Stocks or bonds? Choose wisely.
You might think I’m exaggerating by suggesting that this major investment decision is worth more than $10 million, but I’m not. I’ll show you the data, although of course I hope you don’t immediately start planning your expenses.
Many investors believe that their financial future will be better if they embrace the “safety” of bonds and avoid the risks of stocks.
But historical evidence strongly suggests that the opposite is true.
This is the first in a series of articles that I consider the 2024 Investor Boot Camp.
Explore: Investor Boot Camp 2023
Whether you’re just starting out and have relatively little money to invest, or you’re retired and have been reading my articles for decades, there’s something valuable here for you.
For more than a quarter of a century, I’ve updated some important articles that show how investors can get the premium returns they deserve for the risks they take.
In the past, I started the series by showing how investors can take advantage of 10 capital asset classes with particularly good long-term returns.
But this year I begin with a huge decision that all investors must make: the choice between investing in stocks or bonds.
Of course, you don’t have to keep all your money in either one, and most investors over the age of 50 should have a mix of both. But to help you think through that choice, we’ll compare the historical performance of all bonds versus all stocks.
The easiest way to follow is to download two tables with very powerful information and catchy titles: J1a and J2a. Fixed Income and Equity: 1, 15 and 40 Year Returns (1928 – 2023)
Start with J2a below, which is all about bonds.
As most investors know, a bond is essentially an IOU, a promise to repay a loan, plus interest. Because of this guarantee, bond market prices do not fluctuate as much as stock prices.
My examples are based on bonds issued by the US government, which has never defaulted on these obligations.
Table J2a has three columns. On the left, short-term government bonds; of the three, these are the least volatile, maturing every 30 days. In the center, medium-term government bonds, usually maturing in five years. On the right, long-term government bonds, typically with maturities of 20 to 30 years.
All of the return and growth numbers in these tables assume that you bought bonds and proceeded to reinvest all proceeds, including interest, each time they mature. And “years” refers to calendar years.
As you can see, for all one-year periods from 1928 to 2023, short-term bonds had an average return of 3.3%. For medium-term bonds the figure is 4.9%, for 30-year bonds it is 5.2%. Over 96 years, the initial investment of $100 grows to $2,172 or $9,541 or $12,477, depending on the type of bond.
Although bonds aren’t particularly volatile, you’ll see a wide variety in the best and worst one-year returns, with the spread being particularly wide for long-term bonds. (Here’s an article on bond prices and yields.)
Once you know how to read the tables, you can see the comparable results for 15-year periods and 40-year periods.
The good news about bonds is that they are relatively safe in the short term and their volatility is minimal in the long term. The bad news is that in this long run their returns are not enough to create much wealth, especially after the effects of inflation (roughly 3% since 1928) and income taxes.
The alternative is the stock market and for this we turn to Table J1a below. It’s very similar to the one we just looked at, but this time it has seven columns.
Each of the first four columns represents a major US equity asset class.
The top row shows that over 96 years, an initial investment of $100 would have grown to $948,715 in mixed large-cap stocks (essentially those in the S&P 500 SPX). And notice this: That’s roughly 79 times what that $100 would earn in 20- to 30-year Treasury bonds.
The next three columns show results for large-cap stocks (LCV), small-cap mixed stocks (SCB), and small-cap stocks (SCV). Note the $14.8 million in small-cap stocks.
In short, large-cap stocks are those of very large companies; small-cap stocks are those of small companies, often unknown to most people. Value stocks are companies that, for whatever reason, sell at bargain prices relative to their earnings. “Blended” funds combine value stocks with more popular (and more expensive) growth stocks.
In one-year periods, none of these four asset classes can avoid significant one-year losses. That’s the downside of owning stocks instead of bonds: In the short term, anything can happen.
However, you will see that the worst-case losses were much nicer for 15-year periods, and for 40-year periods there were no losses at all.
You could put all of your holdings in just one of these four asset classes, but history shows that you’ll do better with one of the three combinations in the columns to the right.
The US 4-Fund portfolio is clearly a long-term winner, as you can see at the very top of Table J1a. This combination of four funds, for example, turned an initial $100 into $4.31 million, or 4.5 times what the S&P 500 did on its own.
If you’re really in it for the long term, you might find it interesting that the worst 40-year return for the 4-fund portfolio was 10.8%, very close to the S&P 500’s 40-year average return (11.0 % ).
If you’re old enough to be reading this, it’s unlikely you’ll be investing in anything for 96 years. But those 96-year incomes aren’t as absurd as you might think.
About a year and a half ago, my wife and I invested money for our newborn granddaughter for the rest of her life. Current actuarial tables show that about half of the people born this year are likely to live to be at least 103.
Read: How $10,000 will help my newborn granddaughter have a better retirement
So it’s possible that just $100 spent today on a baby could grow to $5 million or more.
In the remainder of this Investor Boot Camp 2024 series, we will discuss these asset classes and portfolio combinations in detail. You’ll learn how to combine stocks and bonds to control your risk level, how to safely withdraw money when you retire, and much more.
For a more detailed discussion of today’s topic, check out my podcast, The $20 Million Solution.
Richard Buck contributed to this article.
Paul Merriman and Richard Buck are the authors of Talking Millions! 12 Easy Ways to Boost Your Retirement