Stocks or Bonds for Your Retirement Account?
Stocks are riskier than bonds which is why they have a higher expected return. The right risks, taken Foolishly, can pay off in the long run.
“Behold the turtle. He makes progress only when he sticks his neck out.”
— James Bryant Conant, American diplomat
In our Foolish Steps to Retirement, we recognize that we’re going to have to take risks to reap rewards.
Market risk (the chance you will lose money) and reward (the chance that your investments will head skyward) travel hand in hand. The greater the risk, the greater will be the potential return — or potential loss — for taking it. But by and large, risk is basically a short-term phenomenon, particularly in the stock market.
About those rewards …
Let’s examine at what various investments have returned over time.
- From 1926 to 2008, U.S. Treasury Bills, which serve as a relatively efficient proxy for money market accounts, have yielded roughly 3.7% annually on average, according to Ibbotson Associates. While this may not seem like a lot today, remember that for much of this century, inflation was nonexistent, making a 3.7% average return very attractive until the 1960s. Had you put $1 into T-Bills in 1926, you would have amassed about $20 as of Dec. 31, 2008.
- Long-term government bonds returned around 5.7% per year from 1926 to 2008. Had you invested $1 in long-term bonds in 1926, you would have had about $100 as of the end of 2008.
- Stocks have also been very good to investors. Large-cap stocks have returned an average of 9.6% per year from 1926 to 2008 — considerably higher than bonds. Had you put $1 into stocks in 1926, you would have seen it rise to $2,048 as of Dec. 31, 2008.
Perhaps most surprisingly, though, the long-term return extremes for bonds and stocks are largely similar. Both have had weak 10-year periods with small average annual losses, and both have had strong decades with double-digit average gains. On the whole, the higher average returns of stocks makes them superior in our view.
Fools recognize that the long-term odds are overwhelmingly in our favor. We know the market shifts every day — sometimes sharply downward. That can be absolutely gut-wrenching when it occurs, but history shows us that over the long haul, the stock market moves inexorably upward. Therefore, stocks will provide the biggest bang for our buck.
That’s why Fools opt for stocks above all else as our vehicle of choice for growth over the long term.
Don’t slack on stocks
When will your retirement arrive? Twenty years from now? Five years? Tomorrow? If you’re close to it, or are already retired, how long must the money last? Now think about your retirement investments. Is the bulk of your money positioned for long-term growth (read: stocks) or short-term stability and income (read: bonds and bills)? Only you can decide the right mix. Just remember that retirement investing is a long-term goal, so you’ll want to shoot for the best investment growth you can get. Over the long haul, you won’t find that growth in bills and bonds. Keeping most of your money in such lower-yielding vehicles is a great way to set yourself up for a disappointing (and possibly dismal) retirement.
You should also remember that you probably still have many years of productive life ahead of you after you finally do retire. While bonds and bills’ income and safety may seem appealing, approximately half of your portfolio must still be invested for growth to ensure you can maintain purchasing power. Inflation has run at about a 3% to 5% annual rate in recent years. At that rate, the cost of all we buy doubles about every 14 to 24 years. To a retiree living on a fixed income, that can be nothing short of devastating. Hence the need for growth in a retiree’s portfolio.
Bonds and cash certainly have a place in a portfolio, especially if you need the money within the next five years. Plus, they add stability to a portfolio during the rough times (such as the bear markets of the 2000s). But for money you don’t need for a decade or two, stocks have historically been the place to be. (For more on how to apportion your portfolio, see our series on Asset Allocation in our retirement area.)