Bonds Can Outperform Stocks Over Decades

During one of the breaks between speakers in the DFA conference there was a slideshow running with some of the greatest quotes from investing and economic giants of our time. Unfortunately, they were running too quickly for me to write them down verbatim but one in particular caught my eye.

Dr. Kenneth French was quoted as saying that the equity premium needs 30 or 35 years before we can say with any statistical confidence that stocks will outperform bonds.

Again, since I didn’t have time to write it down verbatim, the above is my best recollection of the quote (so it could be slightly off). In any case, what Dr. French is saying is that based on past data it is possible that it can take a VERY long time before a stock investor realizes a larger return than a bond investor. For actual evidence, one need only look at the market return of the S&P500 versus the risk free rate from 1965 – 1981. In this 17 year period the equity premium is negative – which means you would have been better off holding T-Bills instead of stocks during this almost two decade period.

Note: The “equity premium” is the extra return from holding equities (stocks) versus fixed income (bonds, GICs, T-Bills, etc.). It is another way of saying that investors expect higher returns on stocks than bonds.

So while the longest period where there was no equity premium was 17 years, based on the data Dr. French is saying that it is possible that it could be as long as almost 30 years, however the liklihood of that happening is pretty low.

Moral of the story? It can take a LONG time before the decision to invest in equities over fixed income can be rewarded, however research indicates that an equity premium does exist. As more time passes in which you see your fixed income portfolio outperforming your equities it can be tempting to sell stocks and buy bonds – but this is one of the greatest mistakes an investor can make. For example, the 19 years following the above mentioned period of 1965-1981, the S&P500 returned an annualized 16.9%.