Ask Karen Gibbs

Veteran business correspondent Karen Gibbs answers your personal money questions and addresses current topics that affect YOUR finances on a daily basis. Karen is the financial expert in your corner--no question is too basic or too small. Karen boils down the issues simply: here's what you need to know, and here's what you need to do. Send your money questions to AskKaren@mpt.org and post your comments below.

17

August

Investing in Stocks and Bonds

Karen Gibbs

Hi Karen, considering the recent volatility, why are stocks considered the best long-term investment when compared to bonds?

- Denise, Westminster


Close up of stock PricesGreat question, Denise, and the key phrase here is “long term” – some time frame longer than ten years.

Most stock market analysts look at rolling time periods, meaning they look at stock price action over a longer period of time.  In some cases they use ten years, others use 25 years.  Rolling means they look at successive years, dropping the first and adding the latest year, similar to a moving average. 

While stock prices can have wild swings daily and yearly, the median annual rate of return for the S&P 500 index from 1925 to now is around 10%.  For that same time period, the median annual rate of return for treasury bonds is around 4% - that’s a gap of 6%.  Stocks are considered a higher risk investment than bonds, and to offset that risk, they must pay a higher rate of return to attract investors.

When you take into account the magic of compounding, you can see the difference that 6% premium can make overtime.  Say you had $1,000 to invest in 1990.  If you had put $1,000 in a bond paying 4%, compounded semi-annually; that $1,000 would now be worth $1,485.95.  If you had put that $1,000 into the stock market returning 10%, compounded semi-annually, that $1,000 would now be worth $2,653.30  That difference in return will grow wider the longer you hold that investment.  Stocks clearly are the winner.

That’s not to say that you should put all your money in stocks.  Stocks pay a greater return because they carry a greater risk.  Adding bonds to your investment portfolio will reduce your overall return, but will also reduce your overall risk.  You must strike a balance between your fear of missing out on a stock market rally and your fear of losing money. Depending on your risk tolerance, you may have a larger portion of your portfolio in stocks.  Less risk tolerance would have a smaller portion invested in stocks versus bonds.

A balanced portfolio would have 50% of stocks and 50% in bonds.  Common wisdom suggests that as you age, you take on less risk.  One strategy is to peg your bond position to your age; at 75 years of age, you would hold 75% bonds and 25% stocks.  But it is a personal decision; there is no one size fits all.

Finally, remember that the earlier you start investing, the less you’ll need to achieve your long-term goals and the more risk you can take.  No matter what age, stocks should be part of your investment portfolio.

 

That’s smart thinking about your money!

 - Karen

No comments.
Name:
Email:
Comment:
Enter verification code: Captcha not loaded