No matter where in the world you were invested in 2022, it was a painful year. That’s because both stock and bond prices fell.
Typically, bonds are supposed to be a buffer to your investment portfolio when stock prices crash.
However, last year – given the rapid pace of interest rate hikes by the US Federal Reserve (Fed) – bond prices fell as yields went up (bond prices and their yields have an inverse relationship).
So, now that there’s talk of a potential “pause” in Fed rate hikes at their current level, or perhaps just one more 25-basis point (bp) hike to come, what should investors be thinking?
That’s because yields on bonds are at the most attractive they have been in well over a decade. For example, the latest 6-month T-bill issued by the Singapore Government provides a yield of 3.85% per annum.
That’s great in the short term but are bonds the better buy right now versus stocks when we’re thinking about long-term returns? Let’s find out.
More volatility for stocks but higher returns
It makes sense that buying stocks gives you better returns – over the long term – but with more volatility involved.
In fact, in US stock markets (which have the biggest data set available) from 1926-2019, a portfolio with 100% in stocks would have produced an average annualised return of +10.3%.
That’s according to data from Morningstar (among others) as well as calculations by financial services provider Vanguard.
So, what about bonds? Well, over that same period a 100% bond portfolio would have given you an average annualised return of +5.3%.
That’s nearly half the average annual return of a stocks portfolio. But on the volatility side, the drawdowns are obviously a lot more violent for stocks.
The worst year for stocks during that period saw the market fall by a whopping 43.1%. Meanwhile, the worst year for bonds in that timeframe was a decline of 8.1%.
Stocks outperform bonds the longer you hold them
If you’re looking at just 2023, then bonds may well be the better investment given the attractiveness of yields from short-duration bonds (basically anything less than two years in tenor).
However, from the perspective of the data, stocks outperform bonds the longer the holding period.
As readers can see below from a chart from BlackRock, during the period 1957-2022, stocks outperformed bonds 68% of the time over a one-year time horizon.
However, stretch that time horizon out to a decade and stocks outperformed bonds 77% of the time – a pretty big “margin of safety” for stocks.
Think of investing horizon in years, not months
So, while there’s talk of an impending recession and the “return of bonds”, when general consensus is to hate on an asset class it tends to be a great time to look for bargains.
That may be the case in the coming months for stocks as higher interest rates and a likely recession start to adversely impact corporate earnings.
As a result, while stocks might have another difficult 2023, if you were to keep investing steadily in stocks throughout the rest of this year (and have the discipline to hold) then you’ll likely be thanking yourself in three to five years’ time.
The data is there for everyone to see that stocks outperform bonds over the long term. At the end of the day, the only factor that holds people back is impatience or fear of volatility.
