Bonds: Why Bother? by Robert Arnott is available at http://www.indexuniverse.com/publications/journalofindexes/a...Here are some excepts: Starting any time we choose from 1979 through 2008, the investor in 20-year Treasuries (consistently rolling to the nearest 20-year bond and reinvesting income) beats the S&P 500 investor. In fact, from the end of February 1969 through February 2009, despite the grim bond collapse of the 1970s, our 20-year bond investors win by a nose. We’re now looking at a lost 40 years!In real, inflation-adjusted terms, the 1965 peak for the S&P 500 was not exceeded until 1993, a span of 28 years. That’s 28 years in which—in real terms—we earned only our dividend yield … or less. This is sobering history for the legions who believe that, for stocks, dividends don’t really matter.From the share price peak in 1905, we saw bull and bear markets aplenty, but the bear market of 1982 (and the accompanying stagflation binge) saw share prices in real terms fall below the levels first reached in 1905—a 77-year span with no price appreciation in U.S. stocks.My point in exploring this extended stock market history is to demonstrate that the widely accepted notion of a reliable 5 percent equity risk premium is a myth. Over this full 207-year span, the average stock market yield and the average bond yield have been nearly identical. The 2.5 percentage point difference in returns had two sources: Inflation averaging 1.5 percent trimmed the real returns available on bonds, while real earnings and dividend growth averaging 1.0 percent boosted the real returns on stocks. Today, the yields are again nearly identical. He concludes the article: * For the long-term investor, stocks are supposed to add 5 percent per year over bonds. They don’t. Indeed, for 10 years, 20 years, even 40 years, ordinary long-term Treasury bonds have outpaced the broad stock market. * For the long-term investor, stock markets are supposed to give us steady gains, interrupted by periodic bear markets and occasional jolts like 1987 or 2008. The opposite—long periods of disappointment, interrupted by some wonderful gains—appears to be more accurate. * For the long-term investor, mainstream bonds are supposed to reduce our risk and provide useful diversification, which can improve our long-term risk-adjusted returns. While they clearly reduce our risk, there are far more powerful ways to achieve true diversification—and many of them are out-of-mainstream segments of the bond market. * Capitalization weighting is supposed to be the best way to construct a portfolio, whether for stocks or for bonds. The historical evidence is pretty solidly to the contrary. As investors become increasingly aware that the conventional wisdom of modern investing is largely myth and urban legend, there will be growing demand for new ideas, and for more choices.
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