Here’s some useful data on historical asset class returns for the US market.
The graph to the right shows US total asset class returns with income reinvested since 1925, as calculated by Barclays [1] for its Equity Gilt Study 2015.
As you can see, equities (stocks) have done much better than bonds or cash over the long-term.
Four important caveats:
- These nominal asset class returns include rises from inflation [2], which don’t actually make you any richer.
- The seemingly steady graph disguises a lot of ups-and-downs, such as the 2008/9 bear market [3]!
- The US has been one of the very best performing countries [4] in stock market terms over the past 115 years. Extrapolating that to other regions (or even into the future) could be misleading.
- A UK investor putting money to work in the US faces currency risk [5], which can increase or reduce your returns.
Let’s now look more closely at US historical asset class returns in real terms (that is adjusted for inflation).
US real asset class returns (% per annum)
| 2014 | 10 years | 20 years | 50 years | 89 years | |
| Equities (stocks) | 9.7 | 5.5 | 7.4 | 5.6 | 6.7 |
| Government bonds | 23.0 | 5.1 | 6.0 | 3.4 | 2.6 |
| TIPS | 18.3 | 4.0 | |||
| Corporate bonds | 14.9 | 4.8 | 5.9 | ||
| Cash | -0.7 | -0.7 | 0.3 | 0.9 | 0.5 |
Source: Barclays Equity Gilt Study 2015 (Note: Where no data is available, there is a gap).
The table shows real returns, which is the annualized percentage amount by which each asset grew (or shrunk) over the period, after inflation.
Remember that inflation eats away at your savings every year.
- You need a positive (greater than 0%) real return to keep up with inflation.
For example, if inflation is 3% then your money needs to grow by at least 3% nominal to keep up with its impact – after-tax [6] – in order to preserve your spending power.
As the table shows, US equities have delivered returns far ahead of inflation.
American dream
As it happens US returns have also run ahead of most markets around the world.
You can see the impact of this hyper-growth for US shares in the following two pie charts from Credit Suisse.
They show how the US stock market has expanded over the past 115 years to make up a far larger share of the global total.
[7]
Source: Elroy Dimson, Paul Marsh and Mike Staunton, Credit Suisse Global Investment Returns Sourcebook 2015.
The sheer size of the US stock market means it makes up a very large percentage of any world equity [8] tracker fund.
Combine that with its traditional strong returns and the vast breadth and depth of its markets and the US is an impossible country to ignore, whether you’re a passive or an active investor.
Using historical asset class returns
An understanding of historical returns is important because it helps us get over behavioural quirks [9] such as recency bias.
Recency bias is the tendency we all have to think that things will continue in the same vein as they have recently, even when the long-term data says otherwise.
For instance, if you go out in a T-shirt and shorts in October in Scotland without checking the weather forecast – just because it was sunny yesterday and the day before – then you are suffering from recency bias.
(You’ll probably soon be suffering from flu, too!)
Hence it’s very misleading to consider just the last couple of years of asset class returns when deciding how to construct [10] a long-term portfolio.
Only cash and very short-term government bonds provide a secure return over a short period.
All other asset classes are too volatile [11] for that.
For example, consider the equivalent data for the US from 2010:
Returns to 2010: US real asset class returns (% per annum)
| 2009 | 10 years | 20 years | 50 years | 84 years | |
| Equities (stocks) | 28.7 | -2.2 | 5.8 | 5.5 | 6.6 |
| Government bonds | -15.5 | 5.0 | 5.3 | 2.9 | 2.3 |
| TIPS | 5.8 | 6.7 | |||
| Corporate bonds | 16.3 | 4.7 | 5.2 | ||
| Cash | -2.6 | 0.2 | 1.0 | 1.2 | 0.6 |
Source: Barclays Capital Equity Gilt Study 2010 (Note: Where no data available, there is a gap).
You can see the long-term return figures are little changed (for instance, equities had returned 6.6% a year over the 84 years to 2010, versus 6.7% a year over 89 years to 2014).
Shorter-term though, things are different.
Against popular expectations, 2009 was a stellar year for US stocks. Yet despite this they were still showing a negative return over 10 years of minus 2.2% in 2010, and they had been soundly beaten by less risky US government bonds.
That compares to the 5.5% positive annual return from US equities over ten years to 2014 shown in the first table, against a 5.1% annual return from US bonds.
This demonstrates how the longer-term traits of the different asset classes have reasserted themselves in the US, after that very poor ten-year period for equities.
The long and short of it
Stocks tend to outpace other asset classes over the medium to long-term precisely because they are far riskier over the short-term.
If the expected returns from equities weren’t higher than bonds, then nobody would choose to own them over less volatile and ultra-safe bonds – and the prices of stocks would accordingly fall until their expected returns rose.
That’s exactly what happened after bubbly periods for equities such as 1999 or 1929.
But while all this looks obvious in hindsight, timing the market to try to avoid booms and busts is notoriously difficult.
Nearly all the methods of stock market forecasting [12] you’ll read about have proven very unreliable, and the best method isn’t much better than that.
This means that most people trying to save and invest for the future are best advised to follow a passive investing [13] strategy, rebalancing their portfolios periodically to smooth out the booms and busts.
Over the long term – such as 40 years of investing towards retirement – the characteristics of different asset classes such as stocks, bonds, and cash should play out like they have in the past.
For that reason, if you’re using an investment return or compound interest calculator [14] then it’s OK to use long-term historical returns as a proxy for the interest rate function required. Just bear in mind that the US stock market has been one of the best performing of all developed world nations.
UK historical asset class returns [15] offer a more cautious reference point.