For many decades, investors have relied on the belief that over the long term, stocks will virtually always provide a higher return than bonds. Despite this fact, many investors incorporate bonds into a portfolio in an effort to minimize risk and provide guaranteed income. Beginning toward the end of the 20th century, changes in the market have led to new ways of thinking about bonds and the role they play in meeting retirement goals.
When you purchase a bond, you are lending money to the bond issuer in exchange for interest payments. You are not purchasing an ownership share of the issuer of the bond, but instead are acting as a creditor to the issuer. When you buy stock, you are actually purchasing a small share of the firm, making you a part owner. Instead of earning interest, you may earn a return in the form of dividends or an increased stock price. Historically, bonds are associated with lower risk and lower returns than stocks, though that has changed in recent years.
Many investors include a variety of stocks and bonds in their portfolio in an effort to balance risk and reward. This is generally seen as an effective strategy because the two tend to move in opposite directions. As bonds go up in value, stocks tend to go down, and vice-versa. That's because stocks tend to rise as economies grow, when people and businesses are both spending money freely. Bonds are more likely to grow as economies shrink, when financing is more difficult to get and people are hesitant to spend.
In the period 1928 to 2010, stocks earned an average of 11.3 percent, while bonds earned just 5.28 percent, according to U.S. News and World Report. This historic trend has led to the general belief that stocks will usually outperform bonds over the long term. From 1981 to 2012, though, stocks returned an average of 10.98 percent, while bonds returned 11.03 percent, according to USA Today. Over the decade from 2002 to 2012, bonds outperformed stocks by 5 percent, according to ABC News.
While bonds outperformed stocks in the latter part of the 20th century and the early years of the 21st century, this trend is very unusual and likely unsustainable, according to U.S. News and World Report. Since the early 1980s, bonds have performed well above average, while stocks have performed well below average. Based on historic data, this trend is unlikely to continue over the long term.
- USA Today: Why Are Bonds Outperforming Stocks Over Long Term?
- U.S. News and World Report: Bonds Beat Stocks for the Last 30 Years—What Now?
- Charles Schwab: Q&A: Estimating Long-Term Market Returns
- ABC News: Riding the Bond Bull—With a Helmet
- Market Watch: Stocks Vs. Bonds--Here's Why Bonds Are Right
- American Association of Retired Persons: The Great Stock Vs. Bond Debate
- Stock quotes image by Chad McDermott from Fotolia.com