Stocks for the Long Run?
The best plans take into account the worst scenarios, not with an act of denial.
Jeremy Siegel wrote a book explaining why stocks are a good deal for long term investors. He explained in
an interview that while he believes the risk of stocks do go up over time, they do not go up as much as they
should. The financial press often states that the risk of stocks go down over the long run, but this notion is
incorrect. By trying to maximize wealth without considering how the wealth accumulation can be used to pay future
expenses essentially solves the wrong problem. There are some circumstances where wealth maximization can be used,
but typically only after one's ability to retire is secured. This article counteracts a widely held but unsupported
view that simply investing in stocks is the solution to all your retirement needs. One should focus on
the financial plan to determine which risks make the most sense.
Stocks for the Long Run?
In the financial world, both pension funds and life insurance companies have very long term liabilities,
similar to individual investors. It is quite interesting to note that both have very different approaches to
dealing with equities. For example, pensions often maintain positions as high as 60-70% in equities depending on
the age of their workforce. But life insurance companies rarely have more than 10% of their assets in stocks. The
financial press seems to favor the pension model. But even before the 2008 financial crisis, the pension fund
industry was having serious problems. Life insurance companies, on the other hand, have
been performing much better. It is interesting to note that life insurance companies forecast their liabilities
and buy assets with the intention of matching their liabilities very closely. They often have less than a one
year mismatch. The mismatch for the pension industry by comparison is huge. So it is by no coincidence that with
large swings in the financial markets, the pension industry could suffer greatly while the life insurance
industry would simply keep chugging along.
Professor Zvi Bodie suggests the financial press is getting it wrong - that the risk in stocks increases
over time as opposed to decreasing and therefore financial pundits incorrectly recommend levels of equity exposure
that are far too high. Jeremy Siegel, Wharton Professor who wrote
"Stocks for the Long Run" agrees that the risk in stocks does go up over time. However given that the one
measure of variation (the standard deviation) goes down over time twice as fast for stocks as would be predicted
by a random series, he feels stocks are a good deal for the level of risk.
Consider that we expect to do better over the long run in equities, but how long is the long run? To support the
argument that stocks are not risky in the long run some market pundits claim stocks have outperformed bonds
over every historical period of 30 years. This argument would cause Zvi Bodie's point some serious indigestion. So
here is all data available on the 30 year treasury bond, comparing it to returns on stocks for the 30 year
period that matches the term for the bonds:
The comparison is engineered to evaluate Zvi Bodie's challenge to the the riskiness of stocks. The 30 year
treasury rates begin 2/15/1977 and stock returns end 1/1/2013 (care of FRB St Louis). The comparison is to buy
a 30 year treasury on 3/1/77 or buy stocks on the same day to see where the return was higher when the 30 years are
up. Here we can see, contrary to popular belief, that there was not a single period where stocks outperformed
bonds. While one might argue that we were going into a period of historically high interest rates, 1977 did not
begin in that fashion. The returns for stocks never beat the 1977 rates for bonds. Further, the period from 1982 to
1999 included the highest extended period of returns in the stock market for the entire century. So while stocks
have outperformed bonds at times, we can clearly conclude that stocks have not always ouperformed treasury bonds
for every 30 year period in history. This is the reason stocks are referred to as risky assets.
A particular question arises here in discerning which model (pension or insurance) to apply for ourselves. For
what is the purpose of our investing? Is it to make as much money as possible or is it to have the capacity to pay
our bills? The first issue to tease out of this decision is the economic implications, which are straight
What are the risk and rewards of investing in stocks as they relate to our economic purpose - the ability
to pay our expenses at a minimum? Fortunately there are ways to measure the amount of risk we are taking to
determine if the deviation from our expenses will place us in serious jeopardy or not. For example, in our
case study, we used a 60/40 stock/bond mix and a 10/90 mix with 88% in
Treasury Inflation Protected Securities. The details suggest that the couple using the 60/40 mix suffered
serious impairment with a $12,000 loss in living standard per adult. This occurred during circumstances
that closely mirrored the greatest stock market rally of the 20th century followed by its dismal aftermath.
With the 10/90 mix they did were not materially affected by stock market shifts. In their situation, the
economics alone suggest 60/40 may be too risky for them.
Two situations can arise where this economic conclusion may be put aside. First is where the family in question
does not need to rely upon the money invested in stocks to maintain their critical needs. Here the same analysis
would show they are not at risk of being unable to support themselves. The second arises where their purpose in
life over rides the pure economic decision. In the first case, as our article on investment process suggests, greed
should not play a part in that process. Instead, someone should think in terms of what wholesome objectives they
wish to accomplish in the world and how such investments would support that activity. The second situation can
arise in rare circumstance after one has properly gauged their ability to be patient during such difficult times.
This sort of decision needs to be made with full consciousness, without glossing the risk or denying it in any
form. The best plans are made with an understanding of the worst scenarios. Then one can turn to managing for
better circumstances in an optimistic manner.
Of course any strategy you choose is dependent upon your personal circumstances. This article highlights the
need to be very clear on the purpose of investing and make sure we target that purpose with precision. We can start
from a purely economic point of view which is represented by matching our assets against our expected expenditures
in the future. Some may either complement or over ride this economic formula in favor of the real meaning of their
lives. But taking such as stand should be done on a completely conscious level. If we unconsciously follow the
crowd as they jump off a cliff without looking down, our happiness may be impaired for those few moments before we
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nature and not to provide any investment advice, planning or recommendations of any securities. The purpose is to
educate you to make your own financial decisions, or prepare you to evaluate your financial advisors with
confidence so you can gain trust in the services they provide.
 On Asset-Liability Matching and Federal
Deposit and Pension Insurance, FRB St Louis 2006
 On the Risks of Stocks in the Long
Run, FAJ 1995, or The Long Run Risk of Stock Market Investing: Is Equity INvesting
Hazardous to Your Client's Wealth, FAJ 2011
 Great Debate NAPFA Apr 2004 Bodie