Swedroe: Stocks, Bonds & Risk

June 14, 2017

Followers of my writings know the perspective I provide isn’t based on opinion, but is grounded in the academic research. However, what do you do when the research seemingly offers contrasting recommendations?

Complicating matters is that, in the following case, we have a conflict between two highly regarded academics, professors Jeremy Siegel and Zvi Bodie.

Questioning The Data On Stocks
Jeremy Siegel’s “Stocks for the Long Run” recommends that equities dominate portfolios for investors who have a long horizon. His recommendation is based on the view that stocks are the less-risky investment when horizons are long. Zvi Bodie argues that equities are too risky over the long term; thus, Treasury inflation-protected securities (TIPS) should dominate retirement portfolios.

Siegel presents evidence showing that, the longer the time horizon, the more likely it is stocks will outperform bonds. He shows that, over very long horizons, stocks have always outperformed bonds.

One problem with this view is that his data are based on one unique history, that of the United States. In addition, there is really only reliable data going back 90 years or so, not the almost 200 Siegel uses. Clearly, an “alternative universe” might have shown up.

Insufficient Horizons

And the bear market of 2008 demonstrated that even 40 years may not be a sufficient horizon to be sure stocks would outperform bonds. From 1969 through 2008, the S&P 500 Index returned 8.98%, barely outperforming the 8.92% return on 20-year Treasury bonds.

Another problem with Siegel’s view is that, while it is true that stocks—because of the presence of the equity risk premium—are likely to produce a higher ending net worth, owning them, regardless of the length of the horizon, also increases the odds of a very poor outcome.

In fact, the longer the horizon grows, the greater the risk that a “Black Swan” will appear, perhaps causing a portfolio to fail and leaving investor without the resources to support their desired lifestyles in retirement. This is the point Bodie makes in both his paper, “On the Risk of Stocks in the Long Run,” and his book, “Worry-Free Investing.”


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