New Cause for Caution on Stocks

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A few catchphrases sum up the 1990s: Bill Clinton's "It depends on what the meaning of the word is is," Forrest Gump's "Life is like a box of chocolates"--and Jeremy Siegel's "stocks for the long run." Siegel, 56, a professor at Wharton, turned his catchphrase into the title of a best-selling 1994 book, in which he showed that stocks had trounced bonds and cash over every 30-year period from Thomas Jefferson to William Jefferson Clinton. Siegel's book coincided with--and helped fuel--a long bull market, and America became a buy-and-hold nation. In 1994 stock funds held $853 billion; by 1999 they had $4 trillion.

But the bull market has been butchered, and now a brilliant new book, Triumph of the Optimists (Princeton), by Elroy Dimson, Paul Marsh and Mike Staunton of London Business School, casts doubt on Siegel's research.

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Siegel argued that U.S. stocks have outpaced inflation by nearly 7 percentage points annually with uncanny consistency since 1802. But his early numbers are rife with what statisticians call survivor bias: all the stocks in Siegel's pre-1871 index were winners, typically staying in business for at least 17 years. No flops such as canals or wooden turnpikes--just a couple of dozen profitable banks, insurers and railroads. Imagine calculating recent stock returns without Enron, and Global Crossing. Would that give an accurate picture? Siegel says in his defense that survivor bias may overstate his 19th century numbers by "1 or 2 points." But Dimson, speaking for his research team, concludes that survivor bias is "highly significant" in the early U.S. data. Even among British stocks from 1919 to 1954, he found, the winners-only problem exaggerated returns by 2 percentage points a year.

Now Dimson's team has created the first full, global picture of how equities performed over the past century. Among the 16 nations the team studied, stocks beat bonds and cash by an average of 4 to 6 points a year. From this, the scholars draw a startling conclusion: putting all your money in stocks is a bad idea. Why? First, most previous research showed stocks beating bonds and cash by a much wider 6 1/2 to 8 1/2 points a year. Second, a big chunk of the rise in stock returns came from the democratization of investing, starting in the 1970s. With mutual funds offering instant diversification, stocks suddenly became safer. "That can't happen again," says Dimson.

And, he adds, it's "irresponsible" to conclude that "the more profitable that stock investing has been in the past, the more profitable it must be in the future." Instead Dimson expects U.S. stocks to return a tepid 6% annually (after inflation, which is running at about 1%). That would be far below the 18% a year that stock investors reaped from 1990 through 1999. It's also fewer than 3 points above the returns on the safest bonds--not much of a reward for the added risk posed by stocks. So, says Dimson, investors may want about 40% of their assets in bonds, particularly inflation-protected Treasury Securities (TIPS). These days TIPS are beating inflation by more than 3 percentage points, risk free.

Dimson's book uncorks another surprise. Only Sweden (at 7.2% a year) and Australia (6.8%) edged out the U.S.'s 6.7% average inflation-adjusted return on stocks since 1900. On the whole, non-U.S. markets earned just 6.1% a year. But Dimson argues that U.S. investors should move more money into foreign markets precisely because the future is unlikely to resemble the past. In 1900 U.S. stocks made up roughly 20% of the world's total. Today the U.S. accounts for half the planetary stock value. That sort of growth is unrepeatable, says Dimson, "unless we discover new life-forms, and the American way gets exported galactically." (Two foreign funds I like: Vanguard Total International Stock Index and T. Rowe Price International Stock.)

Even Siegel is tempering his message. A new edition of his book is coming out in June (McGraw-Hill). He tells me he sees stocks returning just 5% to 7% annually, after subtracting inflation, over the next 20 to 30 years. And an average return of only 4% over the next five to 10 years "wouldn't surprise" him. Siegel used to urge young people to borrow up to 135% of their net worth to invest in stocks. Now he thinks that 75% to 80% in stocks, with the rest in high-yield bonds and tips, is enough. A hedge against the chance of low stock returns is now imperative. No matter what history suggests, remember the rest of Gump's phrase: "You never know what you're gonna get."

E-mail Zweig, a columnist for Money magazine, at