How much time is needed for stocks to outperform bonds?
A stock portfolio is like fine wine. But not in the way you think.
I mean…sure, “it gets better with age.” That’s the low-hanging fruit (get it?). I won’t deny that truth.
But what’s more important – and what we should focus on – is that stocks are like wine because premature expectations can lead to nasty results.
Friend-of-the-blog Matt (who owns a wine store in Rochester), shared some wisdom with me. For some wines and champagnes (and bourbons, and other liquors) waiting years-to-decades is a prerequisite of palatability. Opening that bottle or barrel early leaves a poor (pour?) taste in your mouth.
Stocks are no different.
From Port to Portfolio
Friend-of-the-blog Rubin Miller shared great charts recently. He answered today’s question: how much time is needed for stocks to outperform bonds? These charts show the difference in investment returns between short-term Treasuries (a.k.a. the risk-free rate) and the stock market.
Stocks outperform Treasuries. It’s plain to see. But that truth only clarifies in the long run. Stocks can be volatile; short-term Treasuries are stable. Thus, stocks can woefully underperform Treasuries over short periods.
Rubin’s three charts, below, show this. We see the 1-year, the 5-year, and the 10-year “premiums,” or differences, in stocks over Treasuries.
Blue = stocks outperforming Treasuries, and Red = vice versa.
The 5- and 10-year data is annualized.
The takeaway, of course, is that the 1-year data is more volatile than the 10-year data. Over any given 1-year period, it’s risky to bet on stocks over bonds. But over 10-year periods, that risk drops dramatically.
In fact, we can zoom out even further. I used a similar data set (the S&P 500 vs. 3-month Treasuries, data from Aswath Damodaran), to create plots for 15-, 20-, and 30-year periods.
In the long run – at least historically – stocks crush risk-free assets. Stock outperformance is never guaranteed over short periods.
That’s risk! And we should be thankful for that risk. Risk and reward are intrinsically tied. Without risk, there’s no reward.
How much time is needed for stocks to outperform bonds? Decades. Today’s data shows it clearly.
Let’s go one step further. What does this all mean to you?
What Does This Mean to You?
This data explains why your short-term needs don’t mix well with stocks. And why Treasuries under-serve your long-term goals.
You need to match the timelines of your financial goals with the timelines of your investments. This is the foundation of goals-based investing. This is “bucketing your money.”
And there’s the question of your risk tolerance. Are you ready to live through the “red” periods over 1 or 5 years? Unless you have a time machine, living through short periods is the only way you’ll get to the 10-, 20-, 30-year periods.
The true cost of long-term investing is psychological. Are you willing and able to withstand the ups and downs?
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-Jesse
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