This is going to be both a Gateway Post and a new discussion for a topic scattered throughout this blog. Although Professor Siegel is not mentioned by name in many of the posts linked at the bottom, I am responding to his claim that a diversified portfolio of stocks was the "overwhelming choice for long-term investors". That quote was taken from the Professor's post from yesterday at Yahoo Finance contained in his article titled "Should You Bother With Government Bonds".
First, I would like to summarize some of my main problems with Siegel's thesis from the perspective of an individual investor with a limited time on this earth.
For an individual investor, ten years is a very long time, and to have stocks fail as an asset class for a decade could easily be a major disruptive event in their lives.
Siegel has yet to come to grips with the fact that the major averages are currently at levels seen in 1998 even after the spirited 34.3% rally in the S & P 500 off the low in early March 2009. dshort.com:
It is actually worse for most individuals since they were investing in stocks at much higher levels during the cyclical bull run from 2003 to 2007. I know the names of many who just could not stand the pain of this bear market any longer and pulled all of their funds out of stocks after the Lehman failure and the start of the new phase of this bear shortly thereafter. So, it does not help those investors to talk about how well stocks have done versus bonds since 1871. I have some news for the Professor. That time period is not relevant to me as an individual. As an individual, I have to have shorter blocks of time.
Another problem with Siegel is that he has not come to grips yet with the fact that a 20 year Treasury Bond bond bought at about the same time as the start of the great secular bull market in 1982, and then rolled over at maturity, would have done better than an investment in the S & P 500, at least up to the end of March 2009.
There are two salient points to this observation. I am comparing a staid bond investment, a no brainer, clip the coupons and play golf, to stocks that had one of their best bull runs ever starting in 1982. I have observed many times that I would have been better off in 1981 buying a 20 or 30 year Treasury at 14% than fooling all of these years with trying to beat that fixed annual coupon. That was another mistake that found its way to live into several decades. Well, my excuse was that I was only 30 in 1981, and I was working almost 80 hours a week, every week, happy to just roll over those 3 month CDs, until rates started to fall. Then I decided in August 1982 that I had to do something else, so I started trading stocks again, and so here I am 27 years later trying to cope with that wrong turn.
Another problem with Siegel is that he fails to come to grips with the long periods where stocks fail as an asset class and the importance of that failure to individuals who face really serious situational risk issues. That risk is extremely important to the vast majority of individual investors. It would include the risk, for example, of retiring soon after the start of a major bear market depending on a stock portfolio to provide income. Then, during the bear market, stocks plummet over 50% and corporations including most banks cut or eliminate their dividends, the primary source of income from stocks for individuals. There are countless examples of major situational risks that each individual faces, and it is not hard to visualize them. So Siegel needs to deal with the fact that there are prolonged periods where stocks fail as an asset class, including two long periods in my short life, from about 1965 to 1982 and 2000 to 2009 and counting. This is just a major hole in his analysis.
Having said all of that, the investor now has an asset allocation problem. Ten year treasuries do not yield 14%. As of yesterday, the yield on a ten year was around 3.17%. Okay, you have to be flexible. I can not make the same argument for the next ten years in favor of treasuries by pretending the rate is 14% rather than the real 3.17%. And, I can not ignore that stocks have been shellacked since October 2007. Thus, if I had to make the best decision at this moment in time to invest either in a 10 year treasury or in the S & P 500 for the next ten years, I would choose the stocks. But, then, what if stocks doubled in the next five years and the ten year treasury rose to a 8% yield-what then? It is best to remain flexible rather than dogmatic, and not to have your ego tied up in an opinion which humans are prone to do. Open-mindedness, and a willingness to adjust and to cope with new information, is the primary quality of any successful individual investor.
This is a Gateway Post so it's primary purpose is to provide links to other posts discussing the problems with Siegel's thesis even though his name is not mentioned in almost all of them:
I will simply add any old post relevant to this topic as I find them, and any new posts written after today.
I would add a caveat. I have never taken a course in economics. My criticism of Siegel comes from my experience as an individual investor. I also try to be a free thinker, willing to consider new information and to alter my opinions based on a careful evaluation of events as they unfold rather than stubbornly holding onto to something that does not work for me. I will for example drop the VIX Asset Allocation model, my own creation, when I see that it no longer works and just say time to move on to another model.
