It’s a question that has nagged at investors for as long as both asset categories have existed … are stocks the way to go, or bonds? If both, how much of either belong in a portfolio?
The answer to the “stocks vs bonds” debate is, of course, one that depends on a myriad of factors unique to each and every investors. On a pound-for-pound, dollar-for-dollar basis though, stocks are the superior option for most investors, most of the time. They’re not as safe or stable as bonds when you’re talking about one specific equity. For a smart, long-term investor who knows how to build a diversified portfolio though, stocks just make more sense. Bulletproof? No, they’re not. They can certainly take their lumps and keep on tickin’ though.
With that as the backdrop, here are five specific reasons stocks win the battle of stocks vs bonds. In no particular order…
Yes, bonds offer hyper-reliable income flow. While bond issuers can and sometimes do default on their payouts, that’s a rarity. Meanwhile, it’s not terribly uncommon for a company to reduce or altogether cancel their dividend, even if on a temporary basis.
There’s a flipside to that risk/reward coin though. With a bond, the semi-annual payment is fixed for the duration of that debt. With a dividend-paying stock, the payout usually grows in time. Walmart (NYSE:WMT), for instance, has upped its dividend for 45 straight years now, while NextEra Energy (NYSE:NEE) has done the same for 24 consecutive years.
For veteran investors who’ve owned both stocks and bonds through at least a couple of different economic cycles, they’ll know that bonds often do well in some environments that bode poorly for stocks, while bonds tend to do poorly while stocks are thriving. Namely, rising rates — as we’ve seen of late — have pressured the bond market lower, but the corresponding inflation has coincided with solid growth from equities, since economic growth itself is generally what fuels inflation.
It might take a bit of timing intuition to make good on the nuance, but savvy investors know that sooner or later, every asset will face a headwind and enjoy a tailwind, but will do so at different times.
Stocks Usually Beat Inflation
It has been a mostly ignored secret of late, but not only have bonds lost value of late as interest rates have risen, most interest payments from bonds haven’t kept up with inflation.
This year’s average annualized inflation rate stands at 2.8%, though effectively speaking, the cost of goods seems to have grown a bit more than that. Meanwhile, the average yield on 30-year Treasuries is barely a bit higher, at 2.97%… and that’s a long commitment. Less-committal 5-year paper is only paying 2.75%, which means in the end, holders of that debt are only breaking even relative to inflation.
Yes, inflation-protected instruments like the iShares Barclays TIPS Bond Fund (NYSEARCA:TIP) can help fight the adverse impact of inflation on debt-based interest payments. Its upward adjustment is always backwards-looking though, and never quite seems to keep up with the full pace of price increases.
More Price Transparency
To be fair, technology has come a long way, bringing bond trading via the web on par with the amount of information that stock traders have enjoyed for years now. Yet, in that the bond market just isn’t as brisk or as big as the equity market is, bond prices (or bond liquidity, for that matter) aren’t always perfectly clear.
It’s still a far cry from days gone by, when it took a phone call and several minutes, as a brokerage firm had to literally contact someone at a trading desk to make a purchase or sale. Nevertheless, the bond market remains a bit slow, and frustrating, to navigate.
Better Long-Term Bottom Line
Last but not least — and perhaps a culmination of all four of the other advantages of stocks compared to bonds — they just to better in the long run.
Ask ten different experts what the average annual performance for stocks is, and you’ll likely get ten different answers. Almost all of the answers, though, will be somewhere between 8% and 11%. Not so with bonds. Their average annual return is more like 5% to 6%.
Granted, it takes time and patience to secure those kinds of results … time not all investors are readily willing and able to give. For the truly long-term-minded investor, though, that can ride out the rough patches, stocks simply do better.
The Last Word on Stocks vs. Bonds
None of this is to suggest all investors should always and only own stocks. It’s also not to say bonds are to be avoided at all costs. A balanced approach has been and continues to be the smart-money move in all cases.
Do keep in mind, however, for some investors there’s a tendency to seek out a little too much certainty and current reliability. Considering how long people are living now after they retire from their job — 30 years in some cases — the bigger risk these days is outliving your money due to not thinking enough about long-term growth that only stocks can offer.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.