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Are stocks safer than bonds?

If you’ve done any reading about investing, you know that stock market returns are unpredictable over short periods and predictable over long periods.

And you also know that–over long enough periods (however long those may be)–stocks outperform bonds.

However, until I started reading Jeremy Siegel’s Stocks for the Long Run, I’d never heard anyone make the case that–over extended periods–stocks not only earn greater returns than bonds, but more predictable returns as well.

In other words, not only do stocks earn more than bonds, they are actually safer investments for long-term investors.

How does Siegel reach this conclusion?

In short, he compares the range of after-inflation returns of stocks to the range of after-inflation returns of bonds over periods of various lengths. Unfortunately, the data in the edition I have only goes through 1997, and I was curious to see how the conclusion would hold up after updating for the last decade.

Time to pull out the spreadsheet and plug in some numbers!

Updated for 2008: Are stocks less risky than bonds?

The chart below shows us the best and worst stock market returns (after inflation) over periods of various lengths. As you can see, the real return from stocks becomes much more predictable as you look at longer periods.

For example, the worst 1-year real return for stocks was -37.7%, but the worst 10-year real return for stocks was a compounded -4.6%.stock-returns

The next chart shows the same thing, but for bond returns (as measured by the total return on 10-year U.S. Treasury bonds). As with stocks, the returns become more predictable as we look at longer and longer periods.

bond-returnsThe following chart essentially combines the previous two, allowing us to compare the range of bond returns (from best to worst) to the range of stock returns over periods of varying lengths.

Over short periods, the range of stock returns is much greater than the range of bond returns. For example, the worst 1-year real return for stocks was more than 90% worse than the best 1-year real return for stocks. In contrast, the worst 1-year return for bonds was just over 40% worse than the best 1-year return. (This is–in part–why people refer to stocks as “risky.”) range-of-returnsBut look at those 30-year ranges! The range of after-inflation returns for stocks actually becomes lower than the range for bond returns. In other words, stocks are more predictable (ie, safer) than bonds over periods of 30-years.

(If you compare our first chart to our second chart, you can verify this on your own: Over 30-year periods, stock returns fall into a narrower range than bond returns.)

And for any statistically-inclined readers, our final chart shows the standard deviation of real returns for stocks and bonds. Again, we see that 30-year real returns for stocks are more predictable than 30-year real returns for bonds.


What can we learn here?

If you’ve got a 30-year investment time frame a heavy allocation to stocks just makes sense–not just from a total return point of view, but from a risk point of view as well.

The catch: You can’t bail out and sell when the market drops. Otherwise you don’t get those nice, predictable 6-7% after-inflation returns.

Notes on the data:

The period considered is 1928-2008. The yearly returns are for calendar years.

Bond data and inflation data comes from the Federal Reserve Bank of St. Louis’ research site.

Stock return data is from Aswath Damodaran, Professor of Finance at the NYU Stern School of Business.

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  1. Mike – Does this show volatility or safety?

    I am a little confused looking at this because I am not able to understand how the best and worst returns are calculated in this example for longer durations like 30 years…have you taken a moving average or something?

  2. Hi Manshu.

    A great question–volatility as opposed to safety. What it shows is that after-inflation stock returns are less volatile (over periods of 30 years or more) than bond returns.

    As far as I can tell, this–coupled with the fact that the stock returns are greater than bond returns–is the very essence of safety. Granted, if we’re looking at periods of less than 30 years, the opposite case can be made.

    The returns are the effective compound returns over the period (calculated using the “RATE” function in excel). Note, this is not the same as the average annual return over the period. If you’d like to see the spreadsheet, I’d be happy to forward it to you.

  3. Mike. Great work!

    As compelling as this research is, I fear many people may not be able to “hear it” because they are so shell-shocked. However, facts are facts even if they don’t fit with our emotional position.

    Now, more than ever, its important that people read your story. Interest rates and stock prices are so low that bonds become even more riskier and stocks become even safer.

    Again, great job Mike!

  4. Nice post Mike. I have been held up in completing my series on corporate bonds (I appreciate you’re looking at gov bonds here) by an access to up-to-date UK data. I’m going to have to pay up for the 2009 Barclays Gilt-Equity report I think.

    Anyway, now you’ve raised the bar with these yummy graphs.

    Also notice you’ve upgraded to Thesis. It looks great, of course. Please please tell me you clicked on my affiliate link before buying the theme. (I appreciate you probably didn’t – just pulling your chain).

    A Thesis affiliate deal could double my blogging income for the month! (*ironic smile*)

  5. @Monevator: Glad to hear you like the graphs. 🙂

    And thanks for the compliments on the redesign. I’m quite enjoying thesis so far. Sorry to disappoint, but I think I went through copyblogger, hehe.

    And I don’t think I’m much help on UK bond returns. I can’t offhand think of any resources there.

  6. Copyblogger? The law of network effects favours the big guys again. Ah well…

  7. R.G. MAUZER says

    Neal, great web site. My comment would be about the role bonds should play in a structured fomat when developing a retirement program, basically the allocation of them vs. equity percents.

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