Stocks for the Long Run
My review of Stocks for the Long Run by Jeremy Siegel. This classic text by an esteemed Wharton professor powerfully makes the case for investing in equities.
It’s impossible to do justice to this great book in a short review. Combining a sweeping view of economic history, the link between markets and the real economy, valuation methods, detailed analysis of stock market anomalies and factors, behavioural biases and practical insights into investment strategy. This book beautifully bridges academic rigour and practical application. It is, without doubt, one of the best ever books on investment (perhaps even the GOAT?) and a must read for any DIY investor.
Siegel is known for being a stocks permabull. But that’s perhaps unfair. He called the top of the tech bubble in 2000 almost to the day with his Wall Street Journal article Big-cap tech stocks are a sucker bet, written on 14 March 2000. But he certainly believes that stocks are consistently the best long-term bet, calling history as his witness.
The verdict of history and six recommendations for successful investing
Analysis of 200 years of data highlights some simple truths for Stiegel:
- Keep your expectations in line with history: 6% to 7% real returns with stocks selling at a price-earnings ratio of around 15x.
- While stocks can indeed be very volatile over periods of 20 years or less, that volatility declines dramatically over periods of 30 years or more.
- This is due to a tendency of stock returns to mean revert, meaning that over the long term stocks are actually less risky than bonds.
These truths lead him to make six recommendations for successful investing (paraphrased):
- Stocks have produced remarkably stable real returns of around 6.5% a year over major sub-periods of 50 years or more since 1802, nearly 3% a year more than long-term government bonds.
- Stock returns are much more stable in the long run than the short run and over time compensate investors for inflation. The longer your investment horizon, the more you should invest in equities.
- Invest the largest percentage of your stock portfolio in low-cost, stock-index funds.
- Invest at least one-third of your equity portfolio in international (i.e. non-US) stocks.
- Tilt your portfolio towards ‘value’ stocks, which outperform over time.
- Establish firm rules to keep your portfolio on track and to protect against emotion-driven decision making.
So that’s the past, what about the future?
The latest edition of Stocks for the Long Run was written in 2013. A bullish stance on US stocks has certainly been borne out since. But what about the future?
In an interview in 2020 with Barry Ritholtz, Siegel presented a subtle evolution of his views. He now warns that we should expect lower returns from stocks in the future than the past. Reductions in the cost of investing, the ease with which widely diversified portfolios can be accessed, and reduced interest rates mean that the ‘normal’ market price-earnings ratio is likely to be permanently elevated from its long-term average value of 15x to more like 20x. The consequence of elevated valuations is lower future returns, which he expects to be around 5% ahead of inflation in the long run, as opposed to the 6% to 7% a year seen historically (note that the reciprocal of the market price-earnings ratio is a first order estimate of future long-term real returns on stocks). This is only slightly more optimistic than the assumption I tend to use in financial planning.
But despite expecting reduced equity returns, Siegel expects equities to outperform bonds by significantly more than the 3% a year seen historically. This is because of today’s rock-bottom interest rates, which has caused Siegel to call the end of the bond bull market. He expects bond returns to mean-revert following the great bond bull market of the last 40 years. As such, he now recommends an even higher weighting to equities, saying that the 60/40 stock/bond portfolio, which served investors so well for much of the 20th century, should be replaced by a 75/25 portfolio. In part, he recommends this because of his expectation of a return to moderate inflation of 3% to 5% over the coming years. This will damage fixed-interest bond returns but won’t be high enough to seriously harm equities.
Simply a great read
Siegel’s book is slightly US-centric. It was also written before the explosion of interest in quantitative strategies like risk parity and smart beta or alternatives like hedge funds and private equity, so it doesn’t contain his wisdom on these developments.
It might also be argued that his definition of long term (30–50 years) would test the patience of many ordinary investors. Siegel recognises this and addresses behavioural issues in the text. Indeed, in his conclusion he states that ‘proper investment strategy is as much of a psychological as an intellectual challenge.’
But the book is undoubtedly a brilliant tour de force, which can be summed up by his concluding sentence: ‘The main thesis of this book, that stocks represent the best way to accumulate wealth in the long run, remains as true today as it was when I published the first edition of Stocks for the Long Run in 1994.’
Buy it, read it and learn.