Bob Carlson

August 10, 2012

Reviewing Stocks’ Long-Term Returns

Filed under: Asset Allocation,Investing — Bob @ 5:25 pm

A generation or more of investors were educated to believe that stocks offer the highest long-term returns, and that stocks offer an extended real return of 6.6% annually. Bill Gross last week questioned whether that situation will persist for the next generation of investors, or at least for the next 10 years or so. Barry Ritholtz goes a step further and argues that the mantra of “stocks for the long run” never was valid. He believes the concept was derived from flawed or incomplete data and good promotion.

We’ve been aware of these arguments and data for a while. We’ve also been aware that in the modern era stock bull markets and rallies and followed by bear markets and corrections that routinely wipe out half of more of the previous gains. That’s why our recommended stock investments follow several principles. We prefer tactical investing: Buying stocks when they’re fairly cheap and selling as they become overvalued. Long-term stock positions should be taken either with managers that invest that way or at market lows. A buy-and-h0ld portfolio that depends on stocks is too volatile and uncertain to depend on for financing retirement.

But the most damning criticism leveled at SFTLR is that it uses bad data to prove its point. Not only is the fundamental premise wrong, but its flawed in a way that dramatically overstates equity returns.

As Jason Zweig observed, “There is just one problem with tracing stock performance all the way back to 1802: It isn’t really valid.’ Siegel relied on data selectively cherry picked by professors Walter Buckingham Smith and Arthur Harrison Cole. Of over 1000 stocks in existence during 1802-1845, they ignored 97% of them. Hence, Siegel’s data series has an enormous survivorship bias built into it, especially in the 1802-1900 period.

By erroneously front-loading excess returns, the compounding effect over a century is enormous.

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