Stocks for the long run?

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Sarenco

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It's commonly stated that stocks provide superior long-term returns to bonds.

But what does "long-term" mean in this context?

Over the last 20 years, the S&P500 has produced an annualised 4% return, with all dividends reinvested. That's an annualised real (after-inflation) return of less than 2%.

However, over the same time period long-term (20 year) US Treasuries provided an annualised 7.4% return.

Is this unprecedented?

Nope.

For the 30-year period to 30 September 2011, the S&P500 returned an annualised 10.8%, compared to an annualised return of 11.5% on long-term Treasury bonds.

In fact, for the 40-year period to 31 December 2008, the annualised return on the S&P500 was essentially the same as the return on 20-year US Treasuries (8.98% v 8.92%).
 
Sarenco I could highlight other arbitrary 20 or 30 year periods where stocks vastly outperformed treasuries
 
settlement said:
Sarenco I could highlight other arbitrary 20 or 30 year periods where stocks vastly outperformed treasuries
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Of course. But that's not the point.

We each only have one investment lifetime and luck plays a huge role in the returns we receive.

If you look at the really long-term, the outperformance of stocks over bonds may be somewhat exaggerated -

 
US bonds generally (not just long-term treasuries) have outperformed US equities since the turn of the century.

From the close of trading on 31 December 1999, the Bloomberg Barclays US Aggregate Bond Index (known as the "Agg") has produced a cumulative total return of 176% to 1 April 2020.

The S&P500, in contrast, has risen 149% in the century to date on a total-return basis.

Obviously that tells us nothing about the future but it does demonstrate that bonds can outperform equities over extended periods of time.
 
Sarenco said:
Over the last 20 years, the S&P500 has produced an annualised 4% return, with all dividends reinvested. That's an annualised real (after-inflation) return of less than 2%.

However, over the same time period long-term (20 year) US Treasuries provided an annualised 7.4% return.
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Actually one can be reasonably certain of bond returns. If 20 year US Treasuries provided 7.4% return over the last 20 years that is because their yield in 2000 was 7.4% p.a.
The yield on 20 year US Treasuries today is 1.04% p.a. That is what you will nominally earn for certain over the next 20 years if you invest in them.
After tax, costs, inflation and exchange rate movements you would have a fair certainty that you will get a negative return over the next 20 years. In fact if you wanted to avoid the exchange rate risk it is German 20 year bonds you would plump for, yielding -0.25% p.a. before costs.
I don't know how any investment manager can justify having bonds in a retail investment fund at these yields. If the punters are risk averse then sit on cash until some normality returns.
 
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Sarenco said:
US bonds generally (not just long-term treasuries) have outperformed US equities since the turn of the century.

From the close of trading on 31 December 1999, the Bloomberg Barclays US Aggregate Bond Index (known as the "Agg") has produced a cumulative total return of 176% to 1 April 2020.

The S&P500, in contrast, has risen 149% in the century to date on a total-return basis.

Obviously that tells us nothing about the future but it does demonstrate that bonds can outperform equities over extended periods of time.
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Can you explain the difference between bonds and long-term treasuries?
 
I opened a thread several years ago asking why U.S treasuries were so cheap relative to European sovereign debt

It was a very sound buy at the time, still is in my view when you see how little unity there is in Brussels as to how to deal with this
 
Duke of Marmalade said:
In fact if you wanted to avoid the exchange rate risk it is German 20 year bonds you would plump for, yielding -0.25% p.a. before costs.
I don't know how any investment manager can justify having bonds in a retail investment fund at these yields.
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Warren Buffet made this point in back february , nobody buying negatively yielding bonds now expects to hold them to maturity, they will all be looking to offload them to someone else, what happens if they all look to do this at once?
It wasn't very prescient advice as the stock market started crashing a week later and bond prices rose to new heights a trend they have been in since 1982.
The irish government are going to borrow much more money from the bond markets at very low interest rates and they are not one bit worried about getting this money. I think this is very good for the irish government and it is good that they can do this, but who would want to buy those bonds ?
 
I think it's important to consider the diversifying potential of bonds within a portfolio, even at historically low yields.

The equity funds within my pension are down around 18%, year-to-date (boo!).

However, my bond fund is up around 2%, year-to-date (yay!).

So at a portfolio level, the bond fund has helped to cushion the falls.

I don't hold bonds for income or return - I hold them to dial down the volatility within my equity heavy portfolio.
 
Sarenco said:
I think it's important to consider the diversifying potential of bonds within a portfolio, even at historically low yields.

The equity funds within my pension are down around 18%, year-to-date (boo!).

However, my bond fund is up around 2%, year-to-date (yay!).

So at a portfolio level, the bond fund has helped to cushion the falls.

I don't hold bonds for income or return - I hold them to dial down the volatility within my equity heavy portfolio.
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That is the Capital Asset Pricing model. People hold a mix of the overall equity market and risk free cash. That gives the Capital Market Line which varies from entirely risk free to whatever risk you want (if necessary by gearing). The expected reward will be an increasing function of the risk taken.

But bonds are not risk free, in fact at these yields the risk seems to me all downside, unless of course you hold to maturity it which case you will get a negative return albeit without any "risk" to that return.

Following all that PRISM stuff punters have to indicate their risk rating on a scale of 1 to 7. The only credible way to meet that range of requirements is to adjust the mix of equities and cash as per the Capital Asset Pricing model. At these negative yields bonds have no role to play in a retail investment fund.
 
DeeKie said:
If you were starting to build a portfolio now where would you start?
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I would start with a global equity fund and then add a Euro Government Bond fund to taste.
zephyro said:
How far are you from retirement?
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I don't know TBH - it's a bit of a moving target.

My rough plan at the moment (which may change over time) is to hold roughly 10 years' worth of annual expenses in fixed-income investments (bonds and cash deposits) at retirement, with the balance in a global equity fund.
 
Duke of Marmalade said:
At these negative yields bonds have no business in being in a retail invstment fund.
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You have been making that point for some time now Duke.

I'm surprised that you can't see that recent events have demonstrated the potential value of holding bonds within an equity heavy portfolio.

Duration has very definitely been my friend in recent weeks.

Cash de-risks a portfolio but it doesn't diversify a portfolio.
 
Sarenco said:
You have been making that point for some time now Duke.

I'm surprised that you can't see that recent events have demonstrated the potential value of holding bonds within an equity heavy portfolio.

Duration has very definitely been my friend in recent weeks.

Cash de-risks a portfolio but it doesn't diversify a portfolio.
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Any asset class which is uncorrelated is a diversification but I won't get into the semantics.
In "normal" times, say when interest rates are at 3% or higher I would absolutely agree that bonds are a suitable asset class for the retail investor.
You are recommending Euro govies and indeed you claim a +2% kicker YTD on the bond portion of your investments. German 10 year yields have fallen from -.22% to -.44% YTD i.e. a .2% fall and that roughly translates as a 2% price appreciation.
What do you think is the further upside? Can bond yields fall a further .2% to give what is after all a relatively modest kicker?
The pricing here is meaningless to the retail investor. She is definitely better with it under the mattress than earning negative yields. But for a bank or insurance company the mattress costs money and hence the Central Banks are able to force the institutions to pay for custodianship of their liquid assets. But this has limits. Switzerland has been able to charge people for holding their deposits for some time but I doubt that charge ever exceed 1% p.a. So you really must see very little upside potential in bonds at these yields.
On the other hand there is a school of thought that borrowing rates for governments could soar as they seek to fund the massive fiscal deficits incurred in defence of the virus. If bond yields reverted to say 2% p.a. (itself historically very low) 10 year govies would fall c. 25%.
I can't understand why you don't see the risk reward dynamics of current bond yields as hugely skewed against the retail investor.
 
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Duke of Marmalade said:
Any asset class which is uncorrelated is a diversification but I won't get into the semantics.
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I disagree.

Diversification strives to smooth out portfolio returns, so the positive performance of some investments neutralises the negative performance of others. The benefits of diversification only hold if the securities in the portfolio are not perfect correlated - that is, they respond differently, often in opposing ways, to market influences.

Cash dilutes equity risk but it doesn't diversify equity risk. Cash doesn't "respond" to a falling stock market.

High quality bond prices, on the other hand, often move in the opposite direction to equities during a sharp correction. That's what happened in 2008 and that's what happened last month.

Plenty of talking heads argued until recently that bonds could no longer diversify an equity portfolio at historically low (or even negative) yields. It turns out they were wrong.

As an aside, the interest rate on deposits held by the life company where I have my retirement savings is currently negative. Hiding out in cash doesn't necessarily avoid negative interest rates.
 
Sarenco said:
I disagree.

Diversification strives to smooth out portfolio returns, so the positive performance of some investments neutralises the negative performance of others. The benefits of diversification only hold if the securities in the portfolio are not perfect correlated - that is, they respond differently, often in opposing ways, to market influences.

Cash dilutes equity risk but it doesn't diversify equity risk. Cash doesn't "respond" to a falling stock market.

High quality bond prices, on the other hand, often move in the opposite direction to equities during a sharp correction. That's what happened in 2008 and that's what happened last month.

Plenty of talking heads argued until recently that bonds could no longer diversify an equity portfolio at historically low (or even negative) yields. It turns out they were wrong.

As an aside, the interest rate on deposits held by the life company where I have my retirement savings is currently negative. Hiding out in cash doesn't necessarily avoid negative interest rates.
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Oh dear! I didn't want to go down the rabbit hole of diversification. The correlation of cash returns and equity returns is zero ergo it provides diversification. The correlation of bond returns and equity returns has flipped from positive during the high inflation period to negative during this low inflation/deflation and so may be a better diversifier than cash, I'll concede you that and I'm climbing out of this rabbit hole now.
I am trying to get you to agree that bonds have much more downside risk than upside potential at these (negative) yields. The fact that I would have stated this at the beginning of the year and yet there has still been a 2% upside YTD does not negate the statement. If you think the risk is symmetric then we will have to agree to disagree.
I know cash is earning a small negative yield but I am addressing in this discussion the asset price risk which does not exist for cash.
 
I don't agree that it's a rabbit hole - it's really my core point and the reason why I hold bonds in my portfolio.

I'm not suggesting that the correlation between equities and bonds is consistent. However, when stock prices are tumbling the correlation tends to turn negative and hence the potential diversification benefit. But look, fair enough, I'll leave it there.
Duke of Marmalade said:
If bond yields reverted to say 2% p.a. (itself historically very low) 10 year govies would fall c. 25%
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That's not really as scary a prospect as it may seem. If there is a spike in bond yields then bond prices would obviously suffer a corresponding fall. But bond funds would start buying bonds at these lower prices, with correspondingly higher yields, and would quickly recover.

Besides, can you imagine what a spike in borrowing costs of that order would do to equities?

Stocks are always riskier (more volatile) than bonds; and bonds are always riskier than cash. That's as true today as it's always been.
 
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