Are Stocks Really Riskier Than Bonds? (Updated
for the latest Year)
Here we show you the data, so you can see and decide for yourself if
stocks have really been riskier than bonds.
First we will look at portfolios that are 100% stocks vs. 100% bonds or
100% cash. Then we will look at balanced portfolios.
For short-term investors, stocks are indeed riskier
than Bonds. But for long-term investors the evidence from actual historical
returns indicates that Bonds were actually riskier than stocks. But it all
depends on having a proper definition of what risk means.
Let me be blunt and rather arrogant.
When it comes to long-term investors, virtually the entire investment
community is focused on the
wrong definition of risk. Much of what is written
about risk is at best inappropriate and at worse completely wrong for a long-term investor. This is
caused by an over emphasis on short-term volatility.
For long-term investors we need to have a proper definition of risk. Financial academics and the investment community generally define risk as the
short-term (annual, monthly or daily) volatility of returns from an investment. The volatility of returns is measured
by variance or standard deviation.
From the perspective of a long-term investor, this definition of risk is
flawed for two reasons:
1. The analysis and conclusions almost always focuses on the volatility of
annual (or even monthly or daily) returns. An annual focus might be appropriate for many investors, but
long-term investors should be mostly concerned about risks associated with their
long-term wealth level and not primarily focused on the bumps along the way.
2. The analysis and conclusions are almost always based on
and ignore the erosion of purchasing power caused by inflation. For short-term investors, inflation may not a be a big concern but it has a huge impact in
As to the second point above, it seems self evident that better conclusions will be reached using real
(inflation adjusted) returns rather than nominal returns.
As to the first point above, under the annual volatility definition of risk, stocks
are considered much more risky than long-term Bonds or Treasury Bills (T-Bills). Yet, it
is a fact (based on United States data since 1926) that stocks have (with only
one exceptions) outperformed both 20-year government Bonds and T-Bills over all
historical calendar 30 year periods. With only one exception, in the 57
different 30 calendar year "rolling windows" starting from from 1926 - 1955
the 1227 - 1956 all the way through to the most recent period being 1982 - 2011, stocks
have provided a higher (after inflation) return. But due to higher annual
volatilities, stocks are considered more risky!
To avoid risk (defined as annual or daily volatility) you
may be advised to put substantial portions of your investments into into Bonds or T-Bills
even though the historic data suggests these are in fact are almost guaranteed to under perform stocks in the long run. This kind of
thinking on risk, while it may allow you to sleep better, may be hazardous indeed to your long-term wealth. (That is, if your
goal is wealth maximization at some distant point like 20 or 30 years in the
future, as it is for many investors).
The following graph shows the actual annual volatility in Stock, Bond and
T-Bill returns from 1926 to present. In regards to stocks, this discussion deals
only with the performance of the S&P 500 large company stocks as a group it does not deal with the
risks of investing in a non-diversified portfolio of stocks. The bonds are
20-year U.S. government bonds. The data here is
for U.S. returns as published by Morningstar in their Ibbotson classic edition yearbook entitled,
Stocks, Bonds, Bills and Inflation. (Ibbotson SBBI classic yearbook). The
returns are total "real" returns including dividends and capital
gains ot losses downward each year by inflation. (In the depression years
the real returns are adjusted upwards by deflation since inflation was
Sure enough, the stock returns (the blue bars) are clearly
far more volatile on an annual basis.
Long-term Treasury Bond returns (the red bars) are also quite volatile while T-Bill returns
(in green) are more stable. It's also fairly obvious that the average stock return
is much higher than the average Bond return which in turn is much higher than
the average T-Bill return.
On a real return basis, stocks have had calendar year
losses of over 30% in four of the 86 years since 1926, with the latest occasion
of course being 2008. And two (1930/1931 and 1973/1974) of those occasions
included an adjacent calendar year with a loss of at least 20%, meaning the
total compounded loss was over 60%! Using daily data there would be more occasions when
stocks have plunged at least 60% from a previous peak. That is certainly real
risk and is hard to stomach. Yet we know that despite this
stocks have clearly out-performed bonds in the
The age-old question for investors is whether or not the (highly probable but
perhaps not certain) higher average return from stocks justifies the extra risk
In judging the risk of Stocks versus Bonds, you must consider more
than the annual volatility. The following illustrates this.
Imagine your rich uncle offers to play a coin toss game with you. If you lose
he gets half your net worth. If you win he gives you an amount equal to twice your net worth.
Your expected return is 0.5 * (-0.5) + 0.5 * 2.0 = 0.75 or 75%.
So on average you will win 75% of your net worth but you have a 50% chance of
losing half your net worth and a 50% chance of tripling your net worth.
Should you play this game? Simple expected value math says yes, but most
people would consider it too risky and would not play. It would be a real downer
to lose half your net worth on a coin toss. (If in doubt, a male could ask his
wife, she would likely have no doubts).
How risky is this game? It's very risky unless you are allowed to play
several times. But imagine now if your starting net worth were $100,000 and your rich
uncle said you could divide your money into ten piles and play the game 10
times, each try based on $10,000. If you win 5 times and lose 5 times, you will win
$100,000 and lose $25,000 to net $75,000 ahead. If you win only 2 times and lose 8
you win $40,000 and lose $40,000 to break even. So now you can only lose if you
only manage to win less than 2 coin tosses out of 10. This changes things drastically. It
now seems much more sensible to play the game since you have only a 1 in 10
chance of losing. Your expected return is still the same 75% but your risk is much
This illustrates that in looking at any risky venture it is important to
how many times you get to play the game. If the average return is positive, the
risk declines with the number of times you get to play and if you are allowed to
play many times then the risk approaches zero. Technically speaking, the
standard deviation of your total return over "N" tries is equal to the
standard deviation of each individual try divided by the square root of
"N". As "N" becomes large your total risk becomes very
Similarly, the stock market becomes much less risky, if risk is defined
as a lower possibility of failing to beat bond or cash returns, the longer you
In regards to the stock market and the range of possible returns you
simply cannot analyze
your risk unless you first consider how many years that you will be investing. It is
generally accepted that the average investor is concerned very much with annual
and even daily returns
and has perhaps a year time horizon. Most of the discussion you will ever see about
stock market risks will focus on the one year or even daily volatility. That might be fine for
the mythical average investor but it leads to completely wrong conclusions, for
true long-term investors.
For a long-term investor, I would argue that the more relevant risk is clearly the
risk of insufficient growth in long-term real purchasing power. Analysis which
focuses on the risk of short term volatility in wealth or returns is quite
simply looking at the wrong risk when it comes to the
ACTUAL RETURNS IN THE MARKET STOCKS vs. LONG GOVERNMENT
BONDS vs. T-BILLS
Each point on the above graph shows the compounded annual return from holding
each asset class for 30 year periods ended in the year shown on the "X" axis. For
example, the leftmost points on the graph indicates that the average compounded
return from holding stocks (the S&P 500 index stocks) for the 30 year period
started in 1926 and ended in 1955 was
about 8.5% while holding the twenty year treasury bond earned about a compounded
2.1% and holding treasury bills for that 30 year period earned just less than
0.0%, in all cases the returns are after accounting for inflation, omit taxes,
omit trading costs and assume reinvestment of all income.
The above graph shows that for 57 different 30 calendar year rolling investment periods ranging from 1926
through 1955, all the
way to 1982 - 2011, real (after inflation) stock returns were higher than
20-year government bonds in all cases except for the 30-years just ended in 2011.
In most cases stock returns were very significantly
Note that stock portfolios that
were set up in 1928, just before the massive stock crash of 1929 - 1932, and
ending in 1957, still
beat bonds - and by a huge amount.
Stock (S&P 500 total return index) real returns for
30-year holding periods ranged from a compounded return of 4.4% to per year to a
maximum compounded return of 10.6%, with an average of 7.1% across the 57
different 30-year holding periods.
T-Bills which are supposed to
be safe are almost a guarantee that your return will at best barely outpace
inflation in the long run. Treasury Bills always returned less than a compounded 2%
(after inflation) over 30 year periods, and often returned less than 0.0% as
T-Bills failed to even compensate for inflation. The average T-Bill return for
the 57 different 30-year investment periods was 0.4%.
Treasury Bonds real returns for 30-year holding periods
ranged from a compounded return of minus 2.0% per year to a maximum compounded
return of 7.8%, with an average of 1.4% across the 57 different 30-year holding
periods. Treasury bonds provided compound average real returns over 4% in the 30-year periods that ended after 2000 due
both to the high interest rates that prevailed in the late 1970's and 1980's and
due to the huge drop
in interest rates over those 30 year periods.
To my way of thinking, this graph
illustrates that over 30 year
investment periods stocks have not been riskier than long-term government bonds
given that (with one exception) they always outperformed
bonds over these historical 30 calendar year holding periods. If the future is like the
past, then we might be justified in concluding that stocks will likely continue to
outperform bonds over a 30-year investment period. We are therefore justified in
expecting stocks to continue to outperform over 30-year periods.
Admittedly, what the above 30-year rolling returns graph does not show is how volatile the annual returns were.
For example, in any given 30 year period, stocks always won out in the end (with
the one very recent exception), but
they did subject the investor to horrifying volatility along the way. as
illustrated in our first graph above.
The 30 year stock returns are indeed riskier in terms of annual
volatility of results but
clearly are not riskier in terms of what really should matter most (to long-term investors),
long-term growth in
wealth and purchasing power. It seems wrong-headed to consider a return that
historically varied between 4% and 10% per year, after inflation, (this is over 30-year
periods) to be riskier than the
return on treasury bills, which never got above 2.0%, after inflation.
Most investment theory teaches that the risk versus return trade-off is a
matter of personal preference. The stock market offers higher average expected
stocks but at the cost of higher annual volatility. To their credit, the industry encourages
those with longer term time horizons to use a higher equity weighting but still
advises that all investors allocate some funds to Bonds and Bills. But this really
offers little guidance to investors.
My conclusion is that the risk return trade-off is more a matter of time
horizon and education, rather than personal preference. If you are virtually
certain that you will not require the funds prior to 20 years or more, then
history teaches that stocks have not been riskier. Stocks will almost certainly return
more than Bonds or Bills (based on historic data).
If investors are educated about this then most of them can
become more comfortable with the daily, monthly and annual volatility of stocks safe
in the knowledge that high returns in the long-term is their almost certain
destiny. It's a bit like taking a drive on a mountain road with a lot of switchbacks. If
you don't know the road, the switchbacks and back-tracking might be highly
stressful (as you think you are going in the wrong direction). But if you have
studied a map carefully then you can relax and the switchbacks will not bother
you since you know that the road to your destination will be circuitous.
Shorter time periods
For 15-year holding periods there are a few periods where
bonds beat out stocks. Since stock portfolios began
in the late 20's or began at the end of 1993 through 1997 did not out-perform
long-term government Bonds over the next 15 years, it might be
wise to refrain from investing 100% in stocks during times where stocks seem to
be clearly over-valued, if one can identify that.
For 10-year holding periods there are still not very many
periods where bonds beat out stocks. However, we do see that in the 10-year
periods ended 1008 through 20121, bonds did beat stocks by a significant amount.
Overall it appears that the range of bond returns is relatively large from minus
5% compounded for ten years to over 10% compounded per year. It is apparent that
the average return from stocks over the many 10-year holding periods has been
significantly higher. The worst case scenario for stocks was not quite as bad as
the worse bond scenario.
Before concluding that a 100% allocation to stocks is a
reasonable approach even for very long-term investors, we need to take a look at how
diversification through balanced portfolios can affect the outcome.
Most investment advice advocates holding a balanced portfolio of stocks,
bonds and cash. It is sometimes claimed that due to dollar cost averaging
balanced portfolios can provide both higher returns and lower risks. So let's take a look at the average returns over 30-year periods
using balanced portfolios.
The above graph illustrates that over the 57 rolling 30
year periods ending in 1955 through 2011, Balanced portfolios have
noticeably under-performed 100% stock portfolios. The notable exceptions
the 30 year period ended in 2002, where the 70% stocks, 30% bonds portfolio
equaled the 100% stock portfolio and the 30 year periods ended 2008, 2009, 2010
and 2011 where the 70%
stocks, 30% bonds managed to beat the 100% stock approach. The balanced
approach managed to beat the all-stock approach in the 30-year periods ended
2008, 2009, 2010 and 2011 due to the benefits of dollar cost averaging.
that in more recent periods Balanced Portfolios have under-performed by a
smaller percentage over 30 year periods or even beaten 100% stocks. This leads many to conclude that
is to be expected in future. Not so. Balanced Portfolios nearly kept pace with
(or even beat) stocks in
more recent years only because of the dramatic drop in interest rates. Now that
interest rates are at historic lows, that situation will almost certainly not occur for 30
year periods that are starting now.
Proponents of Balanced Portfolios often argue that you
will only give up a small amount of return and will get lower annual volatility.
But note that a $100,000 stock portfolio growing at say 8% (after inflation) grows
to $1,006,300 in 30 years, while a Balanced portfolio growing at say 6.0% grows to
only $574,300. So, the stock portfolio in this case is worth a hefty 75%
more. So much for giving up a "small" amount of return!
Balanced approaches, however may be advantageous for
shorter periods, as the following illustrates.
The above graph illustrates exactly what would have happened to
an investor following a partly balanced approach of 30% stocks and 30% bonds
(the yellow line) or
following a more fully balanced 50%, 25%, 25% stocks, bonds and cash (bills)
allocation (the purple line).
This assumes U.S. data and that stocks are represented by the S&P 500 index
by 20-year U.S. government bonds and cash by 30-day U.S. government Treasury
bill investments. This
assumes annual re-balancing to maintain the balanced allocation. There is no
speculation in this data, only historical reality.
The result is
that the partially balanced portfolio significantly under-performs a 100% stock
portfolio in about half of the 72 different rolling 15 year periods. There were
about 21 cases
where the balanced portfolio was only slightly below the 100% stock approach.
The partially balanced approach was superior only for the 9 periods that started in 1926
through 1931 and ending in 1940 through 1945 and as well in the 15 year periods
ended 2002 and 2007 through 2011. The more fully balanced portfolio trailed the stock returns by
a significant margin most years but did beat the stocks in the 15 year
periods ended 1940 through 1944, as well as 1974, 1982, 2007 thru
2011. And holding the partially
balanced portfolio came at the expense of very noticeable under performance
compared to 100% stocks in about half of the 15 year rolling periods. The
underperformance was much more pronounced with the more fully balanced portfolio.
One thing that the graph illustrates is that for 15 year
holding periods, all of the asset classes gave poor returns for the 15 year
periods ending approximately 1975 through 1986. And being balanced among three
poorly performing asset classes was of no help.
Overall, the graph above provides good support for the
notion that a balanced portfolio such as 70% stocks, 30% bonds is a good
approach for investment periods of around 15 years.
The balanced 70% stocks / 30% bonds portfolio occasionally outperforms the
100% stocks approach over these ten year holding periods. The 50% Stocks, 25%
bonds, 25% cash portfolio appears to consistently under perform the 70% stocks
approach. It would be possible to conclude from this graph that the 70% stocks
approach is a reasonable approach compared to 100% stocks.
In regards to stocks, this discussion deals only with the performance of
the large stocks comprising the S&P 500 index as a group it does not deal with the risks of investing in a
non-diversified portfolio of stocks.
For shorter term investments the stock market is very risky compared to Bonds
and short term treasury Bills. The average return from stocks has been
consistently higher over long periods but over shorter periods
(anything under 10 to 15 years) the results from stocks are hugely uncertain. It would be most unwise indeed to
invest money needed next month or next year or even prior to about 10 to 15
years in 100% stocks
As the time horizon lengthens, we reach a point where stock returns
almost (but never quite) certain to exceed Bond and Bill returns - at least based on
historical U.S. results from 1926 through 2011. For time
horizons exceeding 15 years it seems quite unlikely that stocks will under
perform Bonds and virtually certain that they will out perform Bills. With a 30
year time horizon it seems virtually certain (based on history) that stocks will outperform Bonds.
A 100% (diversified) stock portfolio seems virtually certain to outperform, over
30 year periods, portfolios with any portion of the funds allocated to Bonds or
This analysis was based on making an initial investment
and letting it grow over time.
Of course, if one is capable of expertly timing the
markets then it would be possible to beat the 100% stock approach in the
long-term by "simply" being in the highest returning asset class each year.
This will be attractive perhaps to psychics and clairvoyants. Mere mortals
investing for 15 years or longer might wish to consider the 100% stock approach.
However, investors that are uncomfortable with annual volatility should use a
balanced approach. And it may be realistic for long-term investors to move some
money out of stocks if stock prices are in an obvious bubble.
Virtual certainty is not quite 100% certainty there is always some small
chance that Bonds will outperform even in a 30 year time horizon. (As in
fact they did in the 30-years ended 2011.)
You don't have to agree with my conclusions. You can also
study the graphs above and draw your own conclusions.
Self-described long-term investors need to be sure that
they really have a long time horizon before they act accordingly. For many
investors, there is a chance that they will need to cash out their investments
early. This could be caused by illness, job loss, disability, legal problems and other
reasons. But, if an investor is virtually certain that they have a very long
time horizon then it certainly appears that stocks (based on a U.S. large stock
index) are not riskier than bonds, in terms of achieving a high ending portfolio
The above analysis shows that stocks tend to significantly
outperform bonds and balanced portfolios as of the end of a 30-year holding
But what about the volatility along the way? And what
about for more realistic scenarios like saving so much per year for 30 years
rather than just majing a one-time deposit and waiting 30 years. And what about
We have all of that covered in two related articles:
The first article shows what
happened to portfolios for all the possible 30-year savings periods
from 1926 to 1955 all the way to 1982 through 2011 invested in either 1. 100%
U.S. stocks (S&P 500 index fund in non-taxable account) or 2. Invested 60%
in stocks, 35% in corporate bonds and 5% in cash.
The second article shows what
happened to one million dollar portfolios for all the possible 30-year
retirement periods from 1926 to 1955 all the way to 1982 through 2011
invested in either 1. 100% U.S. stocks (S&P 500 index fund in non-taxable
account) or 2. Invested 60% in stocks, 35% in corporate bonds and 5% in cash.
Shawn Allen, CFA, CMA, MBA, P.Eng.
President, InvestorsFriend Inc.
Article created, June 2001 and last updated March 24, 2012