Jeremy Siegel, professor of finance and investment adviser, coined the phrase “Stocks for the Long Run” in 1994. Two dynamics of the last 40 years have turned his aphorism into an axiom of U.S. investing.
First, U.S. life expectancy has risen markedly in the last generation, increasing steadily until the COVID pandemic. Retirees can now require 30 years of income after their 40-plus years of working. Stock prices tend to rise on very long timelines, making equities attractive even for investors entering retirement. Especially given the low, fixed-income, security yields of the last decade, the total returns from equities, which have been unusually high, have become all the more attractive.
Second, the efficiency of index investing took the retirement industry by storm beginning in the 1970s. The lower fees of these products have broadly lowered the cost of owning financial products and increased access.
Starting with a modest base in the mid-’70s, the assets under management in index funds have shown a remarkable upward trajectory. Since these funds are market-cap-weighted, however, they fundamentally reify the prevailing valuation of the market. If a stock is overvalued, an index fund will only magnify that trend. As active management has waned and indexing now represents a significant portion of stock purchases, this dynamic mutes price discovery, allowing bubble valuations to continue uncontested.
The growth in stock prices has far outpaced GDP growth and income gains, making the equity markets now the gospel of economic salvation. Buy stocks now. Hold for the long run. Retire happy. A 21-year-old college graduate who entered the workforce in 1980 is now hitting retirement age. The above strategy has proven astonishingly effective for that cohort. If that individual had invested the annual maximum into an IRA since 1980, their account would have considerable retirement savings to their name.
Figure 1: Returns are capital appreciation without dividends. Dividends are a significant component of equity returns, but they are excluded for comparison purposes.
This evidence seems like proof positive of the reigning logic. Warren Buffett’s admonition to “Never bet against America” here finds a rousing endorsement. Our young college graduate would have made $154,670 in contributions by retirement and have capital gains of $887,452. In short, buy stocks for the long run.
Assigning such meaning to these numbers, though, belies the danger of disciplinary silos. Meaning requires story. And story is the terrain of history. Finance is nothing without attention to history, the essential context for judging the aphorisms bandied about the investment world. Untethered from context, numbers can fit any narrative one likes, especially if there’s a marketing message to be sold.
The context of these decades of impressive U.S. equity gains is the popping of the Japanese bubble (1989) and the corresponding flight of capital. A companion episode is the Alan Greenspan era (1987–2006) of accommodative interest-rate policy, which was turbocharged by his successors at the U.S. Federal Reserve. Both had enormously positive effects on the prices of U.S. stocks. If the past had been different, perhaps U.S. equity returns would be less impressive. But there are even better reasons to be concerned about stock-market performance.
The Japanese story is an antithesis to the strategy of stocks for the long run.
Figure 2: Returns are capital appreciation without dividends. Dividends are a significant component of equity returns, but they are excluded for comparison purposes.
Dollar-cost averaging into the Japanese Nikkei 225 index since 1980 has been an investor nightmare. The same contributions of $154,670 above would have earned capital gains of only $156,607 in Japan—instead of the aforementioned $887,452 in the U.S. Japanese stocks have gone up, but not nearly enough. A portfolio of $311,277 is meager indeed for a lifetime of saving. From 1980 to 2012, the Nikkei traded nearly flat. While it’s true that markets cannot be precisely timed, this has evolved into a nearly religious belief that portfolios should always be fully invested. Why? Because stocks go up over long periods of time.
That wasn’t true of Japan. The S&P 500 has galloped along since 1990, the year of Japan’s undoing. The enormous gains of the 1980s, seen in orange below, were followed by almost three lost decades as prices floundered. The languishing lasted so long that the impressive surge of 1989, in whose wake Americans worried that U.S. dominance would be overrun, appears as but a blip in the joint graph on the upper panel.
The differences between the U.S. economy of 2024 and Japan’s in 1980 are profound. Only hubris would venture a prediction for U.S. markets based on analogy. History doesn’t repeat, and even its rhymes are rarely neat and tidy. The valuation of Japanese companies of that era and American companies now provides no easy comparison. Still, frothy narratives abound at the recent new high in the S&P 500.
What Japan’s story shows is that the warning required by law on every investment advertisement is irrevocably true. Past performance is no guarantee of future results. That’s not just because human managers are fallible, it’s because asset classes carry no assurances. Stocks having notched impressive gains over recent decades says very little about their performance over the next 30 years. The future may not be a replay of the past, and the next episode may not be a replay of the last.
This is why valuation is the fundamental and indispensable approach to equity investment. Overpaying is the gateway to portfolio losses. In the task of long-term wealth management, decades are acts, not the entire play. A prudent manager could have sat out most of the 1980s Japanese market and done well by clients over the long term. The utility of such an approach, however, is seen only over very lengthy periods of time. Bear markets must be avoided, even if this requires an antisocial exit from the party before the last call at the bar.
Most strategists who advocate an always fully invested portfolio, though, reply that dollar-cost averaging, rather than value consciousness, is the antidote to such requisite caution. Obviously, a deposit of substantial wealth into the 1989 Japanese market was a foolish allocation, but most investors are saving modestly over the years so will catch both the highs and the lows, making a respectable return with time.
In this regard, Japan is again instructive. As the paltry growth of IRA contributions to the Nikkei index demonstrates, a depressed economy can hamper even the consistent and judicious worker who averages contributions over a lifespan. The simple fact is that stocks have not always gone up, at least within the timeframe that advocates of dollar-cost averaging expect. Indeed, this strategy was no insurance against the dangers of bubbles and overvaluation.
It’s at least possible that U.S. equity markets might not advance in the fashion that most investors currently expect. And little of this scenario is priced into markets. Presently, a soft landing by the Fed, perpetual employment, and a productivity surge from artificial intelligence flood the imaginations of investors. So did perpetually high real-estate prices in 1989 Tokyo. When the Nikkei did turn downward, the reversion was swift. Stocks sometimes do suffer in the long run, and their shift from stardom can constitute a rude awakening. An investment strategy intent on wealth preservation will never lose sight of this fact.