| Buying the S&P Index? Not So Fast,
Says Professor Siegel
In his 1994 classic Stocks for the Long Run, finance professor
Jeremy Siegel champions equities as the path to wealth, and recommends
indexing (buying the S&P Index, for one) as the best way to capitalize
on stocks' superior return over bonds. It turns out Siegel has more
to say about equities -- and, that he has changed his mind about
indexing as the best way to accumulate wealth.
His latest work, The Future for Investors, takes his research
to the next level, focusing on which stocks hold the most potential
for investors. The results of his analysis lead him to backtrack
a bit from his earlier enthusiasm on indexing. "… although indexing
will still provide good returns, there is a better way to build
wealth." Why is indexing not always the best strategy?
Quite simply, Siegel explains, when you buy an index, the S&P,
for instance, you're buying a lot of companies within the index
that are overpriced. Some are overpriced because of their inclusion
in the world's most successful index.
Consider this example: Yahoo! was added to the S&P Index in December
1999, joining AOL as the only Internet companies (at the time) to
be included. One day after the announcement, investor enthusiasm
pushed Yahoo! shares up $9 in one trading session. In five days
the stock rose 64% above the price it traded at before the S&P announcement.
It turns out that excessive market valuation - particularly in the
technology and telecommunications sector - has been a serious drag
on S&P 500 Index returns over time, as Siegel's data shows.
This is counterintuitive. Price appreciation is good right? Well,
yes, in the short-run. But as Siegel points out, in the long-run,
investors should avoid the "growth trap" and seek out companies
with low P/Es and high dividend yields - frequently found in "old"
economy stocks like railroads and consumer staples firms.
The reason? Dividends. Dividends represent leverage because when
they are reinvested into low or reasonably priced shares they have
a multiplier effect on return. "Shareholders who bought Standard
Oil in 1950 and reinvested their dividends would have over fifteen
times the number of shares they started with, while shareholders
in IBM would only have three times the number of shares."
Readers will appreciate Siegel's trademark candor, and thoroughness,
if at times he belabors his point. His charts are helpful, but at
times confusing. He doesn't explain, for instance, the "Years to
Break Even After Price Declines" chart adequately.
His data shows that it would take 20 years to break even with a
5% dividend yield and a 10% price drop versus just 9 years to break
even with a 5% dividend yield and 80% price drop. While we don't
question Professor Siegel's math, and the logic makes sense (lower
price, more shares purchased with dividend reinvestment) it would
be helpful to see the calculations on this surprising result.
In discussing the future for investors, Siegel moves beyond data.
In a welcome contrast to the doom-and-gloom that abounds in many
discussions about Boomer retirement, Siegel reassures that the developed
world will handle its pending Age Wave crisis. Not to worry, Siegel
says. India and China will supply the investors to buy our assets
as we forge into retirement. By 2050, he believes the Chinese and
Indians will gain majority ownership in most of the large global
corporations. (And we shouldn't worry about that, either).
Oh, and what to do with your portfolio? Siegel concludes his book
by recommending 50% of your equity allocation go into a world index
fund, with the rest devoted to high-dividend and low P/E strategies.
Apparently, a little indexing is alright, after all. --nc
About the Author: Jeremy J. Siegel is the Russell E. Palmer
Professor of Finance at the Wharton School of the University of
Pennsylvania. Dr. Siegel received his PhD in economics from M.I.T.
and is the author of the classic and influential Stocks for the
Long Run. Professor Siegel writes and lectures about the economy
and financial markets and has appeared on CNN, CNBC, NPR and other
networks. He is a regular columnist for Kiplinger's and has contributed
op-eds and articles to the Wall Street Journal, Barron's, the Financial
Times and other national and international news media.
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