What this article covers
Stocks have beaten bonds by a wide margin since 1871, but Opher Ganel argues that the next decade may look very different. Using Shiller’s historical data, expert return forecasts compiled by Morningstar and today’s elevated CAPE valuation, he shows why US stocks’ expected edge over bonds has shrunk to well under 1 percent a year, and three financial advisors weigh in on allocation, rebalancing and bond risk.
Key Takeaways
Stocks have historically beaten bonds by 4.5 to 6 percentage points a year after inflation
Based on Robert Shiller’s data, US stocks returned an average of 7.03 percent a year after inflation since 1871, versus 2.41 percent for bonds. Over the most recent 30 years, the gap was even wider: 8.10 percent for stocks versus 1.99 percent for bonds.
Expert forecasts give US stocks only a slim edge over bonds for the next decade
Using the forecasts compiled in Morningstar’s report and an expected 2.3 percent inflation rate, the median real return forecast is about 3.2 percent for US equities versus 2.5 percent for US bonds. Opher Ganel calls that 0.7 percent risk premium measly compensation for stocks’ far higher risk, while developed international stocks are forecast to return about 5.7 percent.
A high CAPE ratio points to more muted stock returns and a higher crash risk
Shiller’s total return CAPE stood at 39.8 when the article was written, 29 percent above its 30-year average of 30.75 and higher than before the 2008 and 2020 crashes. That doesn’t mean a crash is imminent, but it is why Opher Ganel, nearing a work-optional life, raised his bond allocation and tilted toward smaller, value and international stocks.
Mike Hunsberger
Derrick Alexander
Omar MorilloI’ll admit it.
I’ve never been a huge fan of bonds.
I even suggested once that rental property can be a better way to diversify your stock holdings without giving up most of your return as you do with bonds.
Stocks vs. Bonds: Which Is Riskier, and Can You Lose Money on Bonds?
This is a somewhat tricky question.
Stocks are inherently riskier than bonds, especially US treasuries – considered a near-zero-risk asset. This is because stocks provide zero guarantees of higher prices tomorrow, next month, next year, etc.
US treasuries, on the other hand, offer guaranteed interest plus the return of your capital upon maturity.
Can you lose money on bonds?
Yes, you can.
If you buy them when interest rates are low and sell before maturity when rates are higher, you’ll get a lower price than what you paid.
However, if you hold bonds to maturity, the risks you run are significantly lower.
- Inflation: Should inflation run out of control, the dollars you get back will be worth much less – but US inflation has usually been fairly tame. Even at its modern-era peak in 1979, it was just 13.3 percent. Compare that to Venezuela’s peak inflation of 1,698,488 percent in 2018!
- The US government could default on its obligations: This has never happened, and despite politicians posturing around increasing the debt limit, this is very unlikely.
To make up for the higher risk, stocks must offer higher returns on average, or nobody would buy them.
And offer higher returns they do indeed.
How Have Stocks Performed Compared to Bonds Historically?
Over the super-long term, say from 1871 to date, according to data collected by Yale economist Robert Shiller, bonds returned an average annualized 2.41 percent after correcting for inflation.
In that same period, stocks boasted an average real (i.e., inflation-adjusted) annual return of 7.03 percent. That’s more than 4.5 percent higher per year.
This makes stocks the clear winner, right?
Maybe, but what if instead of looking over a century and a half we look at a more plausible 30-year investment period?
Going back to Shiller’s data, we find that bonds brought in a lower average real annual – 1.99 percent vs. stocks’ even higher 8.10 percent – nearly 6 percent more!
Stocks for the win again, right?
Yes, but…
Will the next decade provide the same annualized returns from these two asset classes?
Stay connected
See more of Wealthtender when you search Google
Add us as a preferred source, and our guides to personal finance and choosing a financial advisor can appear more often in your Google results, with a “Preferred” label in AI Overviews.
Will Stocks or Bonds Be the Better Investment Over the Next 10 Years?
One of my favorite quotes of all time came from physics Nobel laureate Nils Bohr (though many mistakenly attribute it to Yogi Berra). Bohr once quipped, “It’s very hard to make accurate predictions, especially about the future!”
With this in mind, the following should be viewed as market expert forecasts, not prophesies.
According to a recent Morningstar report, US equities are expected to return between 2.8 and 6.7 percent a year over the coming 7-10 years, before accounting for inflation.
According to the St. Louis Fed, annual inflation is expected to average about 2.3 percent in the coming 10 years. This implies that US equities are expected to return a rather anemic 0.5 to 4.3 percent, i.e., between roughly half to a sixteenth of their average return in the last 30 years.
International equities are expected to return between 7.1 and 9.6 percent in nominal dollars, or 4.7 to 9.1 percent in real terms for developed markets. For emerging market equities, the expected real returns are between 2.8 and 8.5 percent.
In all three cases, these are broad ranges. Taking the median forecasts, the forecasted real annual return is 3.2 percent for US equities, 5.7 percent for developed market stocks, and 2.5 percent for developing market stocks.
None of these even comes close to the above-mentioned 8.1 percent average real annual return of US equities from 1995 to date.
How about bonds?
The Morningstar report shows forecasts ranging from 3.7 to 5.3 percent in nominal dollars, or 1.4 to 2.9 percent adjusting for the expected inflation, with a median of 2.5 percent.
Putting all the above together, you face expected returns of about 3.2 percent for US equities vs. 2.5 percent for US bonds. Thus, US stocks still edge out bonds, but a risk premium of 0.7 percent (stocks’ edge over bonds) is measly compensation for the far higher risk you take when investing in the stock market, especially one as richly priced as it currently is.
Is the Stock Market Overvalued? What the Shiller CAPE Ratio Shows
The two things we know about the stock market is that on average over long periods it provides a large positive real return, but that in the short term, it can crash and burn.
To assess where the market sits in terms of valuation, Shiller averages over 10 years the price of stocks divided by earnings, what he calls the “Cyclically Adjusted Total Return Price Earnings Ratio” or TR CAPE.
The TR CAPE smooths out the short-term bumps in stock prices, providing a less volatile assessment of how richly the market is valued.
Over the past 30 years, the TR CAPE averaged 30.75. Its current value is 39.8, or 29 percent above average.
Putting this in perspective, at its pre-dot-com bust peak, the TR CAPE reached a high of 48.1, following which the NASDAQ composite index lost nearly 80 percent of its value.
Prior to the 2008 financial crisis, the TR CAPE was slightly lower than 30. From August 2008 to March 2009, the market lost 38 percent in real-dollar terms.
In early 2020, the TR CAPE peaked at 33.92. Then, the COVID-19 crash caused the S&P 500 to plunge 34 percent in a few weeks. Thankfully, that bear market was a short-lived one.
The current TR CAPE is higher than its values leading up to the two more recent market crashes.
This doesn’t necessarily mean the market will crash tomorrow or even this year. However, it does imply a higher risk of a crash, and that returns over the medium term will likely be more muted than their long-term average.
This agrees with the above-mentioned market analyst projections.
Should You Sell Stocks Now? How One Near-Retiree Is Adjusting His Portfolio
Far be it from me to tell you what to do.
However, here’s what I’m doing (given that I want to hit work-optional in the next couple of years) …
First, I’ve increased our bond allocation far higher than what it was in the past three decades.
Second, I’ve tilted our portfolio away from mega- and large-cap stocks more toward mid- and small-cap; from mostly US equities to a sizable allocation to foreign equities, and from growth stocks to core/value stocks.
What Financial Advisors Say About Investing in Bonds Now
Mike Hunsberger, Owner of Next Mission Financial Planning says:
Your allocation, split between stocks, bonds, and/or other assets, depends on numerous factors, including when you’ll need the money, your risk tolerance, and your goals. After another outstanding year with stocks very close to their all-time highs, diversification and rebalancing are key. Your portfolio’s percentage of stocks, specifically larger growth-type stocks, has probably increased. If it’s not in line with your plan, you should rebalance back to your preferred tolerance.
Derrick Alexander, Owner and Lead Advisor of Greater Works Wealth focuses on a major risk factor affecting fixed income. He says:
The biggest thing investors should pay attention to, from my perspective, is the U.S. debt ceiling. In the coming year, we need to address the fact that our national debt is growing too quickly. As a country, we will need to come up with a plan to service that debt or face the risk of defaulting on payments. Either outcome will significantly impact the bond sector of everyone’s portfolio.
I believe this is an especially urgent conversation for those who are retired or planning to retire within the next couple of years. How our country handles the debt issue could influence a variety of sectors. For individuals in this demographic, it would be wise to explore alternative bond options or ensure that the bond portion of their portfolio is properly diversified. Taking prudent action now could help mitigate risks tied to this uncertainty.
Omar Morillo, Founder & Sr. Wealth Advisor at Imperio Wealth Advisors advises:
Regarding asset allocation I have the following opinions but please understand this is not specific advice. For those in their 30s and 40s, consider an allocation of 70-90 percent in stocks and 10-30 percent in bonds to help balance growth and stability. Investors in their 50s and 60s should emphasize preservation with 60-70 percent in stocks and 30-40 percent in bonds, favoring shorter-duration, high-quality fixed income to help mitigate the risk of rising interest rates. Please understand asset allocation does not ensure a profit or protect against loss; all investing involves risk and the potential to lose principal.
Should You Shift From Stocks to Bonds Before Retirement?
Depending on one’s stage of life, I can understand why some people shun bonds and go all-in on stocks. During our accumulation phase, I usually kept our bond allocation under 10 percent.
However, given all the above, especially if one is approaching retirement, bonds seem to offer a much better risk/reward profile than US equities or emerging market stocks, at least for the coming decade.
Among equities, developed market stocks are currently forecast to provide a higher real return.
Thus, my recommendation is to talk with your financial advisor about diversifying into bonds and/or developed market international stocks.
If there was ever a time to overweight bonds, the coming decade appears to be it.
Frequently Asked Questions
Can you lose money on bonds?
Yes. If you buy bonds when interest rates are low and sell before maturity after rates rise, you’ll get a lower price than you paid. If you hold US treasuries to maturity, the main remaining risks are high inflation eroding the value of the dollars you get back and a US government default, which has never happened.
Have stocks always outperformed bonds?
Over long periods, yes. According to Robert Shiller’s data, stocks returned an average of 7.03 percent a year after inflation since 1871 compared with 2.41 percent for bonds, and the gap was about 6 percentage points over the last 30 years. Stocks must offer higher average returns to compensate investors for their higher risk.
What returns are experts forecasting for stocks and bonds over the next decade?
The forecasts compiled in Morningstar’s report put US equities at 2.8 to 6.7 percent a year before inflation and US bonds at 3.7 to 5.3 percent. After about 2.3 percent expected inflation, the median real forecasts are roughly 3.2 percent for US stocks, 2.5 percent for US bonds and 5.7 percent for developed international stocks.
What is the Shiller CAPE ratio and what does it say about the market?
The CAPE ratio compares stock prices to earnings averaged over 10 years, smoothing out short-term swings to show how richly the market is valued. At the time of writing, Shiller’s total return CAPE was 39.8, about 29 percent above its 30-year average, which the article says implies a higher crash risk and more muted medium-term returns.
Should you move from stocks to bonds as you approach retirement?
Opher Ganel suggests that, especially for people approaching retirement, bonds appear to offer a better risk and reward profile than US or emerging market stocks for the coming decade, and he has raised his own bond allocation. One advisor interviewed recommends rebalancing back to your plan after strong stock gains, and another suggests 30 to 40 percent in high-quality, shorter-duration bonds for investors in their 50s and 60s, while stressing that this is not specific advice.
Find financial advisors who specialize in helping people like you
Search Wealthtender by specialty, location and fee type, compare advisors’ approaches, and read what their clients say before you reach out.
Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the author
Contributing Writer, Wealthtender
My career has taken some unexpected turns, from earning a PhD in experimental high-energy physics, to conducting cosmic-ray research in Antarctica, to supporting NASA projects and programs, to running my own consulting business. I also run several other small businesses and help my wife run her Marriage and Family Therapy practice.
Those experiences taught me to question assumptions, think critically, and recognize that real-world decisions of any significance rarely have simple answers that apply to everyone. Today, I bring that perspective to writing about personal finance. Drawing on my analytical background, business experience, and research, I explore financial decisions, challenge conventional wisdom, and help readers understand the tradeoffs that can affect their financial well-being. To complement my own research and experience, I also weave insights from financial professionals into my articles, drawing on their expertise and real-world experience helping clients navigate financial decisions and challenges.
At medium.com/@opher-ganel, you can read more of my articles and subscribe to receive email notifications when new ones come out.