Performance of Stocks versus Bonds and Cash

Published: 08th April 2010
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Performance of Stocks versus Bonds and Cash

This article examines graphically the long-term performance of the three major asset classes of stocks, bonds and cash. The results are truly enlightening and amazing! The results are based on U.S. data going back to 1926. The data source is a well-known reference book called "Stocks, Bonds, Bills and Inflation" 2007 edition. The book is published annually by Ibbotson Associates. (Ibbotson SBBI classic yearbook)

Note that most analysis of historic returns that you have seen is horribly flawed in that it is based on "nominal" returns before inflation. The graphs and figures below are based on "real" returns after inflation. That is, this analysis shows the real increase in purchasing power generated by each investment asset class.

The graph below shows the real (after inflation) returns on large capital U.S. stocks (The S&P index), long term U.S. Treasury bonds, Long Term Corporate Bonds and 30-day cash investments (represented by U.S. Treasury Bills).

Isn't that amazing? In real-dollar terms (adjusted for inflation), large U.S. stocks have absolutely walloped long bonds and short-term cash investments in terms of total return. Each $1.00 invested in stocks at the end of 1925 is now worth $271.72 (81 years later at December 31, 2006). The same $1.00 invested in long U.S. government treasury bonds for those 81 years is now worth $5.77. $1.00 invested in U.S. long-term corporate bonds in 1926 did slightly better than treasury bonds and is now worth about $8.89. $1.00 invested in T-Bills in 1926 is now worth just $1.72. Remember, all figures are after inflation and also assume tax-free investment accounts. (With taxes the growth would be less dramatic but would be even more in favor of stocks given the lower tax rates on capital gains and dividends.)

This means that if old Grampa had foregone just 1 case of beer in late 1925 and invested the money in the S&P index of large stocks (and reinvested all dividends and rebalanced to stay with the index over the years), his grandson, at the end of in the year 2006, could go out and buy 1 case of beer and still have enough left to buy 273.7 more cases! This is truly amazing and is really a case where you can in fact have your cake and eat it too, if you just delay eating the cake and instead invest the money for a long time. Note that the year-end market data peaked at the end of 1999 when the $1.00 in stocks had grown to $303.

But look at the Bonds and T-Bills. The Corporate Bond investor with only $9.21 after 81 years has only 3.3% of the amount that would have occurred in stocks. And the T-Bill investment at $1.72 has just barely kept ahead of inflation.

The above graph which has a normal linear scale does a great job of showing the huge difference in the ending portfolio values but unfortunately is distorted in three ways. First, the results from the earlier years are not really visible, Second, it looks like the percentage rate of growth for stocks was increasing toward infinity until 1999, and third it also looks like the early 2000's stock crash was by far the biggest market crash ever. A logarithmic scale solves these problems because a constant percentage growth appears as a straight line and the percentage gains in the earlier years are much more visible. Unfortunately a logarithmic scale tends to somewhat obscure the huge differences in the ending values. When viewing a growing data series it is probably best to view it with both logarithmic and linear scales to better understand the results.

The same data presented in the above graph is presented below with a logarithmic scale.

In this graph (with the same data as above) you now have to look more closely to realize the amazing extent to which stocks outperformed bonds over the 81 year period. But this logarithmic scale allows you to view the volatility over the years. A constant slope on this graph represents a constant annual percentage growth.

This graph reveals that stocks (blue line) were much more volatile than bonds, particularly 1926 - 1932, the mid 70's and in the last six years. Again, remember that the graphs show real returns, adjusted for inflation. It is Interesting that the big stock market crash in 1987 is not apparent on this graph. The reason for that is the fact that the graph here shows only year-end figures. The big crash in 1987 was actually very short lived in the U.S. and was largely recovered by year-end.

The Graphs below take the data above and break it out into 20 year periods and reveal some very interesting insights into asset performance in different periods. Note that the scales below are linear and that all the scales go to $8.00 (A 700% gain, from the $1.00 starting point). By using the same scale it is easier to visually compare the performance across the different 20 year periods. Also note that in the graphs below, Treasury Bonds are included but not corporate bonds, this is because as illustrated above, the corporate bond return is quite similar to the treasury bond return and was only moderately higher.

Bonds look like the place to be in the 1926 - 1945 period. Stocks beat out Bonds in the end but it was a rough ride indeed. The stock index returned 291% after inflation in the 20 year period while the Treasury bond index returned 148% and Treasury bills eked out 22%

The (relatively) unique thing about this time period was the huge stock valuation bubble in the late 20's followed by a bursting in late 1929, which was then exacerbated by poor government policies that led to the Great Depression. Note that the full extent of the crash is not visible in this graph because it uses only year-end, rather than daily data.

Wow 1946 - 1965, what a run for stocks, while bonds and cash (T-Bills) failed to even keep up with inflation. It's interesting to note that stocks would be considered to be much more risky, they increased in a volatile fashion while bonds were pretty flat and went nowhere. But if this is what people call risk, I'll take it! The stock index returned a whopping 664%, after inflation, while the long bond index investment lost about 21% and even so-called risk-free Treasury bills lost 16% after inflation, over the 20 years.


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