Why Stocks Pay More Than Bonds

Let’s talk about the difference between a 10% expected return in stocks and a 3.8% return from TBills. 

That extra 6.2% makes a big difference. Over 20 years, 10% turns $1 into $6.72. 1.038 grows it to just $2.11. That’s 3x the return, and the difference only expands with time. 

Perhaps more startling is what happens when you factor in inflation. Even 3% takes that $2.11 down to just $1.17. So if you invest $1 in bonds and then wait 20 years, you end up with just $1.17 in terms of actual purchasing power. Is that 17 cents worth it? Hardly. Though I guess it’s better than leaving it in cash and letting inflation whittle that dollar down to fifty-five cents. 

Inflation also reduces stock returns. But the result is vastly superior to bonds. After 20 years of stock ownership you’ve got $3.72 (after inflation) for every dollar invested at the outset. Stocks give you triple the amount of real purchasing power that bonds do, in this example. And again, the difference only expands further with time. 

The big takeaway is that if you want to grow your money in real, after-inflation terms, you can’t do it in bonds. You have to do it in stocks. 

So why don’t more people own more stocks? Well, stocks appear to be quite risky. Especially in the short term. 

And indeed, this additional perceived risk is the reason stocks produce higher returns than bonds. The volatility of stocks means that the returns are delivered erratically, if not randomly. Some years are up 30%, other years are down 30%. This is typical, and it illustrates why stocks are not a short term investment vehicle. They just bounce around too much for anyone looking at funding an immediate purchase or life goal with them. 

Yet, without this characteristic uncertainty, it is likely that stocks would not earn 10% as they have historically, but would instead earn something closer to bonds. Similar predictability, similar return. Which is logical. 

But we live in a world where stocks are risky, and hence have earned that 10% rate of return. Given that markets (and the world) are as unpredictable as they have ever been, I expect markets to continue to produce roughly 10% annually in the long run.