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 Stocks, Bonds, Bills and Inflation and Gold  - Asset Class Performance

This article examines graphically the long-term historic performance and returns of the five major asset classes of stocks, long-term bonds, T-bills, Gold and the U.S. dollar. The results are truly enlightening and amazing! The results are based on U.S. data from 1926 through 2010. The data source is a well-known reference book called "Stocks, Bonds, Bills and Inflation" 2011 edition. The book is published annually by Morningstar. (Ibbotson SBBI classic yearbook). In addition we added Gold's long-term performance from www.onlygold.com

Note that most analysis of historic returns that you have seen is horribly flawed in that it is based on "nominal" returns before inflation. The graphs and figures below are based on "real" returns after inflation. That is, this analysis shows the real increase in purchasing power generated by each investment asset class.

The graph below shows the long-term real (after inflation) returns on large capital U.S. stocks (The S&P 500 stocks), long term U.S. Treasury bonds (approx 20 years), U.S. Treasury Bills (30-day cash investments) and the real value of a U.S. dollar after inflation) and Gold. The return is illustrated by showing the growth over the years of a $1.00 invested in each asset at the end of 1925.

Isn't that amazing? In real-dollar terms (adjusted for inflation), large U.S. stocks have absolutely walloped long bonds, short-term cash investments, Gold, and the dollar itself in terms of total growth or return. Each $1.00 invested in large stocks at the end of 1925 is now worth $244 (85 years later at December 31, 2010). Compared to large stocks, the other asset class values after 85 years are so low they barely show up on the graph. (We'll fix that below) $1.00 invested in long U.S. government treasury bonds for those 85 years is now worth $6.88. (It's not shown but $1.00 invested in U.S. long-term corporate bonds in 1926 did slightly better than treasury bonds and is now worth about $7.60.) $1.00 invested in T-Bills in 1926 is now worth just $1.68. $1.00 invested in Gold for the 85 years is now worth $5.62. $1.00 left literally in cash and not invested at all is now worth only 8 cents, due to the ravages of 85 years of inflation.

Remember, all figures are after inflation and assume reinvestment of dividends or interest received and also assume tax-free and no-fee investment accounts. (With taxes the growth would be less dramatic but would be even more in favor of stocks given the lower tax rates on capital gains and dividends. However since the Gold held for the 85 years would attract no taxes and no transaction fees it would improve relative to stocks if those were taken into account.)

This means that if old Grampa had foregone just 1 case of beer at the end of 1925 and invested the money, in a tax-free account, in the S&P index of large stocks (and reinvested all dividends and rebalanced to stay with the index over the years, and ignoring transaction costs), his grandson, at the end of the year 2010, could go out and buy 1 case of beer and still have enough left to buy 243 more cases! This is truly amazing and is really a case where you can in fact have your cake and eat it too, if you just delay eating the cake and instead invest the money for a long time. (Later I will show that there are some pretty good returns over 20 year periods, so you don't have to actually invest for 85 years!). Note, however, that the year-end market data peaked at the end of 1999 when the $1.00 in stocks had grown to $303.

This amazing out-performance of stocks (which beat long-term government bonds by a factor of $244/$6.88 or 35 to 1, in the 85 years) has occurred in spite of the two huge stock crashes that have occurred since the year 2000, not to mention the stock crash of the great depression. The stocks also beat Gold by a factor of $244/$5.62 or 43 to 1.

The T-Bill investment at $1.68 has just barely kept ahead of inflation. And a dollar kept literally in cash as in a safe deposit box or under a mattress still is the same dollar but it now buys only what 8 cents would have bought in 1926.

The above graph which has a normal linear scale does a great job of showing the huge difference in the ending portfolio values but unfortunately is distorted in three ways.  First, the results from the earlier years are not really visible, Second, it looks like the percentage rate of growth for stocks was increasing toward infinity until 1999, and third it also looks like the early 2000's stock crash was by far the biggest market crash ever.  A logarithmic scale solves these problems because a constant percentage growth appears as approximately a straight line and the percentage gains in the earlier years are much more visible. Unfortunately a logarithmic scale tends to somewhat obscure the huge differences in the ending values. When viewing a growing data series it is probably best to view it with both logarithmic and linear scales to better understand the results.

The same data presented in the above graph is presented below with a logarithmic scale.

In this graph (with the same data as above) you now have to look more closely to realize the amazing extent to which large stocks (the S&P 500) outperformed bonds, T-bills, Gold and the dollar itself over the 85 year period. But this logarithmic scale allows you to view the volatility over the years.

A constant slope on this logarithmic graph represents an approximately constant annual percentage growth. By the nature of logarithmic graphs, a dip or gain on this graph of a certain height represents the same percentage change whether it happened in the 1920's or the 2000's. Any dip or gain visible on this graph is actually large since a logarithmic scale tends to make even large percentage changes look small.

This graph reveals that large cap stocks (the blue line) were much more volatile than bonds, particularly  from 1926 - 1932, the mid 70's and in the 2000's. Again, remember that the graphs show real returns, adjusted for inflation. It is Interesting that the big stock market crash in 1987 is not apparent on this graph. The reason for that is the fact that the graph here shows only year-end figures. The big crash in 1987 was actually an event that happened within the year as stocks soared until October that year and then crashed. On a calendar year basis U.S. large cap stocks were actually up slightly in 1987.

The Graphs below take the data above and break it out into 20 year periods and reveal some very interesting insights into asset performance in different periods. Note that the scales below are linear and that all the scales go to $8.00 (A 700% gain, from the $1.00 starting point). By using the same scale it is easier to visually compare the performance across the different 20 year periods.  

Long Treasury Bonds (the red line)  look like the place to be in the 1926 - 1945 period. Stocks beat out Bonds in the end but it was a rough ride indeed. The stock index returned 291% after inflation in the 20 year period while the Treasury bond index returned 148% and Treasury bills eked out 22%. Gold gained 78% in real terms. A paper dollar in a safe or under a mattress gained in value during the depression due to deflation and ended up losing just 1.5% in purchasing power over these 20 years. 

Notice that the dollar exactly tracked Gold (or was it vice versa?) until 1934 which was when the U.S. government forced citizens to turn in their Gold for $20.67 per ounce (so called expropriation, but they did pay for the Gold) and then the government effectively devalued the dollar by redeeming U.S. $35.00 dollars from foreign banks in exchange for one ounce of Gold as opposed to the former $20.67. ($1000 therefore that used to "buy" 48.4 ounces of Gold would now buy only 28.6 ounces due to the devaluation of the dollar). 

The (relatively) unique thing about this time period was the huge stock valuation bubble in the late 20's followed by a bursting in late 1929, which was then exacerbated by poor government policies that led to the Great Depression. Note that the full extent of the crash is not visible in this graph because it uses only year-end, rather than daily data.

Wow 1946 - 1965, what a run for stocks, while bonds and T-Bills and Gold all  failed to even keep up with inflation. The dollar itself fell in real value due to inflation. It's interesting to note that stocks would be considered to be much more risky, because they increased in a volatile fashion while bonds were pretty flat and went nowhere. But if this is what people call risk, I'll take it! The stock index returned a whopping 664%, after inflation, while the long bond index investment lost about 21% and even so-called risk-free Treasury bills lost 16% after inflation, over the 20 years. Gold lost 46% in real terms and the dollar itself lost a similar 43%. Gold was tied to the dollar because the U.S. government would (for foreign governments) redeem dollars for Gold at $35 per ounce, hence the similar loss.

Whenever you look at long term data that shows the huge margin by which stocks have beaten bonds, it is wise to remember that a huge chunk of that came from the 15 years after 1949.

During this period there was moderate inflation, in contrast to the deflationary 30's. Long-term bond rates did not appear to reflect an expectation of even moderate inflation. Stocks were able to keep up with inflation, (in fact far out-paced inflation) while long term bonds got hammered due to unanticipated inflation.  The post war years also saw unprecedented gains in productivity and the birth of the consumer society. This benefited stocks, hugely. We should not expect these factors to be repeated in future.

Ouch! 1966 - 1985 was an ugly time to be an investor, no place to hide except for Gold! Note that the scale extends to $8.00 so that the graph can be easily and properly compared to the 1946-1965 graph above. These were the really big inflation years and both stocks and bonds as well as treasury bills had a very hard time keeping up with high inflation. The dollar itself lost an ugly 71% mostly due to the famous high inflation of the 70's.It does not look like much, but stocks returned a total real portfolio gain of  53% over the 20 years while long bonds lost 7% and Treasury bills made 20%. Both stocks and bonds were volatile and both had periods where they dropped about 50%. T-bills were looking good with low volatility and reasonable returns compared to the other assets.

But Gold, was the place to be. It continued to track the dollar until President Nixon took the dollar off of the Gold standard during in 1971 and then Gold soared in dollar terms. From 1972 to 1980, Gold did a LOT more than keep up with inflation. It rose about 500% in real buying power terms after adjusting for the big inflation. 

Next we look at the period from the end of 1985 through the end of 2005.

$1.00 invested in large stocks at the end of 1985 was worth $5.29 at the end of 2005 for a gain of 429% (in spite of the stock crash of the early 2000's) in real after-inflation terms at the end of 2005. The corresponding figure for Long Bonds was $3.15 (215% gain) and for T-Bills is $1.36 (36% gain). Gold did not quite hold its purchasing power and was down 13% in these 20 years. Gold had fallen to 54 cents at the end of 2000 but then roared back to 87 cents at the end of 2005. The purchasing power of a cash dollar fell by 44%.

A very distinctive thing about the period of 1986 through 2005 was a huge drop in interest rates. This provided a huge boost to bond returns. It also contributed to higher P/E multiples being justified for stocks, which boosted stock returns. Another relatively unique thing about that period was the huge stock valuation bubble of the late 90's which then deflated and then partially recovered.

In order to cover the 20 years ended December 31, 2010, our last graph will significantly over-lap the one just above.

 

In the four other 20-year periods shown above, stocks handily beat out long government bonds. However in the 20 years from the start of 1991 through 2010 stocks beat out government bonds by only a small amount. Bonds were also tremendously less volatile.

$1.00 invested in large stocks since the start of 1991 (end of 1990) was worth $3.52, in real terms, after inflation at the end of 2010. For long-term government bonds the figure is $2.79 and for Treasury bills $1.20. Gold at first did poorly but then surged after 2001. $1.00 in Gold at the end of 1990 fell to  just 54 cents in real purchasing power by 2000 but then roared back to and past $1.00 and ended up at $2.25. In nominal terms and based on daily data the rise in Gold was even higher from its lowest day but we are dealing with year end figures here and adjusted for inflation. The purchasing power of a cash dollar declined 49% in these 20 years. 

Many analysts will use this last 20 years or so to conclude that a balanced position between stocks, Bonds and T-Bills is always best. (And some will argue for an exposure to Gold as well). I'm not convinced that balanced is best for everyone. If you are investing for at least 20 years, a good case can possibly be made for a 100% allocation to stocks. I would reconsider though if I thought that stocks were way over-valued at a particular point in time. I consider stocks to be approximately fairly priced at this time and not in a bubble. However, long-term government bonds are arguably at bubble levels and therefore it may be wise to avoid them, in spite of (actually, because of) their great performance in the past 20 to 25 years.

The above graphs demonstrate that the market looks very different in different time periods and it is therefore very dangerous to make assumptions about the relative performance of stocks and bonds in the next 20 years.

Conclusions and Summary 

By studying these graphs, you can draw your own conclusions about the relative returns and risks of Stocks, Bonds, T-Bills and Gold. And you can see the decline in purchasing power that occurs with actual cash held in a safe or in a mattress for 20 year periods.

Note that these total return indexes ignore taxes (effectively assumes a non-taxable account) and also ignore trading costs.

Stocks (the S&P 500) out-performed Bonds and T-bills and Gold by an absolutely staggering amount over the last 85 years. Stocks therefore also did a far superior job of protecting against inflation over the full 85 year period.

Stocks even out-performed over the 20 years from 1926 through 1945, in spite of the depression and crash of 1929-1932. Bonds also did reasonably well. T-Bills were basically the after inflation equivalent of stuffing cash under the mattress. Gold did reasonably well in the end but was highly volatile in terms of purchasing power. Actual cash in a mattress basically rotted away.

For the 20 years from 1946 to 1965, stocks were far superior. Bonds and T-Bills imitated mattresses (but did protect against inflation, although not fully). The dollar itself and Gold which was tied to the dollar both lost almost half of their purchasing power. 

The 20 years from 1966 through 1985 were ugly all around (unless one held Gold). Stocks came out slightly ahead of bonds. Gold had very large returns as it was de-coupled from the U.S. dollar and as Americans were again allowed to own it.

During the 20 years ended 2005, Stocks did very well but with high volatility, Bonds did unusually well compared to stocks and with a lot less volatility. T-Bills continued to only slightly out-perform inflation. Gold slightly trailed inflation.

In the 20 years ended 2010 stocks barely beat out long-term government bonds and were also extremely volatile. Despite its recent huge surge, Gold was not a very good investment if held over the full 20 years.

A major learning from the above graphs is that the markets look very different in different time periods. It would be foolish indeed to base your investment decisions solely on the results from the last 20 years or so. Those two decades were unique due to a combination of low inflation and declining interest rates. Long-term interest rates probably won't get much lower (and have been heading up) and so the next 20 years is sure to look far different than the most recent two decades.

The above data and graphs focus on just four investment periods beginning at the end of 1925, 1945, 1965, and 1985 (plus the over-lapping period beginning at the end of 1990). Given the significant differences in the performance of stocks, versus bonds or T-bills and Gold over those four+ periods, it is also very useful to look at the comparison over all the possible 10 to 30 year holding periods beginning each year since the end of 1925. My related article does this by graphing the average annual returns over all those possible holding periods and attempts to answer the question of whether stocks are really riskier than bonds.

Originally written Summer 2001 and last updated February 13, 2011

Shawn Allen, CFA, CMA, MBA, P.Eng.

President, InvestorsFriend Inc.