In 2006, Anne Hathaway made People magazine’s 50 Most Beautiful People list. That year, the actress had starred in the film, The Devil Wears Prada. Nine years later, the now 34 year-old beauty reported that she’s already starting to lose roles to younger actresses. It’s a sad Hollywood truth. Time Entertainment reports that older male actors often get leading roles into their 40s, 50s, even 60s. Far fewer women do.
Once they hit a certain age, they become blasé, like a bond market index fund. Today, bonds rarely get respect. Stocks have won their Oscars for seven straight years. Bond yields, in contrast, are lower than a drug-addicted actor in rehab. But that doesn’t mean you shouldn’t own bonds.
Plenty of investors ignore that advice. They’ve built stock-heavy portfolios because bond interest rates are low. They’ve tossed bonds aside because stocks keep turning heads. Over the 5-year period ending May 8, 2017, the S&P 500 Index has averaged a compound annual return of 14.38 percent. Bloomberg Barclays’s U.S. Aggregate Bond Index has gained a compound annual return of just 2.13 percent.
But like an aging actress, bonds deserve a role.
Let me ask a couple of questions:
Will bond yields remain low over the next 1, 3, 5, or 10 year periods?
Will stocks hit new highs over the next 5-10 years?
If you know the answers to those questions, you can obviously see the future. As Peter Parker’s uncle told the future Spiderman, “With great power comes great responsibility.” So stop reading this. Go out and save some people.
Long-term, stocks beat bonds. But that doesn’t mean stocks always beat a diversified portfolio of stocks and bonds. Take the 17-year period from 1996 to 2012. The S&P 500 gained a compound annual return of 6.92 percent. A combination of stocks and bonds actually did better. A portfolio with 60 percent in a S&P 500 index and 40 percent in a broad U.S. bond market index gained a compound annual return of 7.01 percent. Such an investor would have taken lower risk and earned higher returns over that 17-year period.
In 1996, nobody knew that a portfolio split between stocks and bonds would beat the S&P 500 for close to two decades. Likewise, nobody knows if a stock market index will beat a balanced portfolio over the next 17 years.
Balanced portfolios might also help us collar our emotions. When stocks fall, balanced portfolios don’t fall as far. For example, from September 2000 to September 2002, a $10,000 investment in the S&P 500 index would have dropped to $5,518. The same $10,000 would have dropped to $7,779 if it were invested in a balanced portfolio (60% stocks, 40% bonds).
People start freaking out when their portfolios fall a lot. They often sell low, putting a nail in their investment coffin. They often jump back in (at a higher price) after the market has recovered. Balanced portfolios (with bonds) might prevent investors from doing something silly.
Bonds aren’t sexy. Their yields aren’t high. But nobody knows the future. That’s why bonds deserve a role, just like an aging Hollywood actress.
Stocks vs Stocks And Bonds 5-Year Compound Annual Returns - 1987-2016
|100% Stocks||80% Stocks
*Using data from Vanguard’s S&P 500 Index (VFINX) and Vanguard’s Total Bond Market Index Fund (VBMFX).