According to Jeremy Siegel (a renowned finance professor at the University of Pennsylvania’s Wharton School of Business) historical data shows that stocks have outperformed bonds, hands down, over the long run. Before I start rattling off the numbers, however, it is important to mention the role of inflation (the rise in prices of goods and services) when considering returns. As a general rule, you should always be able to separate “nominal” returns from “real” returns when evaluating investments.
The Significance of Inflation
For example, if your portfolio of stocks has a 12% annual return over 5 years, your “nominal” return is simply 12%. However, if prices have increased by 2% over the same period, your “real” return is only 10%. Why? Because it now costs you more to buy the same goods and services. Therefore, you’re really only better off by 10% instead of 12%.
Stocks Beat Bonds in the Long Run
Even after we take inflation into account, $1 dollar invested in stocks in 1801 would have become approximately $600,000 by 2001! A dollar invested in bonds, on the other hand, would only have become about $952 over the same time period. The key here is “long-term”, however, as it is important to realize that stocks can go through extended periods of negative returns as well. A recent example of this, as many investors probably remember, is the period from mid-2000 to Q1 ‘03, where the S&P 500 fell about 40% after the dot-com bust. Only recently has it returned to its prior value of around 1,520 (almost 7 years later!).
In Sum
So, can we be 100% sure that stocks will continue to outperform bonds in the future? Absolutely not - but at least we can use this information as a reasonable indicator of future performance. Remember, no investment is ever a sure bet - good investments can only be “likely” bets.