• Home
  • About
  • Services
  • Contact
  • Media

Stocks vs. Bonds – Offense & Defense

Posted September 12, 2019 by Denis Smirnov

I’m very excited about the start of the football season (Go Blue!) and keep catching myself thinking of investments in football terms. The basic financial wisdom has it that stocks are great at putting up “points” over time but can be very volatile and hard to stomach (Team Offense). Bonds, on the other hand, are steady Eddie of investments and offer decent returns with much smoother ride (Team Defense). Another key benefit of combining both of them in the same portfolio is that bonds tend to zig when stocks zag thus providing a valuable diversification benefit. So let’s compare stocks with bonds and how they act relative to each other (see boring notes below about methodology).

Exhibit 1 shows some stats for stocks, bonds and a 50/50 mix of the two. Stocks had double the return but also double the volatility of bonds. Both stocks and bonds have had same number of negative years (15), thus about 80% of the annual returns are positive. 50/50 mix showed some diversification benefit with only 12 negative years (17%).  For stocks the good years were really good while the bad ones hurt a lot, including almost 37% drop in 2008. The worst bond year was 11% drop in 2009 (albeit preceded by a 20% rise the year before in the flight to safety during the GFC). The 50/50 portfolio was quite appealing – providing 78% of the stock return with only 55% of the volatility.

Exhibit 1 – Stock and Bond Stats 1950-2019 (as of 9/10/19)

Looking at stocks’ 11.2% annual return versus 5.5% for bonds in a table doesn’t quite do it justice as compounding benefits are really huge over 70 years (Exhibit 2). Even if we just look at the last 30 years, stocks are clearly much better Team Offense, although 50/50 is not looking bad either.

Exhibit 2 – Cumulative Returns

Now let’s take a closer look at the interplay of the two asset classes. Out of the last 70 years, stocks and bonds were both positive in 42 years or 60% of the time (Exhibit 3). One or the other was negative 37% of the time. But for both of them to be negative was very rare indeed with only 2 years or 3% of the time. And one of them (2018) was just barely negative at -0.02%. So far so good.

Exhibit 3 – Positive and Negative Years for Stocks & Bonds (1950-2019)

Digging deeper I broke down the negative years (Exhibit 4). Of the 15 down years for stocks some were manageable while others hurt a lot; the average decline was almost -12%. However, bonds offset some of the stock drops in 13 of those 15 years (87%) with average return of +6.2%. In fact, in some of the worst years for stocks (2008 and 2002) bonds benefited from flight to safety and posted very attractive returns. The 50/50 portfolio declined 11 or the 15 years for a still unpleasant 73%, but the average decline was much more manageable 2.8% – a full 9% better than all-stock portfolio. And the worst year was -12% in 1974 compared to -36.5% for stocks in 2008.

On the flip side, when bonds have bad years (also 15 with average drop of 4%), stocks tend to do well posting 17% average gain. The 50/50 portfolio went up by 6.5% on average in those years. And while it’s no fun to see both stocks and bonds decline in the same year, it only happened twice in 70 years and the 50/50 returns weren’t so horrible with -4.4%.

Exhibit 4 – Breakdown of Negative Years (1950-2019)

Ben Carlson had a nice post with similar analysis and more eloquent description of diversification benefits. You can find more information on the bond market composition in this post.

Takeaways:

So stocks are (or at least have been) better at putting up “points” like a high-powered football offense, but akin to a pass-happy teams they also provide many heart-stopping moments for investors. Bonds, like defensive squads, can score some points but generally their main benefit is allowing the offense to take calculated risks in order to win games (achieve investors’ long-term goals).

Another takeaway is that like good football teams investors need to pay attention to both sides of the ball to improve their outcomes. Mixing in some bonds in the portfolio might reduce long-term returns but if that’s what it takes to stay invested during volatile periods it’s well worth it in the long run.

Boring Notes:

I’m using S&P 500 as a proxy for stocks and 10-Year Treasury as a proxy for bonds. I have the data going back to 1928 but let’s just look at 1950 forward. The 30’s and 40’s were very unusual between the Great Depression and World War II, so post war period is more representative. Besides, the conclusions of the analysis remain the same, there is just more data to muddle through.

I chose to not include inflation in this analysis to keep it simple. With inflation there would be more negative years all around but the main conclusions would remain the same: stocks do better but with more occasional pain.

Share this:

  • Facebook
  • LinkedIn
  • Twitter
  • Pocket
  • Email

Sign up to the newsletter

Categories

  • Bear Markets
  • Bonds
  • Economy
  • Education
  • Financial Planning
  • Indexing
  • Investing
  • IPO
  • Retirement
  • Taxes
  • Uncategorized
  • Valuation

Archives

  • January 2023
  • October 2022
  • September 2022
  • August 2022
  • July 2022
  • May 2022
  • April 2022
  • February 2022
  • January 2022
  • October 2021
  • September 2021
  • July 2021
  • February 2021
  • January 2021
  • November 2020
  • October 2020
  • September 2020
  • July 2020
  • June 2020
  • May 2020
  • March 2020
  • February 2020
  • January 2020
  • November 2019
  • October 2019
  • September 2019
  • July 2019
  • May 2019
  • February 2019
  • January 2019
  • December 2018
  • October 2018
  • September 2018
  • July 2018
  • June 2018
  • May 2018
  • March 2018
  • February 2018
  • January 2018
  • December 2017
  • November 2017
  • September 2017
  • August 2017
  • July 2017
  • June 2017
  • April 2017
  • March 2017
  • February 2017
  • January 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016
  • August 2016
  • June 2016
  • May 2016
  • April 2016
  • March 2016
  • February 2016
  • January 2016
  • December 2015
  • November 2015
  • October 2015
  • September 2015
  • August 2015
  • July 2015
  • June 2015
  • April 2015
  • March 2015
  • February 2015
  • January 2015
  • December 2014
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • April 2014
  • March 2014
  • February 2014
  • January 2014
  • December 2013
  • October 2013
About
  • Background
  • Who We Are
  • The Gordian Knot
Services
  • Services
  • Planning Process
  • Investment Philosophy
Contact
  • Contact Details
  • Inquiry Form
  • Map
Media
  • Articles
  • Blog
  • Reviews
Dave
Denis
 
 
 
 

Gordian Advisors Financial Planner

Office: 2200 E. River Rd., Suite 109, Tucson, AZ 85718

Phone: 520-615-2779

Email: info@gordianadvisors.com

Download Form Form CRS Client Relationship Summary

Download Form ADV Disclosure Brochure

Gordian Advisors may only transact business or render personalized investment advice in those states where we are registered, or have filed notice, or are otherwise excluded or exempted from registration requirements. Material discussed is meant for general illustration and/or informational purposes only, and is not to be construed as investment advice. Nothing on this web-site should be interpreted to state or imply that past results are an indication of future performance. Although this information has been gathered from sources believed to be reliable, please note that individual situations may vary. Therefore, any information should be relied upon only when coordinated with individual professional advice.