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Questioning Stocks vs. Bonds



December 09, 2011 – Comments (0)

Board: Macro Economics

Author: lobodoug

Over the last 30 years, bonds have beaten stocks, but barely.

This means, in the grand scheme of things, that bonds and stocks have been fairly efficiently priced. The long term yields of both are almost exactly the same. It is almost as if the investors over the past 30 years saw into the future over many decades, and the price of the vast swath of potential investments ended up equalizing into a perfectly efficient market.


First, good to quote your source for the data, as it is a little unclear what you mean: I assume it is looking at the annual return over 30 years, using indexes. But, the volatility of stocks that you equate with risk, I equate with opportunity.

I suspect that if you bought stocks using any back-tested, reputable timing system, or added a value screen to the mix, or included emerging market stocks along with the S+P, the results might be different. The results are really only applicable to the general US market, or an S+P index investor.

Also, as was recently noted, if you bought the S+P on an equally-weighted average vs. the S+P's market-cap adjusted basis, you would have done better.

I doubt there are many S+P index only investors here.... Why spend so much time reading about macro-economics if it does not inform your investing strategy? They could be reading People magazine instead! Of course, that does not mean that we outperform the S+P, or bonds. But, if you are not doing so, then I suggest following one of the many proven methods that do outperform. The Ivy Portfolio, by Mebane Faber, would be one, although I have no idea if it is the "best".

I do not index. I also do not worry about beating an index, as I find that misleading: "beating" the index in 2008 meant losing less than 1/2 your investment! My goal is to earn a return that lets me continue to live from my returns while reducing risk of capital loss. I do this by moving in and out depending on valuation and macro-economic factors, with some consideration of the technical aspects. I often have only a small percentage of my money invested, and use options heavily. Option trades are almost always either short, or spreads, not long. If I can set up an option strategy that earns me 10% on the money at risk in just 2 months, I have achieved my annual goal for that money, and do not need to put it at risk again that year unless I see great opportunity. The risk, in this scenario, is not the loss of the capital, but the purchase of the stock at the agreed-on price. If I chose my stocks to sell options on wisely, this is not a negative outcome, as I then consider the stock under-valued and look for it to return to fair value (see my post just above on Rio Tinto for an example). This means possibly a longer time to achieve my return, but not the loss of capital unless the business fails.

So, I think one can say that for 30 years bonds have beaten the S+P index (I am assuming this was their proxy for "stocks"). But that does not mean that every bond, or every bond investor beats every stock or every stock investor. It is inaccurate to go directly from the general to the specific. I see this mistake routinely, typically from someone selling an packaged investment product. My sister-in-law regularly sends me info from Vanguard about how, on average, people who trade stocks under-perform the index (and thus, under-perform the Vanguard index funds). Their point (and my sister-in-law's) is that I am stupid to try to choose my own investments and should instead just buy their index fund (I pointed out to my relative that Vanguard's two largest funds have been basically flat over 1, and 5 year periods, and the biggest is flat over 10). The key is not being an "average" trader. This means extensive reading and education in investing. Significant time requirements following the market. And honest, unemotional evaluations of your performance, based on real numbers, which of course represent real money!



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