I knew that Jeremy J. Siegel's book The Future for Investors: Why the Tried and the True Triumph over the Bold and the New espoused the virtues of dividend reinvestment and long-term buy-and-hold strategies. It's a philosophy I've believed in for some time, and it's one that Mathew Emmert's Income Investor newsletter -- to which I have been a longtime subscriber -- frequently reinforces. So when I read the book, I was well prepared to play choir to Professor Siegel's preaching. Perhaps it was because I had such high expectations that I was left somewhat disappointed.
Before I comment on the source of my displeasure, let me first say that there is much to like in this book. Siegel attempts to address two questions: "Which stocks should I hold for the long run?" and "What will happen to my portfolio when the baby boomers retire and begin liquidating their portfolios?" Both are questions that every investor should seriously consider.
To answer the first question, Siegel details a study he undertook in which he determined the total return of the original stocks that made up the Standard & Poor's benchmark index from when it was expanded to 500 holdings in 1957 through 2002. He discovered that a portfolio of these original companies, accounting for mergers and spinoffs in various ways, outperforms the overall index, which has added new companies and eliminated others throughout the years.
Siegel explains his discovery as being composed of two components. The first is overpaying for growth. Newer emerging companies that have been added to the index are often expensive in relative valuation terms to those that have been discarded, and this overpayment for future potential diminished the overall return in the later years. The second is the power of long-term dividend reinvestment.
The best-performing original members of the S&P 500, or, as they are referred to in the book, "corporate El Dorados," were all generous dividend payers. The list contains the likes of Philip Morris, now Altria
My biggest gripe with the program that Siegel proposes can be summed up in one word: taxes. Dividends are taxable, and any discussion of their collection and reinvestment needs to emphasize that taxes will diminish returns. Yet the book puts forth no effort to correct for taxes, possibly because doing so would have altered the conclusions of the study. Sure, taxes can be a non-issue for employing the strategy within an IRA, but the preference for tax-advantaged accounts only rates the briefest of mentions in the closing pages of the book. IRAs don't even rate a listing in the index, even though they are a critical factor for obtaining the types of returns that Siegel details (had they been available in 1957, which they weren't). Very disappointing.
Siegel is well aware of the taxation issue. He mentions that the taxation of dividends is a key reason why Warren Buffett's Berkshire Hathaway
A second source of disappointment in the book for me was its lack of effort to evaluate the strategy over different time frames and/or market cycles. We know that the "thesis" would have worked from 1957 to 2002 (ignoring taxes), but what about in between? Which decades favored the strategy? How long, on average, should a program of dividend reinvestment take to show outperformance? Does it require nearly 50 years? Siegel doesn't adequately address the issue to my satisfaction, although as mentioned, and to be fair, my expectation level was set high. I was left with the impression that I was looking at a well-researched anecdote and not data interpreted over time, and so I was left wondering whether the book might have touted growth stocks had it been written in late 1999.
As to the second question of how the wave of retiring baby boomers will affect the market moving forward, Siegel suggests we look to foreign investments to balance our portfolios and protect against such demographic factors. The book shifts here from analysis of past data to speculation on the future, but the transition is handled well. Here again, Siegel warns about investing in the fastest-growing economies, since they too frequently are overpriced, in valuation terms, and can become growth traps. He strongly recommends approaching international investing broadly, such as via an index fund or exchange-traded fund such as the iSharesMSCI EAFE Index
Siegel's thesis for international growth is only partly directed at U.S. citizens investing internationally. A large part of his argument is that international growth will keep the U.S. market from experiencing a sell-off as the boomers retire. He believes that U.S. stocks are and will be an attractive place for investment among international investors, such as the newly wealthy from India and China, and that this increasing foreign ownership will keep the U.S. market strong. This is speculation at best, but it's an interesting theory with a good dollop of plausibility.
The Future for Investors lays out a look at investing strategies of the past and suggests strategies for successful investing in the future. The lessons and anecdotes contained in the book are quite valuable to individual investors.
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Fool contributor Ralph Casale, known on the discussion boards as HelicalZz, is a firm believer in the strategy of dividend collection and reinvestment. He owns shares of Abbott Laboratories but holds no financial position in any other firm mentioned. The Motley Fool has a disclosure policy.