ET Helping me are some of the wisest financial advisors in the U.S., who I interview. Assume an older bond has a 5% coupon and a newer bond has a 7% coupon, and interest rates are now at 7%. There are a lot of cases when bonds are riskier than stocks. Principal or face value: amount of the investment. Over 20 years, stocks returned an average 881% and bonds 247%—stocks beat bonds by a 3.6-to-1 margin.5 Pretty darn good!
If that’s the case, why do so many investors fear stocks? But if the current interest rates are 5%, the 7% bond will fetch a premium price. The conventional advice is that it’s good to have stocks in your portfolio for growth and bonds as ballast, to zig when stocks zag. If the issuer goes bankrupt, bond holders will be paid before stock holders. Standard & Poors give bonds letter-ratings, with AAA the highest and CCC the lowest. Key to that is helping you to build a solid financial future.
The credit-worthiness of the issuer is also a major concern. Whatever problems get in our way—energy, food, water, disease—someone (or someones) will find ways to collide past innovations in new ways to yield something new that can knock down or at least greatly mitigate whatever problems pop up. On a daily basis, the odds stocks are positive are slightly better than a coin flip. By contrast, the S&P 500 has delivered average annual returns of 10.31% over the past three years, has an earnings yield of 6.2% and is trading at a forward 12-month P/E of 16.1, which is the 25-year average. When interest rates rise, prices of currently issued bonds fall, and vice versa. And yes, volatility goes both ways.
Investing is about probabilities, not certainties. All Rights Reserved, This is a BETA experience. The issuer borrows money and promises to pay back the debt plus interest twice a year. Since February, stocks have had a rough time due to interest rate fears and now anxiety about a trade war with China. That’s creative destruction, and it’s a powerful force for societal good. If you don’t believe that, check London, which isn’t buried under nine feet of manure. Bonds are attractive investments to people within five years of retirement, who wish to preserve their capital, and who need income. The wildly popular 1968 book Population Bomb assured us that in the 1970s, famine would kill hundreds of millions. Incidentally, over 30-year rolling periods, bonds have never beat stocks. For example, one person might think “safe” means a low level of expected shorter-term volatility. Coupon rate: annual income stated as a percentage of the face value. I still recommend diversifying in stocks and bonds. We have a chart that shows how the yield and duration of the AGG has changed since 1990. Sometimes it means taking a chance on an unloved but worthy stock. And over longer periods like 20 years or more, they’re actually less volatile than bonds. Businesses and, hence, stocks adapt.
But hang on—if you increase your observation period, something happens. © 2020 Forbes Media LLC. Please turn on cookies or check if you have another program set to block cookies to allow full website functionality.
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