It wasn’t exactly a “man-bites-dog” story, but a recent article in USA Today will surely catch many investors by surprise.
Over the past 30 years, bonds have outperformed stocks, according to Ibbotson Associates, a research firm. For an investment that many people think is the sole province of ultraconservative investors, that’s nothing short of a revelation.
The edge was modest. Ibbotson’s SBBI bond index, a broad measure of government bonds, returned 11.03% per year on average over the past 30 years, compared with a 10.98% return on the stocks of large U.S. companies.
The bond index bested stocks for the past 10 and 20 years, too. In the shorter term, the difference was dramatic. Last year, the SBBI bond index returned 28%, while the S&P was basically unchanged. The municipal bond market, meantime, had its best year since 2009, outperforming not only stocks, but Treasuries, corporate debt and commodities as well.
Rethinking conventional wisdom
Despite the edge over 30 years, the mere fact that instruments known for their boring-yet-dependable returns outperformed the roadster of investments for over a generation turns conventional wisdom on its ear.
Tune into the financial channels and there’s little talk of the advantages of bonds and their steady stream of income. Typically, the chatter focuses on the thrills and chills of stock-market gyrations, which offers more exciting theater and endless fodder for debate, if not a skewed view of prudence for individual investors.
And when attention is directed to the municipal bond market, the talk is usually dominated by two trains of thought: Wait for interest rates to rise and be careful of the imminent Armageddon in the muni market.
Waiting for the unknown
Park your money, the wisdom goes, until interest rates rise (whenever that is). The unfortunate advice to “wait-and-see” before “putting new cash to work” was recently trumpeted in Barron’s, quoting Citigroup. What isn’t mentioned, however, is the cost of sitting on the sidelines – the income investors sacrifice as they wait for that magical day sometime in the future. It’s a prohibitive cost investors are becoming acutely aware of as they live through the wait-and-see fog and other failed strategies which depend on guesswork, such as laddering.
Meanwhile, interest rates, over the years, have declined or remained steady and the punishing effects of such strategies have never been higher, as the Ibbotson research shows.
Of course, the bond market wasn’t completely spared of drama last year. Financial shows were replete with talk of the unfounded but breathtaking prediction of “hundreds of billions of dollars” in muni defaults in 2011. It turns out that missed bond payments, already a tiny fraction of the market, were even lower in 2011 than in 2010.
An essential part of a diversified portfolio
The long-term performance of bonds and stocks underscores a simple reality: It’s not either/or. Bonds have never been an alternative to stocks. They’re an essential element of any diversified investment portfolio, and their value is best understood by facts, not whimsy masquerading as wisdom.
Veteran muni investors weren’t shocked by the Ibbotson figures; they have a long-term perspective and don’t focus on day-to-day market swings. They appreciate receiving tax-free income like clockwork and return of principal. For them, there are few surprises.