business and investing

Siegel's third edition is the best introduction to the traditional assets classes (i.e., stocks and bonds) that I have ever read, hands-down. This book has two strengths: One, it is a rigorous empirical study of historical market returns and their components. Two, it is broad and accessible introduction to various investment theories and styles, economic influences (e.g., inflation, business cycles, economic data) and newer product categories like exchange-traded funds. This is an ambitiously broad anthology chock-full of important topics, so it serves as a great starting point for new students of investment theory. For example, his Chapter on "Gold, the Federal Reserve and Inflation" is a brief, helpful introduction to the history of monetary policy. Another great Chapter is "Market Volatility," which illustrates that market volatility has been remarkably stable over the long run, with some violent exceptions.

What I really love about Siegel is his intent: he wants to educate the average investor and he is not dogmatic. I understand that a handful of negative reviews arise from a credible concern that the stock market could be a lot more hazardous in the future than in the past, but Siegel is not blindly extrapolating into the future. It is pretty unfair to call this "naïve empiricism," by the way. His conclusion is more specific and relative: he believes stocks should outperform bonds, but they will downshift from the long-run historical pattern to outperform bonds by about 2%, give or take.

He reaches this conclusion by showing how the stock market has historically averaged roughly 7% percent in real returns over any long-run stretch. He then presents various alternative valuation models and shares his carefully qualified conclusion: that economic factors justify an modest upward revision in the price-earnings ratio (P-E ratio) to the low 20s, and from that starting point, we might look forward to real equity returns of "4 to 5 percent." Granted, he then goes on to discuss some factors that could well propel returns even higher, and one big unfavorable factor that could send them lower (i.e., the demographic problem of fewer investors in the developed world). But you get to see how his model works, and he serves up each assumption logically and in balanced form so that you can consider the conclusion for yourself. In this vein and offered as a minor critique at the margin, I happen to question his assumption that higher equity valuations per se lead to increased earnings (via cheaper stock offerings and hence cheaper investment capital) because I do not think you can necessarily assume that more capital leads to better investments. Also, he does not address or incorporate the dilution effects of employee stock options.

Similarly, his case for "buy and hold" is balanced. The data in the Chapter on "Stocks and the Business Cycle" could in fact be used to advocate market timing. Siegel shows that successful timing (or more specifically, buying near the bottom) produces impressive returns. He just thinks it is really hard to predict business cycles.

This is the bible of traditional classes, and so I would note that there is no discussion of so-called alternative investments (e.g., hedge fund, private equity, real estates). Also, I missed the lack of an explicit discussion of asset allocation; can we maybe get that in the next edition?

Siegel's book is a good read, and he makes the case for equities a compelling one. However, if you're already aware that bonds, savings accounts, and gold are terrible long-term investments due to erosion from taxes and inflation (let alone lousy performance), then this book's strongest point is moot. Siegel's extensive research (some of which has been previously published) overwhelmingly supports the long-term investor; not the long-term investor as defined by today's market paradigm, i.e., long = 12-18 months, but rather looooong, like 20-30 years long...Two-day corrections or eighteen month bear markets can't hold a candle to Siegel's evidence proving that being 100% invested for long periods of time makes for sound financial acumen. Unfortunately, after all that great evidence, Siegel leaves individual investors at the altar, as he concludes that the only way for us to enjoy any investment success is to plunk most of our money in diversified mutual funds with low expense ratios (preferably index funds). This comes off like some kind of a thinly-veiled Vanguard endorsement and is extremely anti-climactic, considering all the great info in the previous chapters. I guess it's good to have on your bookshelf the next time the market drops 512 points and you become tempted to liquidate, because Seigel definitively proves you're better off sticking with stocks through thick and thin.

An interesting and educational book about stocks, but it could be dangerous for some people who may come to believe the stock market will make them rich if only they have the patience. To warn these people, I quote Professor Siegel himself from an article: "In a severe inflationary period, real estate tends to do better than stocks, as the 1970's demonstrated. By contrast, severe inflation would devastate bonds, just as it would stocks."* Elsewhere in this article, the Professor makes it clear that over a 30-year period you can expect real estate (in his book I can't find a place where he considers real estate as a viable investment alternative) to outperform stocks and bonds. I know inflation has been under control now for quite awhile, but no one knows what inflation will be like in 10 years, let alone in 30 years.

I recommend this book for the education about the stock market it provides the reader.

*Jonathan Clements, "Investing Isn't Just Happily Ever After," The Wall Street Journal, March 2, 1999, p. C1.