Stocks outperform bonds in the very long term

Economic theory and common sense dictate that equities should outperform bonds:

p.5 Conventional wisdom tells us that stocks tend to outperform government bonds in the long term. That is, if stocks are held long enough, they are usually better investments because their total return is likely to be higher than the return on bonds. While this view may be correct in principle, in practice a crucial question remains: How long is long enough?

Watch out for the short-term

p.7 For example, when the overall economy is in recession, profits of most of the companies in the economy tend to suffer, causing aggregate earnings to decline. As a result, the short-term price fluctuations for stocks—even for an index of the entire stock market—are typically much greater than the short-term fluctuations for bonds.

p.10 Theoretically, as an investor’s holding period lengthens, the ups and downs in short-term stock returns will likely offset each other. Thus, for investors who can lock away their stock investment for very long periods, the risks of their stock portfolios should be smaller than those for short-term investors.

Can you wait 26 years?

p.17 It is clear that the relative riskiness of stocks depends crucially on how long investors can hold their portfolios without liquidating any portion of them. To take advantage of the diminishing risk of long-term stock investment, investors must make sure that they can continue their investment in stocks until the end of a sufficiently long holding period. For example, for a 30-year-old investor who thinks she may retire between the ages of 50 and 65, the applicable holding period for her 401(k) is only 20 years because she can only be sure that she will not need the money before the age of 50. Therefore, for this particular investor, the historical fact that stocks have always outperformed bonds if held for at least 26 years is of little help in her asset allocation decisions because her holding period is only 20 years.1 9

p.18- But how many investors know with certainty that they will not need to touch their stock investment for at least 26 years? The percentage may be quite small.2 0 For example, even for investors of age 30, the holding periods for their 401(k)s may be much shorter than 26 years if they have, or expect to have, some health problems that may force them to retire early and tap their 401(k)s.21

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