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An Excuse for Bad Advice

Posted By Barry Ritholtz On March 24, 2005 @ 2:42 pm In Books,Investing,Markets | Comments Disabled

This chart has been used primarily as an excuse for bad investment advice:


[1] [2]

Source: Marketwatch [3]

Why an excuse? It builds in an out for the advice giver: See, you just have to hold onto stocks long enough . . . then you will outperform other asset classes.

Now all we need to do is figure out how to have a 200 year lifespan.

Why brings this up now? Yesterday, Wharton Prof Jeremy Siegel [4] (whom I have appeared on several shows with and is a genuinely nice fellow) had a WSJ op/ed [5]. The chart above is straight out of Siegel’s 1998 book Stocks for the Long Run [6]. It sits on my bookshelf (gently mocking realists with its idealistic platitudes). Siegel’s newest book, The Future for Investors [7], is in my queue.

Both of his books are thoroughly researched, well written — and of little value to most Humans.

Yes, stocks go higher in the long run, but only if you have enough time — occasionally decades — to ride out the normal cyclical shudders. Yes, if you dollar cost averaged post 1929 crash, you might have made money. Of course, without index funds back then, there is a built-in survivorship bias, and it assumes you didn’t buy dogs which went belly up. (Recall what happened to most of the original Dow stocks).

And that’s before we get to the very Human foible behavior of not buying into the teeth of a miserable Bear market. So that aspect of Siegel’s advice is terrific, if you happen to be from Mars. Most of the investing inhabitants of this rock, however, will find it quite uncomfortable to follow. Ask yourself this: How many people dollar cost averaged after 1929? How about after 2000? Except for people who set up an automatic salary w/d, most Humans didn’t.

On the above chart, you will note it is in a logarithmic scale. That makes the 1929 and 2000 crashes¬† mere squiggles. I find the scale very misleading — If you bought in 1929, you did not get back to breakeven until 1954. Lets consider an unlucky 40 year old investor, pre-crash. By the time he hits 65, his retirement investments would have returned back to where he started — exactly 0% per year (Mazel Tov!).

A similar situation occured in 1966, following the post WWII rally. That’s when the Dow first kissed 1,000. This time, it took a mere 16 years to return to breakeven. So our unlucky 40 year old investor had the same 0% annual returns for 16 years — and he hit breakeven on his 56th birthday, instead of his 65th (post ’29 crash).

Now, lets consider someone born in 1960, who put a lot of money to work in early 2000. I suspect that this investor will hit that breakeven point sooner than either of the prior example. Unless he was heavily invested in the Nasdaq. Anyone in the financial business knows all too many investors in that situation.

Siegel is out shilling for his new book, which I am sure is full of terrific advice that human beings will probably not be able to live with. Hence, it will ultimately do more harm than good. (DISCLOSURE: I have skimmed, but not fully read the new book).

That’s the difference between profs and traders:¬† Behavioral economics in the real world, versus neat, lovely unrealistic theories in academia . . .


The Next Great Wave of Growth [5]
March 23, 2005; Page A14

Charting the long run [3]
By Peter Brimelow & Edwin S. Rubenstein,
Marketwatch April 14, 2003

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2005/03/an-excuse-for-bad-advice/

URLs in this post:

[1] : http://bigpicture.typepad.com/.shared/image.html?/photos/uncategorized/18002002_returns.gif

[2] Image: http://www.ritholtz.com/blog/wp-content/uploads/2005/03/long_run.gif

[3] Marketwatch: http://cbs.marketwatch.com/news/story.asp?dist=&param=archive&siteid=mktw&guid=%7B66F978EE%2D329E%2D4FA2%2DACB0%2DA0726D5D5350%7D&garden=&minisite=

[4] Wharton Prof Jeremy Siegel: http://www.wharton.upenn.edu/faculty/siegel.html

[5] WSJ op/ed: http://online.wsj.com/article/0,,SB111153988480887131,00.html

[6] Stocks for the Long Run: http://www.amazon.com/exec/obidos/ASIN/007137048X/thebigpictu09-20

[7] The Future for Investors: http://www.amazon.com/exec/obidos/ASIN/140008198X/thebigpictu09-20

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