Stocks for the Long Run | Jeremy J. Siegel

Summary of: Stocks for the Long Run : The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies
By: Jeremy J. Siegel


Embark on a journey through the historical milestones of the US economy and discover the power of stocks in the long run with this summary of Jeremy J. Siegel’s book ‘Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies’. Gain insights into the major transitions of the US economy, from agrarian to industrial society, and its evolution into a global powerhouse. Learn how stocks have consistently outperformed other asset classes like bonds, commodities, and gold, providing a 6.6% annual real return for over 200 years. Understand the intricacies of portfolio construction, the impact of taxes on your investments, the role of behavioral finance in decision-making, and the changing world of investment instruments.

Two Centuries of Financial Fluctuations

The US economy has undergone significant changes in the past 200 years, but stocks have remained the most dependable asset class, with a 6.6% annual real return. Over this period, bonds and gold barely kept up with inflation, while stocks doubled their “purchasing power” every 10 years. While stocks have experienced tremendous volatility in the short run, they are still the best performing asset class in the long term. Despite prolonged inflation in the 1970s and the 2008 financial crisis, equities promise their owners nothing but remain the most trustworthy investments.

The Root Causes of the 2008 Financial Crisis

The 2008 financial crisis was caused by subprime mortgages and real estate investments, which had surpassed $2.8 trillion by the summer of that year. The high ratings given to mortgage-backed securities by major rating agencies gave buyers a false sense of confidence. However, the home prices fell by about 4% from June 2006 to June 2007. This decline destroyed the rating agencies’ risk models for mortgage-backed securities. If a mortgage borrower defaulted, the underlying property was worth less than the mortgage. Regulatory failures and political pressures also contributed to the crisis. As a result of the downturn, real GDP growth fell by a record 4.3% from the end of 2007 to mid-2009, which propelled the US economy into its second-longest recession.

Constructing a Robust Portfolio

A portfolio is a combination of various securities that generate returns dependent on the investor’s risk tolerance. To create a diverse portfolio, investors must understand their total real returns by examining dividends, interest, and capital value fluctuation. By studying historical data, investors can compare total real returns from different combination of assets ranging from single to thirty-year periods. The book suggests that countries promoting free-market economics have contributed to the superior performance of stocks over the last two centuries. The standard deviation of average real annual returns outlines the portfolio’s risk- over longer periods, stocks have the lowest risk, and a diverse stock portfolio yields consistent returns between 6 to 75 percent. Modern portfolio theory emphasizes the “efficient frontier,” identifying the minimum risk expected from a combination of stocks and bonds. Thus, variations in managed portfolios yield different risk and return profiles, helping investors gauge standard deviation of their average annual return.

Invest in Stocks for Higher After-Tax Real Returns

Long-term investors seeking to boost their total real returns after-tax should consider investing in stocks instead of bonds. Since 1913, the after-tax real return on equities has ranged from about 2.7% to 6%, while bonds have ranged from minus 0.3% to 2.2%. Municipal bonds have an average annual real return of 1.3%, while treasuries ranged from minus 2.3% to 0.4%. Despite the recent financial crisis, the longest period it has ever taken an investor to recover from a bear market was five years and eight months. Investor returns from stocks are primarily dividends, accounting for most of the 6.48% real equity return from 1971 to 2012. The future value of dividends determines stock prices, but earnings reflect various expenses over varying periods, which the FASB allows firms to report differently.

Beating the Market: Factors to Consider

A proper investment strategy is a psychological challenge, not just intellectual. Valuation data based on business growth, sales, earnings, and dividends are the most important indicators to consider when investing in stocks. However, relying on growth in revenue and earnings will often lead to below-average returns. The critical consideration in portfolio decisions is risk, which is the correlation of an asset’s return with the overall market. This relationship is embodied in the capital asset pricing model (CAPM), where beta is the cornerstone. In the CAPM, an asset’s beta is always present, and diversification cannot reduce it. Therefore, the share’s beta is a risk for investors, and the company must compensate them for it. A diversified portfolio can mitigate risk independent of the market, requiring investments in bonds and various US equities. Firms’ market capitalization and dividend valuations predict an equity’s return better than its beta. Analysts in the internet sector had a high propensity to shut out bad news.

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