Sometimes the conventional wisdom that everyone knows is true turns out to be wrong. The world is flat, the sun rotates the Earth, the wealth from corporate tax cuts trickles down… There are many examples. Even in a field of advice-giving as conservative as personal finance (btw, have you tried saving more?), this can happen, and a retired business school professor named Edward McQuarrie recently made one such discovery.
While poking through some historical data about the returns on 19th century municipal bonds — thrilling, right? — McQuarrie found that a key assumption about investment advice for young people is … wrong.
I knew I had to call him up.
When the Conventional Wisdom’s Wrong
One of the most oft-repeated pieces of financial wisdom is that stocks always go up in the long run, so if you’re young, buy stocks, hold them for a few decades, and your money will grow. As you get older, migrate over to more bonds which are safer — but won’t grow your money as much. This assumption steers a ton of our country’s retirement infrastructure. If you use a robo-adviser, it’s using your age in its formula for figuring out how much stocks you should have. If you use an employer-provided 401(k), it’s probably in a target-date fund that will start ya off with a lot of stocks, and gradually switch to bonds.
This wisdom comes from a legendary Wharton finance professor named Jeremy Siegel, whose book Stocks for the Long Run looks at market data going back to 1802. He found that stock prices grow about 6.7 percent annually. That’s pretty good: Invest $50 a week for 40 years at a 6.7 percent return and you’ll have $400K on which to retire, according to BankRate’s returns calculator. Bonds return less, but they’re safer. McQuarrie, however, thought this philosophy seemed a little too neat. How could something as irrational and unpredictable as the stock market turn out to be so consistent, so reliable, even over long stretches of time? The
“You could begin to speak of natural law,” he tells Inverse. “6. percent is the return on stocks and 32 feet per second squared is the gravitational constant.”
Fresh into retirement and with some extra free time on his hands, McQuarrie decided to double-check Siegel’s work. And he found that when Siegel originally wrote the book, the quality of the data left a lot to be desired. All the good data was from the 20th Century, where the US, among other things, won a couple of world wars and dominated the global economy. The data from the 1800s, as you may imagine, was sparse, often drawing on a handful of stocks and bonds. This, McQuarrie thought, was baking in a bias for stocks — which do better in good times — and a bias against bonds, which tend do better when investors are nervous.
“[During the 20th Century] the US won 2 world wars in a row, emerged the leader in the global economy, and screwed the world like a colossus in the 50 years thereafter,” McQuarrie explained. “So of course US investors did well in stocks, so did Roman investors during their golden age.”
Armed with better data from the 1800s, McQuarrie revisited Siegel’s work and found that, actually, stocks don’t always outperform bonds in the long run. And, more interestingly, there are times when boring old bonds do way better, even over 50, 60, or 70 years. Of course, it’s not a good idea to extrapolate much from 19th Century American markets either, which were about as hairy as the 20th Century was booming. The Brits burned down the White House, Andrew Jackson literally shut down the equivalent of our central bank, and the Civil War happened. But what we can take from all of this is that it’s important to not let recency bias affect how we plan for the future.
“That basic research that fuels every bit of financial advice you ever read is confined to a period where the US was so successful,” McQuarrie says. “How confident can we be about generalizing to the 21st century? It’s not as clear the US will be as dominant on the scene 2099 as it was in 1999.”
So what can we do with this information? Do not sell all your stocks to buy bonds. This would be expensive, rash, and, after all, it’s just one study. But there are still two major takeaways here as far as personal finance goes.
2. Check Your Bias
McQuarrie’s study is an eye-opener: Even some of the safest wisdom can be misleading. Advice comes from people, and people have their biases. Figuring out our own biases as well as the bias in the information we consume is important for getting anything close to resembling the truth. And, just like 20th century finance professors were biased in thinking American economic growth would continue forever, financial journalists actually have an interesting bias of their own, according to a helpful new paper from researchers at Arizona State University and the University of Texas A&M. Those researchers found that finance journalists tend to be too soft on the companies it writes about.
1. Saving > Strategy
McQuarrie’s findings also shed light on how there is a limit to what any investing strategy can accomplish. No amount of preparation and homework can account for every contingency. What the bond millionaires of the 1800s and the stock market millionaires of the 1900s had in common was not superior strategies or better investment advice, it was money to invest in the first place. To quote the great Yogi Berra, “It’s tough to make predictions, especially about the future.”
This has been Strategy, a weekly rundown of the most pertinent financial, career, and lifestyle advice you’ll need to live your best life. I’m James Dennin, innovation editor at Inverse. If you’ve got money or career questions you’d like to see answered here, email me at email@example.com — and pass on Strategy with this link!