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Jeremy Siegel, Ph.D. The Future for Investors

Jeremy Siegel, Ph.D., The Future for Investors

Should You Bother With Government Bonds?

by Jeremy Siegel, Ph.D.

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Posted on Tuesday, May 12, 2009, 12:00AM

A few weeks ago Robert Arnott, chairman of Research Affiliates, caused quite a stir by publishing a paper in the May/June edition of the 'Journal of Indexes' entitled "Bonds: Why Bother". In the paper Arnott concludes:

"For the long-term investor, stocks are supposed to add 5 percent per year over bonds. They don't. Indeed, for 10 years, 20 years, even 40 years, ordinary long-term Treasury bonds have outpaced the broad stock market."

Arnott maintains that the long-term excess return of stocks over government bonds is only 2.5 percent, not 5 percent. Although Arnott doesn't identify the source of the 5 percent premium, he claims that it is widely used by pension plans and other investment advisers.

His conclusions are clearly designed to challenge the thesis of my book, "Stocks for the Long Run", which strongly advocates a diversified portfolio of global stocks as the overwhelming choice for long-term investors.

But a careful look at Arnott's data should not lead investors to bonds. At today's prices, stocks are even more attractive, while bonds are considerably less attractive than their historical returns. Here's why.

The Evidence

Long-term financial data has never given a 5 percent advantage to stocks over bonds. The data that I use in "Stocks for the Long Run" from 1871 to the present are virtually identical to the data Arnott uses. We differ only on the stock returns in the early 19th century, where Arnott finds much lower returns. Unfortunately, the accuracy of this earlier stock data, as even Arnott admits, is highly questionable. The well-documented data from 1871 through 2008 gives stocks a 3.2 percent per year advantage over bonds.

Although not as high as 5 percent, 3.2 percent per year is not trivial. If the long-term real, after-inflation return on stocks is 6.2 percent, and the long-term real return on bonds is 3 percent (both very close to their historical averages), then, over 30 years, a portfolio in stocks, measured in terms of purchasing power, will appreciate to a sum of more than 150 percent above that in bonds. Over 40 years, investors more than triple their money in stocks compared to bonds. (By the way, the arithmetic average return -- rather than compound return -- of stocks over bonds from 1871 through 2008 is 4.6 percentage points. This is the number the finance profession uses in the capital asset pricing model and other analytical applications.)

The Past 40 Years

Arnott additionally claims that there are long periods when stock returns fall behind bonds, and he notes that, over the past 40 years, the returns on government bonds have outpaced "the broad stock market."

But this is not true. At the bottom of the recent bear market, in March 2009, government bonds did indeed outperform the S&P 500 Index over the past 40 years. But bonds never outperformed any index that tracked the "broad stock market" that includes large as well as small stocks.

But bonds have admittedly done extraordinarily well over the past four decades. Over that time, long-term Treasuries have returned nearly 12 percent per year before inflation, and the returns on stocks ending at the bottom of the bear market in March of this year were just a few basis points lower.

But 40 years ago treasury bonds were yielding over 6.3 percent, about twice their yield today. It is mathematically impossible for government bonds to come close to matching those 12 percent returns in future decades. Stocks, on the contrary, can easily repeat their returns over the past four decades, since those returns were near their historical average.

Returns on Stocks and Bonds

Should the fact that government bonds did so well in the recent past encourage investors to invest in bonds today?

Absolutely not. In fact, it is quite likely that bonds will not only underperform stocks in the future but will also give investors negative real returns. And it is clear from examining Arnott's graph on stock and bond returns that, after long periods when stocks have trailed bonds' performance, such as in 1900 and 1941, stocks subsequently strongly outperform bonds.

Furthermore, Arnott does not discuss the extremely long periods of time where bonds have not only underperformed stocks but have given investors negative after-inflation returns. For the 55-year period from December 1925, when the well-known Ibbotson stock and bond series begins, through January 1982, total real government bond returns were negative. This means that, by rolling over in long-term government bonds, reinvesting all the coupons, and thereby taking no income, investors' bond portfolios were sinking in value.

Most strikingly, for the 40-year period from 1941 through 1981, government bond investors lost a whopping 62 percent of their value after inflation. A loss in purchasing power over this long a period has never happened in stocks. There has never even been a 20-year period when real returns in stocks have been negative. In fact, the worst 30-year real return for stocks is plus 2.6 percent per year, just slightly below the average real return investors earn with government bonds.

Looking Forward

Looking at today's markets, the forward-looking prospects for government bonds are very poor. Yields on 30-year inflation-protected bonds are 2.3 percent, and yields are only 4 percent on 30-year Treasuries. In contrast, after stocks have fallen 50 percent from their previous high, as they did in March of this year, their subsequent 30-year real returns have always been in excess of 10 percent per year.

The 40-year outperformance of government bonds over large stocks has ended. Since the March 8 lows, stocks have rallied 30 percent, while government bonds prices have fallen sharply. By April 30, the 40-year stock accumulation in the S&P 500 Index is more than 15 percent ahead of bonds and even more for the broader stock market. Years from now, we will look back at Rob Arnott's article as a turning point that marked the end of both the long bull market in bonds and the bear market in stocks.

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73 Comments

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  • WilliamB - Sunday, May 17, 2009, 7:57PM ET  Report Abuse

    • Overall: 4/5

    The point so many analysts and advisors miss is that most individual investors rarely hold investments for as long as 10 yea simply because they start too late or become discouraged in down markets and sell out. So long term market analysis is really irrelevant to small investors. We need a different approach.

  • Yahoo! Finance User - Sunday, May 17, 2009, 7:42PM ET  Report Abuse

    • Overall: 4/5

    Is this debate more about academic ego than investment advice? We don't buy Treasuries for yield, but for safety. Treasuries always pay off. If these guys are going to compare stock yields to bond yields, shouldn't they compare stocks to the more risky but higher yielding corporate bonds? When companies go bankrupt their stocks become worthless. Bonds are better protected - in a bankruptcy the stockholders lose first - but a pool of some level of bond (A/B /B ?) is probably about the same risk as a pool (SP500) of stocks. Comparing total stock returns to the total return of a corresponding risk level of corporate bond could be more helpful to investors like us. A smaller but related point is that each of these guys has argued in the past about against weighting the participation in indexes by total capitalization (shares outstanding times share price). Maybe the company with the most over priced stock (think dot.com boom) is overvalued and over represented in the index. Similarly the company that issues the most bonds may most need the funds from the bonds (think Chrysler vs. Microsoft). I wonder if these guys could figure out which set of bond issuers should be compared to which set of stock issuers to create the most level playing field and potentially provide more useful advice?

  • Sonoran84P - Sunday, May 17, 2009, 1:58PM ET  Report Abuse

    • Overall: 1/5

    'Stocks for the Long Run' is a true statement. You'll have to wait a long, long time to get your money back. Siegel recently told S&P they were wrong on how they calculated the index. He got pie on his face for that one. Corporate execs are looting the firms with their salaries and options. Stock prices represent a hope that some guy will pay more than you did. Shareholders get cheated buying the indexes because many firms go broke and get replaced. It's not accurate real returns. Bonds are a rippoff because of inflation. One comment here said to own a business to create wealth and that's true. Dividend stocks are a good choice but you must watch them carefully.

  • dB - Saturday, May 16, 2009, 2:06PM ET  Report Abuse

    • Overall: 4/5

    The argument where the relatively strong performance for bonds over the last 40 years is actually a bad signal for bonds is nicely explained. Stocks are on sale now, and bonds are expensive.

  • horatio666 - Friday, May 15, 2009, 8:13PM ET  Report Abuse

    • Overall: 1/5

    The anticipated value of short term T notes (ie 5-7 years ) is tremendously different from the risk factor in buying 20-30 year T Bonds especially with the Chinese declining to buy more Bonds and the wide fluctuations in the currency markets re the USD

  • Yahoo! Finance User - Thursday, May 14, 2009, 6:05PM ET  Report Abuse

    • Overall: 1/5

    Bonds are a waste and stocks as an index are a waste. Holding stocks is a fools game. The only way to build wealth in stocks is to have your wealth concentrated in only a handful of companies and to buy those companies when they are way out of favor. No one has ever gotten rich on mutual funds or index funds. Your purchasing power basically stays the same. $10,000 invested in stocks in the 1940's would basically have $10,000 worth of purchasing power today. Ok, so maybe a tiny bit more. The bottom line is that owning every stock on the planet just to say you own stocks is foolish. If you want to start a plumbing supply company, do you also at the same time start a chocolate factory, airplane factory, ravioli company, drug company, and clothes manufacturer? Not a chance. You focus on your business. The only way to build wealth is to start a business. Taking a company public is just a scam for the owner to unload his wealth in the form of shares to idiot shareholders. There is no value in stocks. They are manipulated by the federal reserve. Just look at all rich people. They got rich by starting a business, never by owning stocks. Most go broke by owning stocks. As for bonds, investing in bonds is like flushing it down the toilet.

  • sportsfan - Thursday, May 14, 2009, 4:17PM ET  Report Abuse

    • Overall: 5/5

    This man is brilliant. He's virtually the only one of these "experts" that I listen to and read. His books are simple to understand, and convincing. No, he can't predict what the market will do next week. No, he didn't predict the financial meltdown (anyone who did is lucky, not smart; their next 10 predictions will be wrong). But he gives me the blueprint to making good money over the years, while all my friends just keep buying high and selling low.

  • goldgoldgold666 - Thursday, May 14, 2009, 1:09PM ET  Report Abuse

    • Overall: 5/5

    OMFG, this guy is a Ph.D and he wrote an article where he used actual data and facts and statistics to support his position. As a dolt without a college degree who hates everyone who is educated, I am going to assume he is just trying to sound smart and disregard his advice and do what Robert Kiyosucky tells me to do instead. (Sarcasm off).

  • Yahoo! Finance User - Thursday, May 14, 2009, 11:00AM ET  Report Abuse

    • Overall: 1/5

    Typical PH.D babble titled the Future for Investors. Looking forward. You know right? Who is your audience? Yes, the stock rallied 30%. Now what, should I hold it for 10 years and watch it average 3% like the last 10 years. More bla bla bla for your babble.

  • Yahoo! Finance User - Wednesday, May 13, 2009, 2:30PM ET  Report Abuse

    • Overall: 1/5

    Telling investors to stop bothering to lend us money is like telling our parents to stop giving us an allowance. This is one of the more poorly thought out "financial advice columns" I've read recently. I don't doubt but that for a glimpse of history, this writer is a qualified expert. But for a glimpse of the future, this writer's an unqualified disaster.

  • John - Wednesday, May 13, 2009, 1:29PM ET  Report Abuse

    • Overall: 3/5

    IMHO the discussion shouldn't really hinge on which is better, but on HOW the two asset classes compliment each other. Bonds, international stocks and to a lesser extent REITS and TIPS etc, all help to stabilize a portfolio primarily composed of stocks. This fact is vastly more important that whether bonds have marginally beat out the S&P 500 during some 40 year snapshot in history. The focus should be on the right mix.

  • jim h - Wednesday, May 13, 2009, 12:57PM ET  Report Abuse

    • Overall: 2/5

    No one can predict the future. Isn't that obvious by now? What is the value of a statistically based analysis that over all past 40 year time frames stocks have outperformed bonds? Does that mean one should definitely buy stocks now? Of course not. Does that tell us something about the future dynamics of the stock market? no. Does it tell us that buying low yielding bonds now is a bad idea and will definitely yield less than stocks. no. But neither does it tell us the opposite. Its not an indictment on Dr Siegel, what we are all after as investors just can't be known. Jim

  • Polski - Wednesday, May 13, 2009, 2:02AM ET  Report Abuse

    • Overall: 1/5

    Why not suggest to just pull out of the Market, in general, and hold off until you sit down with qualified friends, over a Stabucks, to decide what really is a good way to go? The Fin Adv's don't know!

  • DAVID - Tuesday, May 12, 2009, 11:22PM ET  Report Abuse

    • Overall: 2/5

    I just love it when the various experts cannot even agree on the historical data record of stocks versus bonds or whatever. 'So and so's study shows this but it's not true because blah blah blah'. Is are all these financial geniuses just talking out of their asses? How is it they can dispute even historical numbers, for God's sake?

  • Ben - Tuesday, May 12, 2009, 10:21PM ET  Report Abuse

    • Overall: 2/5

    The problem with this country is that here, unlike Japan, a guy who has screwed up as totally as Jeremy Siegel, does not resign in disgrace. Instead, he is allowed to appear shamelessly, in polite company, without uttering even the pretense of an apology to all the people to whom he has caused immense anguish.

  • Fillup - Tuesday, May 12, 2009, 7:22PM ET  Report Abuse

    • Overall: 2/5

    Hey Jerry, how's everything under the old wisdom tree. Seen Jerad lately?

  • Yahoo! Finance User - Tuesday, May 12, 2009, 7:06PM ET  Report Abuse

    • Overall: 1/5

    once interest rates rise on bank CDs, stocks bonds and property will look like a trip to vegas....all the things that are happening there will stay there

  • Yahoo! Finance User - Tuesday, May 12, 2009, 5:41PM ET  Report Abuse

    • Overall: 4/5

    LOL at recent posters. Siegel's no genius for saying so, but there's absolutely no doubt that he IS right in this analysis. You want to buy 30-year Treasuries at 4% yield, go for it. Come back and post when your no-default bonds have lost 35% of their value -- before inflation. You won't be happy...

  • Jeff F - Tuesday, May 12, 2009, 5:27PM ET  Report Abuse

    • Overall: 1/5

    Saying that it's impossible for anything to happen in the current market is a bold claim. He doesn't know anything more than anyone else, but that's what he'd have you believe. Listening to his advice in the past 5-10 years will have lost you a fair amount of money. Why would anyone start listening to him now?

  • Yahoo! Finance User - Tuesday, May 12, 2009, 5:06PM ET  Report Abuse

    • Overall: 3/5

    Dr. Siegel's advice has to be taken in context. He doesn't claim to advise investors at a particular age or with a particular risk tolerance. There is no perfect investment. CDs and cash are no more perfect than bonds or stocks; why not gold or real estate in that case? The thing is, it all depends on your risk profile, your needs, and of course luck and real-world events. One strategy is to invest in things that you understand. If you understand business and finance in depth, you can probably pick great stocks and do very well. If you know a lot more about real estate and home repair, buy a house and consider maintaining it to be one of your major forms of employment. Lastly, spreading your risk across asset classes can help ensure that you don't get stuck in a bad situation. http://financialthoughtsnow.blogspot.com/

  • Yahoo! Finance User - Tuesday, May 12, 2009, 4:52PM ET  Report Abuse

    • Overall: 1/5

    Once again we have the professor here who could not call a top in the stock market calling the bottom as early march. Why is it these folks never go back, admit their errors, and try to figure out what went wrong. The problem with this guys analysis is its ivory tower. Depending on what dates you pick as your start and end date, the performance of the market can vary GREATLY. We the people do not have the liberty to pick our start and end dates of our retirements or investments. So how is this kind of analysis at all useful to anyone? the doc will defend his "stocks for the long run" forever. However the fact of the matter is people who bought and believed in it have been destroyed. People who need retirement money today or next week or next year are shivering in fear, after reading this kind of BS from most pundits, they followed it without question, then get handed their butts by the market. My suggestion to the doc is to stop teaching and start listening. The fact that he is already calling a bottom in today's market already tells me too much arrogance to be true. What will happen is the bear market rally will end, to the horror of all the new found bulls all gains will be erased and new depths will be tested. The doc is gonna get schooled this fall. Will it make any difference? Probably not.

  • Jordan - Tuesday, May 12, 2009, 4:40PM ET  Report Abuse

    • Overall: 3/5

    Dr. Siegel speaks about historical averages, and perceived views of what future returns will manifest. One piece of criticism: I did not read one mention of the age of investors and/or their risk tolerance. That is, it makes more sense for someone nearing retirement to reduce their exposure to the broader stock market. The stock market is prone (historically speaking) to significant peaks and valleys which have in the past negatively affected the retirement nest egg of boomers within 5 years of retirement.

  • Yahoo! Finance User - Tuesday, May 12, 2009, 3:37PM ET  Report Abuse

    • Overall: 2/5

    Past performance is no indication of future returns!!!!!

  • Yahoo! Finance User - Tuesday, May 12, 2009, 2:57PM ET  Report Abuse

    • Overall: 3/5

    Bonds and stocks are a sucker bet. A friend of mine has all his money in cd's. He is the smartest investor I know. Cash is King!

  • James - Tuesday, May 12, 2009, 2:48PM ET  Report Abuse

    • Overall: 2/5

    Easy to write such an article when bond yields are 3%. He forgets that people who invested in stocks during the dot bomb era (i.e. Nasdaq 5000) will probably never recover to break even, even in a 40 year time period.

  • Yahoo! Finance User - Tuesday, May 12, 2009, 2:47PM ET  Report Abuse

    • Overall: 2/5

    Article was OK but 5 stars to the comment posters. I got more information from the commentors than I did from the article. I don't know the future so I'll diversify over different asset classes to spread risk appropriate for my age. After this meltdown, with the experts mostly silent, I don't believe anyone in the financial industry giving advise.

  • richard - Tuesday, May 12, 2009, 2:42PM ET  Report Abuse

    • Overall: 1/5

    The problem with Dr. Siegle's analysis is that he is looking at the long term as though it is an endless time frame. People who are looking at using their 401ks for retirement have a 40 to 0 year time frame. While it is likely the stock market will recover in the next 10 years, this won't do you any good if your time frame is within that 10 year period. There are plenty of short term bond funds out there, even ones with insurance wrappers, that pay 3 to 5% a year. No great shakes, but the key is that they probably won't lose money. In the next 10 years it is just as likely that the stock market will have negative or no gains as high gains. Risk is the key component when your time frame for investment is less than 10 years. Right now the stock market is littered with con men and stock market manipulators. Until regulations are put back into place, until usury laws are put in place, and until the banks are cleaned up, the risks in the stock market are simply too high. That makes the market dramatically more risky then the overall economy.

  • Yahoo! Finance User - Tuesday, May 12, 2009, 2:28PM ET  Report Abuse

    • Overall: 1/5

    Me thinks he doth protest too much! 40 year term, great advice for trust fund babies with all their money upfront. The rest of us are hosed. Then again with current raging socialism, all Amerikan middle class and below are. Top it off with the gubmint confiscating our remaining funds to "bail out" the fat cats, and what shot do any of us have.

  • Yahoo! Finance User - Tuesday, May 12, 2009, 2:15PM ET  Report Abuse

    • Overall: 4/5

    Sounds like many posters here will be stuffing what little cash they have into their mattresses.

  • __A_YAHOO_USER__ - Tuesday, May 12, 2009, 2:09PM ET  Report Abuse

    • Overall: 1/5

    Misleading advice. I suggest you study his older advice from 2-3 years ago. Compare it to what really happened. You'll be shocked to see just how often he is wrong on major, major topics. Like all other financial advisors, look for confiicts of interest in his work. Note how Jerry gets paid from the folks in the equites markets. Note how he's pumping equities. 90% of financial advice is totally misleading and just hype to get you into buying equities. Jerry Siegel is no different. Use your common sense. You know things dont make sense here. Don't fall for industry shills like Mr. PhD., See this for what it is, he's just defending himself here, not helping you. Robert Arnott is contradicting the PhD here, and the PhD is pissed off.

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