alternative title: Why the Siegel Constant Never Was


We have, throughout this week, alluded to the recent Bill Gross criticism on the Death of the Cult of Equities (See this and this). Elsewhere, several references to Stocks for the Long Run have been made, including the “Siegel constant” – the concept pushed by Wharton professor Jeremy Siegel that equities have consistently produced returns, including reinvested dividends, of 6.6% after inflation.

I want to suggest that these critics have it all wrong. Its not that “The Siegel Constant” is history — as Gross and Eddy Elfenbein have suggested; rather, it is because Stocks for the Long Run (aka SFTLR) was a deeply flawed and erroneous book right from the start.

There are several reasons for this outlying conclusion. The most obvious (but not IMO the most persuasive) has been equity versus fixed income performance. Bonds have — impossibly according to Siegel — outperformed equities. This isn’t merely a short term phenomena: Bonds have outperformed equities over the past 1, 2, 5, 10, 30 and 40 years.

That raises serious questions about the Siegel Constant. My suspicion is it reflects an invalid belief system; it is fair to say that, at the very least, it has not been thoroughly proven statistically.

What’s that again? SFTLR is one of the most widely read books in economic classes and business schools.

Exactly. Like the Efficient Market Hypothesis, or Homo economics, or the rational human, it is one of those squishy, poorly conceived, not well proven concepts that seems to be the underlying basis of some spectacular disasters. And, these issues have been thoroughly disproven by events of the past half century.

But the most damning criticism leveled at SFTLR is that it uses bad data to prove its point. Not only is the fundamental premise wrong, but its flawed in a way that dramatically overstates equity returns.

As Jason Zweig observed, “There is just one problem with tracing stock performance all the way back to 1802: It isn’t really valid.’ Siegel relied on data selectively cherry picked by professors Walter Buckingham Smith and Arthur Harrison Cole. Of over 1000 stocks in existence during 1802-1845, they ignored 97% of them. Hence, Siegel’s data series has an enormous survivorship bias built into it, especially in the 1802-1900 period.

By erroneously front-loading excess returns, the compounding effect over a century is enormous.

Birinyi Associates undertook a comprehensive analysis of Stocks for the Long Run. Their conclusions?

• We find little evidence that the author undertook basic, roll up your sleeves research. The book depends heavily on a 1989 study for the NBER by William Schwert which in turn was a “cobbling” together of a number of other prior studies varying greatly in terms of composition and methodology.

• Earlier researchers suggested that pre-1871 data was not available. Siegel defended his publication by noting that other, more recent, analysts have found the historic data to be available; however, one study’s data was not as complete as suggested, and in one instance had a huge error in data collection.

• Indexes and measures which overlapped those used by Siegel often have differed substantially from those Siegel used.

• The data used in the book showed an average annual price gain of 2.9% for the 200+ years; his total return result, 8.3%, was achieved by an aggressive dividend assumption, in excess of that suggested by other analysts.

Understand what this means: It does not mean that stocks are not a worthwhile investment, nor have no place in an asset allocation portfolio, Rather, what Gross called the cult of equities has radically overstated long term historic returns of stocks.

By artificially goosing equity return data for the 19th century, Siegel may very well has made equities over-owned in the 20th century.

Consider what this error means for traditional investors: The vast majority of classically educated MBAs and Economists have a very significant flaw in their investing assumptions. Imagine how many fund managers are running 100s of billions of dollars using this error as the basis for their money management.

The tenacity of bad ideas is quite astounding. Just because something is wrong, and verifiably so, does not seem to have much immediate impact. It remains a stable of academia, as well as the actual practice of investing investing — despite its questionable truth. We should not be surprised at this. Recall what Max Planck — who won a Nobel Prize for Physics in 1918 for originating quantum theory — famously said: “Truth never triumphs — its opponents just die out. Science advances one funeral at a time.”

Investing and Economics should be so lucky . . .


Jeremy Siegel is not having a good year (July 11th, 2009)

Does Stock-Market Data Really Go Back 200 Years?
Jason Zweig
WSJ, July 11, 2009

What Do Stocks Really Return?
Birinyi Associates, October 06, 2009

Category: Fixed Income/Interest Rates, Investing, Markets, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

41 Responses to “Bonds for the Long Run”

  1. [...] Barry smashes the Siegel Constant and weighs in on "the cult of equities is dying".  (TBP) [...]

  2. number2son says:

    Hmmm … and here I thought the Siegel Constant referred to his uncanny ability to constantly be wrong. Who knew?

  3. flocktard says:

    I’m glad I never immersed myself in a truly formal investment educational discipline, because why any rational person would choose to draw some comparison from today’s overleveraged, over-algo’ed, 24 hour a day hypertrading environment to the 1800s is beyond my imagination. You may as well benchmark 0-60 times for stagecoaches and compare them to a ZR-1 Corvette. What does it prove?

    The same goes for treatises that date back to the beginning of the 20th Century, and benchmarks against that world. Forget it. Even if you find some correlation, it means you found a coincidence.

  4. A says:

    In too many instances, research is ‘shaped’ to fit a thesis, regardless of how flawed (or corrupted) the process may be: just ask the pharmaceutical industry.

  5. Petey Wheatstraw says:

    In America — especially in economics — you don’t need good data, critical thinking, the scientific method, or intellectual integrity to successfully hype some BS (as Henny Youngman might have said: “Take our currency — please!).

    Never did.

    Never will.

  6. faulkner says:

    This is an example of how our perceptual biases lead to compelling intuitions and incorrect ideas. How could all that stock market activity lead to less than the slow accumulation of bonds? After all, activity makes things happen. Inactivity doesn’t. We see that everyday. So, longer term activity leads to more, inactivity to less. Right?

    It is counterintuitive to think otherwise. Of course, this has to do with the pictures in our heads, not the fact that bonds also make activities possible. Research is a way out of this box, but that means thinking things through, particularly one’s assumptions.

  7. streeteye says:

    If I buy a 10-year Treasury today, I lock in a rate of 1.5%. There is no way that at the end of 10 years I am getting any more than a 1.5% nominal return. If I get better performance next year because rates decline, it’s really just bringing future returns forward, my 10-year return is locked in.

    Any portfolio construction that uses historical bond returns is making a no good, very bad, terrible assumption. In 2012, it’s bonds for the long run of very poor performance.

    Bonds at this point are essentially a hedge against economic catastrophe and deflation, which would be even more disastrous for every other asset class.

  8. Chief Tomahawk says:

    Kind of underscores what Warren Buffett did right: do some (well, a lot) of homework.

    [I wonder what Buffett thought when he read the MCI Worldcom report after the CFO moved $1 billion of liabilities to the assets column?]

  9. bobnoxy says:

    Exactly! Siegel’s ignoring the survivorship bias infers that no investor ever had a dime in Enron, Worldcom, AIG, Bear or Lehman, and thousands of other stocks that blew up, or the thousands of others like all the tech shares that lost almost all of their value but survived for years at much lower prices.

    If they weren’t in the Dow or the S&P 500, they simply don’t matter, and there were no offetting losses against those index gains?

    Where would Siegel’s Dow or S&P 500 be today if not allowed to throw out dying companies and replace them periodically with more vibrant ones? I’m guessing the S&P 500 as configured in 1960 would be a lot lower than it is today.

  10. This isn’t a treatise as to why you should buy bonds today (after a 30 year bull market); rather, its an explanation as to why the prior exhortations to by stocks have been wrong.

  11. constantnormal says:

    “… Bonds have outperformed equities over the past 1, 2, 5, 10, 30 and 40 years.”

    By about the same amount that stocks outperformed bonds in the decade preceding those 40 years …

    Long-ish cycles should be paid attention to …

    … with all this bond mania, and the lowest bond yields in living memory, is it getting close to time for the worm to turn? And if not, what will be the signal, if bond-mania and zero yields are not sufficient? My guess is a rip-roaring stock market crash …

  12. Given current yields and the boomer demographic approaching peak investment, I don’t think anything homogenized will yield very well for the next 20 years. It’s entirely possible for all broad asset classes to underperform inflation.

  13. InterestedObserver says:

    What constantnormal says, particularly if you’re more in the style of buy and hold and not active trading…. mea culpa on that point.

  14. AHodge says:

    right on
    there is another even simpler proof that siegal is wrong.
    domestic profit growth must over the real long run
    meaning 50-100 years
    be roughly equal to dollar GDP growth
    grow GDP by 6% compound per year and profits 7% compound per year for 50 years?
    the profit share of GDP goes to impossible levels.
    how much P/E flexibility can there be?
    therefore his earnings and share growth data MUST be selective and unrepresentative of the profit and equity universe
    you can get some onetime gains from increasing corporatization and going abroad
    but that cant last forever either
    that which cannot go on forever( incl stocks for the long run)—wont. Herb Klein

    but this is basically problem #19 with the finance grad school CFA sylabbus
    producing batallions of buyside losers telling each other how the markets work, with quant “proofs” galore
    muffins everywhere, and the canny sellside knows exactly what bullshit they will buy
    heres your custom derivative reflecting latest theory

  15. wally says:

    “Bonds have outperformed equities over the past 1, 2, 5, 10, 30 and 40 years.”
    I think we are in serious need of some definitions here. Treasury bonds, corporates, junk… what duration? Are we including price appreciation in changing rate environments or just interest earned?

    Problem is, you’ll need to cherry pick “bonds” just as the comparison stocks were cherry picked.

  16. RW says:

    A long-cycle contrarian might take fundamental pessimism about equities as an early sign of a new secular bull but never mind that.

    Whatever one thinks of the Siegel Constant, Gross’s writing was still sloppy and his reasoning flawed; e.g., he conflates real return and real appreciation.

    BR I think you meant to to write “It remains a staple [not stable] of academia”

  17. Mal Williams says:

    I know there is no consensus on whether our current economic malaise is appropriately called a mild “depression” in which we had a recession or not. I think it is because of the deleveraging parallels. So I would like to suggest that you consider, and perhaps offer comment on, the following mental exercise.
    Suppose we woke up tomorrow and all of our unemployed each had two years more of in-demand education and two years more of in-demand work experience. Would we not rapidly boom out of the recession effects with the formation of new businesses with new products and increases in export and domestic demand and production and consequently employment?
    But, would we not still need at least a few years, to overcome the excesses in consumer debt, underwater housing, government debt and other various forms of deleveraging? In short, would we not still be in the depression?
    Thanks, Mal Williams

  18. kek says:

    I just read Harry Dent’s “Bonds for the Long Run” great read.

  19. [...] Why we should pay no heed to uncertain, 19th century equity returns data.  (Big Picture) [...]

  20. socaljoe says:

    What is “stocks”? The SP500… a managed, capitalization weighted index, the composition of which has changed continuously over the last 40 years? What is “bonds”?

    I see this as an academic discussion with little real world practical application.

  21. socaljoe says:

    We’re 30 years into a secular bond bull market and 12 years into a secular stock bear market… I’m not surprised that, at this moment in time, bonds’ historical performance is better than stocks’ historical performance.

    The comparison looked entirely different in 2000… and, in my judgement, will look entirely different a decade from now.

  22. mathman says:

    Did you ever wonder why cures for diseases are so rare?

    This ties in with both A and Petey’s comments above.

  23. socaljoe says:

    Enough about the past.

    What about the future?

    Over the next decade, ten year treasury bond will get you 1.69% per year. (before taxes and inflation)

    Is the total return from stocks likely to be more or less?

  24. algernon says:

    I would like to see documentation that bonds outperformed stocks over the 30 & 40 year time frames. I’m skeptical.



  25. blackjaquekerouac says:

    what a load of CRAP for an article. DO YOU EVEN KNOW WHAT THE INTERNET IS? The point of “efficient market theory” is the simple recognition that INFORMATIONAL ADVANTAGE IS A THING OF THE PAST NOW. You don’t even address this reality with this ridiculous tripe. Get a clue before you spout more nonsense Barry. TOTAL BS here. how can you …let alone me…know more than the market now? and of course ‘we cannot.’ they have so much on their side the ridiculous claim that “treasuries and debt are the winners” simply doesn’t pass the prima facie test. HOW MUCH FRIGGIN’ DEBT WILL IT TAKE FOR YOU TO RECOGNIZE IT?


    BR: Seriously, have you read anything beyond the headline?

  26. Frilton Miedman says:

    Well, that was interesting.

    I’m suddenly remembering Dennis Hopper in Apocalypse Now “You weren’t even there man!…You weren’t even there!””

  27. algernon says:

    People buying bonds in the early 70s got wiped out by inflation & rising interest rates. No way they beat stocks.


    BR: Stocks were flat during the 1970s. The 10 year bond yielded 15%. Both equities and bonds suffered the ill effects of inflation — so its not relevant to comparative performance. And if you held the bonds to maturity, you got paid back in full.

    I dont think you understand that era

  28. For those of you who doubt this data point, there are tons of sources for it:

    Say What? In 30-Year Race, Bonds Beat Stocks

    Bond vs. Equity Returns

    Equities and Fixed Interest Performance under the spotlight

    The Cross-Section and Time-Series of Stock and Bond Returns

  29. [...] Bonds for the Long Run | The Big Picture [...]

  30. [...] Bonds for the Long Run Barry Ritholtz. Although he’s right about Siegel, I disagree with the driver of the cult of equities. There was an Ibbotsen and Sinquefield study that was published in the 1980s that argued that equities provided a 7% return premium over the risk-free rate. That 7% was gospel for quite a while. [...]

  31. [...] yesterday’s Bonds beat Stocks discussion, I thought this chart might be worth reviewing. Its from the most recent Federal [...]

  32. machinehead says:

    Here’s some cockeyed advice from Jeremy Siegel’s Stocks for the Long Run:

    In Table 2-2 on page 34, an “agggressive risk taker” is recommended to hold a 139.1% equity allocation for 30-year holding periods, based on “all historical data.”

    However, from end-August 1929 to end-June 1932, large-cap stocks suffered an 83.4% drawdown (total return basis, using SBBI data). A margin account leveraged beyond 119.9% would have been wiped out.

    Lesson: do not attempt this at home, even if some finance professor told you it was okay!

  33. [...] will persist for the next generation of investors, or at least for the next 10 years or so. Barry Ritholtz goes a step further and argues that the mantra of “stocks for the long run” never was valid. He believes [...]

  34. [...] Romney, Taxer of the Blind Bonds for the Long Run (this seems kinda important) DEPARTMENT OF “HUH!?”: WHAT IS MITT ROMNEY TALKING ABOUT? [...]

  35. [...] Bonds for a Long Run Barry Ritholtz. Although he’s right about Siegel, we remonstrate with a motorist of a cult of equities. There was an Ibbotsen and Sinquefield investigate that was published in a 1980s that argued that equities supposing a 7% lapse reward over a risk-free rate. That 7% was gospel for utterly a while. [...]

  36. [...] Last week, I referenced the fact that Bonds had been outperforming stocks for quite some time. Burton Malkiel and Jeremy Siegel continue to doubt [...]

  37. blatantlyobvious says:

    It is not relevant to prove whether or not Siegel’s constant is correct. Investors only need to assess what is the probable returns during their holding period. Siegel’s constant, if true, is based on 200 years which is 10x the holding period of most investors.


    BR: I care about the process, and whether the data supports the conclusion.

  38. blatantlyobvious says:

    Understood, however, the conclusion is misleading. The implicit understanding of Siegel’s conclusion is if I invest in Equities I will generate those average returns. His process (as most others) miss the important issue which is what returns can I expect during my investment timeframe. No analysis has convinced me on the benefits of equities without inside information, so far only managed futures based on trend following hold up for returns for an investors acceptable recovery period. This may seem like a tangential topic, but the fluctuation during the period analysed is the key measure to then extract a probable returns analysis.

  39. [...] Bonds for the Long Run  (August 9th, 2012) [...]

  40. [...] the questionable data and mediocre results of Jeremy Siegel’s Stocks for the Long Run (See this, this and [...]