Stocks for the Long Run.. a Myth? Part 2

[Doug]

I got this from a column by Madelaine Drohan at the Globe and Mail, who in turn got it from BusinessWeek magazine, who in turn got it from the book "Triumph of the Optimists" I don't know if it includes reinvested dividends. The link is as follows: http://www.businessweek.com/magazine/co ... al+finance. These are the longest periods of inflation adjusted negative stock returns by country:

US 16 years 1905-1920 negative 7% return
Britain 22 years 1900-1922
France 53 years 1900-1952
Germany 55 years 1900-1954
Japan 51 years 1900-1952
Italy 73 years 1906-1978

One can make the case that half these countries were not market democracies during the periods noted, and that war played a major role in low stock market returns. The following table of annual real returns, after inflation, is from wikipedia (?) ( http://en.wikipedia.org/wiki/Stocks_for_the_Long_Run ), which in turn states that it is from Jeremy Siegel. I don't know if it includes reinvested dividends.

Duration Stocks Stocks after tax Bonds Bonds after tax
1871-2001 6.8 5.4 2.8 1.8
1946-1965 10.0 7.0 -1.2 -2.0
1966-1981 -0.4 -2.2 -4.2 -6.1
1982-2001 10.5 6.1 8.5 5.1

An American retiring in 1966 had a bleak future ahead in the stock market; it was even bleaker in bonds.

[Icarus]

I don't know if it includes reinvested dividends.

Duration Stocks Stocks after tax Bonds Bonds after tax
1871-2001 6.8 5.4 2.8 1.8
1946-1965 10.0 7.0 -1.2 -2.0
1966-1981 -0.4 -2.2 -4.2 -6.1
1982-2001 10.5 6.1 8.5 5.1

Yes, that includes reinvested dividends. (I've read the book.) The key point that I took away was not that stocks guarantee a positive real return, but that they historically outperform bonds, which is your other major option. If I recall, Japanese, German and Italian bonds would have fared much worse over those time periods.

That's an important point when you're talking about the "myth" of stocks for the long run. For stocks to be the best investment, they only have to outperform the other options after taxes and expenses, not generate a positive real return. Of course, there are other options besides bonds and stocks, too, and you should probably risk-adjust the analysis.

[Doug]

Icarus, I agree with you. One hears the mantra "stocks for the long run" not infrequently. The purpose of my post was to point out the weaknesses of the idea, as any idea does have weaknesses. The message I take away is that stocks outperform bonds over the long term. Also, one should have a significant portion of your stock exposure outside Canada.

[Clock Watcher]

My take is that on a time-scale basis, stocks do tend to to up more often than they go down. So most of the time buy-and-holders feel good. And for a small minority of the time, they feel really, really, really rotten. In other words, they string you along.

And then about once every generation, they don't live long enough to ever recover.

[banker]

My take is that on a time-scale basis, stocks do tend to to up more often than they go down. So most of the time buy-and-holders feel good. And for a small minority of the time, they feel really, really, really rotten. In other words, they string you along.

And then about once every generation, they don't live long enough to ever recover.

The guy over at www.generationaldynamics.com has been calling the sky has been falling for at least 3 years now. He has been dead on in forcasting exactly what would happen.

His conclusion is that because the ones who lived through the great depression have mostly left us we have forgotten the lessons the depression taught us. The generations that followed mostly were spoiled and didnt think the same way as their elders did. We also see a different way of thinking from the generations that followed, greed, ME,ME,ME,ME now. And its still that way...but the chickens have come home to roost.

[Clock Watcher]

My take is that on a time-scale basis, stocks do tend to to up more often than they go down. So most of the time buy-and-holders feel good. And for a small minority of the time, they feel really, really, really rotten. In other words, they string you along.

And then about once every generation, they don't live long enough to ever recover.

The guy over at www.generationaldynamics.com has been calling the sky has been falling for at least 3 years now. He has been dead on in forcasting exactly what would happen.

His conclusion is that because the ones who lived through the great depression have mostly left us we have forgotten the lessons the depression taught us. The generations that followed mostly were spoiled and didnt think the same way as their elders did. We also see a different way of thinking from the generations that followed, greed, ME,ME,ME,ME now. And its still that way...but the chickens have come home to roost.

And taking this to its logical conclusion, for buy-and-holders, the stock market is like a casino. The longer you stay, the greater your risk.

His conclusion is that because the ones who lived through the great depression have mostly left us we have forgotten the lessons the depression taught us. The generations that followed mostly were spoiled and didnt think the same way as their elders did. We also see a different way of thinking from the generations that followed, greed, ME,ME,ME,ME now. And its still that way...but the chickens have come home to roost.

I definitely see this, even within my own family. My parents lived through the depression, and they saved every penny. My siblings on the other hand take what I consider unreasonable risks, not just in investments but in their everyday life, such as job hopping, and how little weight a DB pension holds in their view.

[SoninlawofGus]

Of course, there are other options besides bonds and stocks, too, and you should probably risk-adjust the analysis.

Where does real estate fit into a global, long-term analysis? Hyperflation would certainly kill any long bond returns, but should we experience that, we probably won't care as much about our investment portfolio.

Also, the inflation-adjusted returns for bonds are total returns, and some of those are negative returns. Wouldn't treasury or short bonds usually track or slightly beat inflation?

[DenisD]

Irrational exuberance redux By Mark Hulbert

Consider two hypothetical individuals who started investing at the beginning of November 1996. The first put everything in the stock market, while the second put everything into 90-day Treasury bills.

The second investor, who has been sleeping like a baby for the last 12 years, was sporting a 3.6% annualized gain as of Wednesday night. The investor who put everything in the stock market, in contrast, was sitting on a 2.9% annualized return.
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Siegel reports the percentage of time from 1802 through 2001 in which stocks failed to beat T-Bills. Not surprisingly, this percentage falls as holding period increases.

But what is perhaps even more surprising: This holding period has to grow to well more than a decade in order for the percentage to drop to below 10%.

Code: Select all

Holding Period % of time stocks didn't beat T-Bills
1 year         38.50%
2 years        34.70%
5 years        26.00%
10 years       19.90%
20 years       5.50%
30 years       2.90%


[DanH]

These are the longest periods of inflation adjusted negative stock returns by country:

US 16 years 1905-1920 negative 7% return

Looking at Schiller's data, that's not even close. Using that data, consumer prices rose 29% while stocks returned a total of 99% over that period (1905 through 1920 inclusive). That's a total return of +54% net of inflation - or an annualized real return of +2.7% per annum. The average dividend yield during this period was north of 5% per year so using price only results in an annualized return of -2.1% per year.

Not sure where -7% came from unless DJIA was used and maybe I have the time period a bit different but I can't see -7%.

[Doug]

The negative 7% comes from page 483, "Handbook of the Equity Risk Premium" edited by Rajnish Mehra. The link is as follows:

http://books.google.ca/books?id=B1oAf8d ... &ct=result

[Doug]

The 7% is cumulative, not annualized, return.

[DanH]

The 7% is cumulative, not annualized, return.

It still doesn't add up for me. I'm not saying that citation is necessarily wrong or I'm necessarily right. It's all in how you measure it. As suspected, they use what's called the DMS Global Database (you can simply go back six pages from your link to here).

I suspect that is where the differences come in. Whether that is a more comprehensive database than what Schiller assembled is perhaps up for debate as I've not devled into the details of the relative merits of each.

[WishingWealth]

In Slate: http://www.slate.com/id/2204247/

Only the Good Buy Young
Why 20-year-olds should invest way more in the stock market, and 50-year-olds, way less.
...
The logical way to fight generational risk is to borrow money to make large, regular investments in stocks while young, then use a proportion of later savings to pay back the loan rather than to pile into the stock market in middle age. That sounds risky, but it is, in fact, exactly what people do in the housing market. Knowing that they will need a place to live all their lives, they tend to buy a small house and gradually trade up to a bigger one, paying off their mortgages only late in life.

Most of us need a retirement fund as well as a place to live; there is nothing intrinsically risky about regular borrowing to get that fund off to an early start.

Not only does the concept—"mortgage your retirement"—make sense; it has paid off in the past. The Yale academics who proposed it, Ian Ayres and Barry Nalebuff, have looked at historical stock market data covering 94 cohorts who retired between 1913 and 2004. For every single cohort, the early-leverage strategy beat the conventional wisdom; it also almost always beat the gambler's strategy of investing every penny in stocks until the moment of retirement. Only the blessed cohorts who retired in 1998 and 1999 did better. Such gambles rarely pay off, so if you're 20 years old and want to spread your risks, mortgage your retirement today.

WW

[Bylo Selhi]

For every single cohort, the early-leverage strategy beat the conventional wisdom...

I imagine that in the climate of the current financial crisis it's probably not the best time to try to convince politicians, CPPIB, DB pension sponsors and the like that increasing leverage (or at least tilting more heavily towards equities) is the right thing to do

[WynnQuon]

The great paradox is that the more that investors believe stocks will outperform bonds, the less likely it is to happen.

The best chance for stocks to outperform bonds is when investors have given up on them.

[queerasmoi]

And taking this to its logical conclusion, for buy-and-holders, the stock market is like a casino. The longer you stay, the greater your risk.

Well certainly the more money you make, the more money you have in a risky investment. So over time a buy-and-holder's portfolio might outgrow their risk tolerance. Which is a good argument for assessing one's own risk level and keeping an appropriately balanced portfolio!

[Taggart]

Citywire (UK)

By Drazen Jorgic | 09:39:00 | 10 July 2009

London School of Business (LSB) economist Elroy Dimson:

‘Out of 17 countries – and then 16, if you take out the US – at most, a quarter of them resemble the American experience and three-quarters of them took periods that are much longer for equities to be safe.’

He added: ‘Equities are risky and they provide you a reward for a serious pain and this pain has to be thought about for the investment horizons that matter to us.’

Dimson noted that in some countries the investment horizon is a disheartening gauge.

He said: ‘For example, if you were an Italian stock market investor, things would not have felt the same as if you were an American investor.

‘In fact, you would have had to have an investment horizon of at least 74 years to have been justified in saying that equities are safe in real terms over the long term. And this is before taxes, cost-management fees and everything else.’

[tidal]

karma's disabled, so in lieu, positive karma to taggart for a good link (Dimson)

[parvus]

ditto

The U.S. experience has been (at least till now) almost unique. While equity risk premiums have been fairly consistent across countries with developed stock markets, the long-term continuity is lacking for war-torn stock exchanges.

In addition, one has to wonder these days how much U.S. markets floated on leverage (margin accounts, e.g.,) and the absence of a stamp tax, as in the U.K., that might dampen trading.

Then, outside the U.S., there's the whole free-float issue.

I don't have anything definitive to say; just thought I toss these things out for discussion.

[tidal]

By the way, one of the main points Dimson makes is:

He said the equity premium in each country is equal to dividend income over the long term, minus the income you would have got from risk-free government securities.

Arguably, this is even worse than what I have presented many times - e.g. here - i.e. that the e.r.p. is the dividend return, and that the total return is dividend yield plus "growth", and that growth is approximated by the 5-year government bond... and that with 5-year bonds at ~1.25%, we in big doo-doo... I say "arguably", because he refers to "dividend income over the long-term", so I am not sure how he is accounting for growth...

In any event, I mention it because this seems quite well supported in the academic literature, and the only counters I ever really see are "yabbuts" and "that can't be true's!" Somewhat sadly, I think this is basically the reality we are working with - in aggregrate - over the long pull...

[Bylo Selhi]

Does Stock-Market Data Really Go Back 200 Years?

As of June 30, U.S. stocks have underperformed long-term Treasury bonds for the past five, 10, 15, 20 and 25 years.

Still, brokers and financial planners keep reminding us, there's almost never been a 30-year period since 1802 when stocks have underperformed bonds.

These true believers rely on the gospel of "Stocks for the Long Run," the book by finance professor Jeremy Siegel of the Wharton School at the University of Pennsylvania that was first published in 1994...

There is just one problem with tracing stock performance all the way back to 1802: It isn't really valid...

[DavidR]

Dan Richards visits Jeremy Siegel and finds Stocks are still king for the long run, except

Stocks for the Long Run advocated the use of market indexes, using low-cost methods to match the overall market.

In our conversation, Mr. Siegel said he has changed his mind on this issue - he now believes that investors would be better served by emphasizing solid stocks that are attractively valued and excluding faster-growing stocks that have that growth priced in.

http://www.theglobeandmail.com/globe-investor/investment-ideas/history-shows-stocks-still-king-for-long-term-investing/article1301032/

[scomac]

It used to be that you had to sift the wheat from the chaff when listening to talking heads. Now, it would appear, that same step is necessary when it comes to certain academics. His suggestion to focus on the value slice wouldn't be quite so self-serving if he wasn't knee deep with WisdomTree.

[marty123]

It used to be that you had to sift the wheat from the chaff when listening to talking heads. Now, it would appear, that same step is necessary when it comes to certain academics. His suggestion to focus on the value slice wouldn't be quite so self-serving if he wasn't knee deep with WisdomTree.

If he ever leaves to work with Vanguard, all will be back to normal and indexing will be king again.

Follow the money

[Clock Watcher]

Based on my current age and when my dad passed away, I have another 15 years left to live. If I invested for the next 10 years and lose money (as happened in the last 10 years with the S&P 500), then I have wasted 2/3 of my remaining life on earth. To me, buying and praying just won't cut it. If that is the best that I can do, then I won't bother - I will instead get satisfaction from spending it.