Should investors believe in the superiority of stocks for the long run and bonds for the short run? In his December 2011 paper entitled “Stocks, Bonds, Risk, and the Holding Period: An International Perspective”, Javier Estrada examines how the absolute and relative risks of stocks and bonds evolve as investment horizon grows (time diversification). Considering both annual and cumulative returns and various measures of variability/risk, he focuses on the question of whether stocks become less risky than bonds for long holding periods. Using annual total returns for stocks and bonds in 19 countries during 1900 through 2009, he finds that:
- The average annualized real return across the 19 countries over the entire sample period is 4.7% (0.9%) for stocks (bonds). The annualized real return for stocks is positive and higher than that for bonds in all 19 countries. The annualized real return of bonds is negative in six of 19 countries.
- Over the short term, stocks are riskier than bonds, regardless of risk measure (general variability or downside potential) and return (annualized or cumulative).
- On average across the 19 countries, the standard deviation of annual returns for stocks (bonds) is 23.4% (12.4%).
- On average across the 19 countries, the semi-deviation of negative annual returns for stocks (bonds) is 11.5% (7.8%).
- Across all 19 countries, the worst annual return for stocks (bonds) is -54.3% (-39.3%).
- Over the medium and long terms, stocks unambiguously (mostly) become less risky than bonds based on annualized (cumulative) returns. For cumulative returns, some measures of relative risk suggest that stocks become riskier than bonds, but most of the increase in relative risk derives from higher upside stock return volatility.
- On average across the 19 countries, the annualized volatility for stocks (bonds) over 10‐year holding periods is 6.5% (6.3%) Over 20-year and 30‐year holding periods, the annualized volatility for stocks is lower than that for bonds on average and in most countries.
- On average across the 19 countries, the annualized semi-deviation of negative returns for stocks (bonds) over 5‐year holding periods is 4.6% (5.2%). Over 10-year, 20-year and 30‐year holding periods, the semi-deviation of negative returns for stocks is lower than that for bonds in most countries and on average.
- Over holding periods as short as five years, the lowest annualized return for stocks (bonds) is -22.1% (-22.0%). In about half the countries, the lowest 5‐year annualized return for stocks is higher than that for bonds. Over 10-year, 20-year and 30‐year holding periods, the lowest annualized return for stocks is higher than that for bonds in most countries and on average. In fact, over 20‐year (30-year) holding periods, the lowest annualized return for stocks is positive in six (11) of 19 countries, while that for bonds is negative in all countries (all countries except Switzerland).
In summary, evidence from long run total returns in 19 countries generally supports the belief that stocks gradually become less risky, both in absolute terms and relative to bonds as investment horizon lengthens (time diversification works).
Cautions regarding findings include:
- Constructing 110-year return series across 19 country stock and bond markets requires arguable assumptions and modeling (such as dealing with hyperinflation events and survivorship).
- A 110-year sample is not long for assessing holding periods of a decade or longer.
