Bonds for the Long Run?

By Charlie Bilello

15 Dec 2020

Over the last 20 years, long-term bonds have outperformed stocks (350% vs. 284%).

Needless to say, this outcome will come as a surprise to many…

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(Note: in this post I’m using the S&P 500 Index Fund (VFINX) as the proxy for “stocks” and the Vanguard Long-Term Investment Grade Bond Fund (VWESX) as the proxy for “bonds”).

Stocks are supposed to outperform bonds over long periods of time to compensate investors for their increased risk. This is outperformance is known as the “equity risk premium.”

But over the last 20 years, stocks have had a standard deviation of 15.1% versus 8.3% for bonds. So how could they not have outperformed bonds?

Because the theoretical equity risk premium is not a guarantee and is far from constant. It can vary dramatically depending on the starting and ending points.

And the starting point of 20 years ago was a very good one for bonds (corporate bond yields of 7.5%) and a bit more difficult for stocks (with high valuations coming off the peak of the dot-com bubble).

The lesson here: the “long run” in “stocks for the long run” can end up being much longer than you might think.

Still, as an equity investor, time is your best friend. While in any given month your odds of outperforming bonds are little more than a coin flip (57%), those odds increase considerably over time (stocks have outperformed bonds in 100% of 30-year periods since 1976).

What will the next 20 years bring?

Nobody knows, but a repeat performance in the corporate bond market (7.8% annualized return) will be extremely difficult to match.


Because corporate bond yields (investment grade) today are at 1.85%, an all-time low. And the single best predictor of future bond returns are beginning yields.

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As for stocks, the calculus is a lot harder. Their total returns will depend on dividend yields, earnings growth rates, and ending valuations.

That last part of the equation is the tricky part, as no one can predict what valuations will look like 20 years from now.

We do know, however, that equity valuations today are at the higher end of the historical spectrum, similar to where we stood 20 years ago (using the CAPE Ratio which smooths earnings over 10-year periods and adjusts for inflation).

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Does that mean bonds will once again outpace stocks over the next 20 years? That seems unlikely given where bond yields are today, but equity investors should be mindful of the impact high expectations can have on future returns, even over long periods of time.

Which is another way of saying that the “long run” may end up being longer than you think.

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