Which is Riskier: Stocks or Bonds?
Which are riskier: stocks or bonds? How about sharks vs. cows? The answers may seem obvious. But what if you’re standing in a field, and a herd of startled cows is stampeding your way? Suddenly those sharks don’t seem like such a threat.
Instead of wondering which are riskier – stocks or bonds – here’s a more useful question: What kinds of risks do each entail?
Stock prices tend to jump around more from day to day, or even year to year. That’s probably why most people think they’re riskier. Bond prices go down too (usually when interest rates are on the rise like they now are), but when stocks take a dive, they often fall much further.
That said, stocks have delivered much higher returns than bonds over the long haul. On average, U.S. company stocks have earned more than 10% annually over the past 90 years. Bond returns have historically averaged closer to 5% annually. Subtract an average inflation rate of around 3% per year, and real annual returns are around 7% for stocks and 2% for bonds. Stick your cash in a super-safe interest-bearing account, and odds are it won’t even keep pace with inflation, especially after tax.
So let’s revisit those risks.
With stocks, you’ve got volatility risk. Prepare for a bumpy ride but higher expected returns over the long haul, if you can ride out the downturns. Thus volatility would make an all-stock portfolio a risky venture for your 16-year-old’s college fund. If stocks take an ill-timed dive, your investments probably won’t have time to recover.
With bonds, you’ve got inflation risk. As long as you invest in high-quality bond funds, you’re unlikely to lose big chunks of money, but neither are you as likely to earn enough beyond inflation to fully fund your financially secure retirement 20 years from now. In this scenario, an all-bond portfolio is certainly the riskier bet.
So again, for optimal investing, which are riskier: Stocks or bonds? The answer is, it depends. Stocks are risker for short-term goals and bonds for long-term goals.