Over the long term, common stocks almost always offer a better return on investment than government bonds. Over shorter time periods, stocks may under-perform government bonds, as they did in the early 2000s. Investors will generally achieve better results with common stock, but government bonds with guaranteed returns at maturity have a place in most portfolios.
The Longest Term
Before comparing long-term ROI for the S&P; 500 -- a representative index of 500 large U.S. corporations -- with the long-term ROI for U.S. government bonds, select a time period that has predictive relevance. The longest time period may not be the best choice. From 1928 to the end of 2011, for example, data originally collected by the St. Louis Federal Reserve and reformatted by Stern Finance Professor Aswath Damodaran shows that the compounded value of $100 invested in a 10-year government bond amounted to $6,726.52. The data shows that returns on $100 invested in the stock market over the same time would total $166,787.51. The out-sized difference in the two returns over this very long period of time strongly suggests that investors should always favor stocks. But that is not necessarily the right conclusion
The usefulness of a comparison between stocks and bonds over a period of more than 80 years is questionable because investors don't remain invested for that long. Michael E. Lind, senior quantitative analyst for Charles Schwab, recommends comparing returns over a 10-year period. Long-term changes in markets make earlier data less relevant than more recent data to future performance estimates. The compound annual growth rate for the stock market from 1950 through 1990 equaled 10.2 percent, but from 1991 through 2011 the stock market CAGR equaled only 8.22 percent.
While older data comparing stock returns and government bond returns can be misleading, historical data over any period, including the 10-year period recommended by Lind, has no predictive relevance if the investor enters the market at the wrong starting point. In the 10-year period of 2000 through 2009, the stock market CAGR was -0.99 percent. The CAGR for a 10-year bond for the same period equaled 8.96 percent. Relying on historical data to invest in stocks rather than bonds for that 10-year period would have been reasonable, but the results would have been poor.
Stocks have outperformed bonds in the long term -- by about 3 percent annually from 1962 through 2012. But the shorter the investment period, the less certain the ROI for stocks and the riskier the stocks-vs.-bonds decision becomes. In the three-year period beginning in January 2000, the CAGR for stocks equaled was -14.28 percent, while the CAGR for 10-year Treasurys was 12.45 percent. While no particular outcome over any time period can ever be guaranteed, Lind believes that for the 10-year period of 2013 through 2022, long-term investors will achieve better returns by investing primarily in stocks, which he expects to return between 6 percent and 7 percent compounded annually, and secondarily in bonds, which he predicts will return a little under 3 percent compounded annually.
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