more than double the annual return in bonds. After 30 years the portfolio would have grown to over $60,000, with an annual return rising to 12.72 percent. Although these returns were not as high as Raskob had projected, the total return of the stock portfolio over 30 years was more than eight times the accumulation in bonds and more than nine times that in Treasury bills. Those who never bought stock, citing the Great Crash as the vindication of their caution, eventually found themselves far behind investors who had patiently accumulated equity.

The story of John Raskobs infamous prediction illustrates an important theme in the history of Wall Street. Bull markets and bear markets lead to sensational stories of incredible gains and devastating losses. Yet patient stock investors who can see past the scary headlines have always outperformed those who flee to bonds or other assets. Even such calamitous events as the Great 1929 Stock Crash or the financial crisis of 2008 do not negate the superiority of stocks as long-term investments.

is the most important chart in this book. It traces year by year how real (after-inflation) wealth has accumulated for a hypothetical investor who put a dollar in (1) stocks, (2) long-term government bonds, (3) U.S. Treasury bills, (4) gold, and (5) U.S. currency over the last two centuries. These returns are called total real returns and include income distributed from the investment (if any) plus capital gains or losses, all measured in constant purchasing power.

FIGURE 1-1
Total Real Returns on U.S. Stocks, Bonds, Bills, Gold, and the Dollar, 1802-2012

These returns are graphed on a ratio, or logarithmic scale. Economists use this scale to depict long-term data since the same vertical distance anywhere on the chart represents the same percentage change. On a logarithmic scale the slope of a trendline represents a constant after-inflation rate of return.

The compound annual real returns for these asset classes are also listed in the figure. Over the 210 years I have examined stock returns, the real return on a broadly diversified portfolio of stocks has averaged 6.6 percent per year. This means that, on average, a diversified stock portfolio, such as an index fund, has nearly doubled in purchasing power every decade over the past two centuries. The real return on fixed-income investments has averaged far less; on long-term government bonds the average real return has been 3.6 percent per year and on short-term bonds only 2.7 percent per year.

The average real return on gold has been only 0.7 percent per year. In the long run, gold prices have remained just ahead of the inflation rate, but little more. The dollar has lost, on average, 1.4 percent per year of purchasing power since 1802, but it has depreciated at a significantly faster rate since World War II. In we examine the details of these return series and see how they are constructed.

I have fitted the best statistical trendline to the real stock returns in . The stability of real returns is striking; real stock returns in the nineteenth century do not differ appreciably from the real returns in the twentieth century. Note that stocks fluctuate both below and above the trendline but eventually return to the trend. Economists call this behavior mean reversion, a property that indicates that periods of above-average returns tend to be followed by periods of below-average returns and vice versa. No other asset classbonds, commodities, or the dollardisplays the stability of long-term real returns as do stocks.

In the short run, however, stock returns are very volatile, driven by changes in earnings, interest rates, risk, and uncertainty, as well as psychological factors, such as optimism and pessimism as well as fear and greed. Yet these short-term swings in the market, which so preoccupy investors and the financial press, are insignificant compared with the broad upward movement in stock returns.