The Nature of Stock and Bond Returns

Since investment returns play so big a role in your retirement security, as pointed out in March 30's post, it would be helpful to put those returns in perspective. Today’s post is my shot at that.

Stocks and bonds are projected to provide you with two types of returns, yield and appreciation, which together account for the investment’s total return. Here’s a bit more:

Yield. “Yield” is the current amount of cash you receive from your investments. Your yield on bonds comes in the form of interest, which is usually fixed. Your yield on stocks comes in the form of dividends, which are less certain: they may be reduced, increased or eliminated by the issuer at any time. Historically, especially in recent decades, yields on bonds have exceeded yields on stock. During the years 1926 through 2008, the average yields on stocks and bonds have been as follows (these are geometric averages, for anyone that’s paying attention).

Average dividend yield on stocks: 4.13%
Average interest yield on bonds: 4.68%

For the record, the stated averages for stocks was determined by looking at the S&P 500 index of U.S. stocks; and the averages for bonds was determined by looking at intermediate term U.S. government bonds. Yield, of course, is only half the return story. Stocks and bonds also gain and lose value.

Appreciation and depreciation. Stocks and bonds fluctuate in value, up (appreciation) or down (depreciation). A stock’s price will fluctuate with the fortunes of the company, its industry, the economy in general, and, importantly, the diverse needs, opinions, and whims of investors. A bond’s value will fluctuate with changes in interest rates, the issuer’s creditworthiness, and the needs, opinions, and whims of investors. It is important to recognize that many non-germane factors influence the prices of stocks and bonds—things like fear, greed, investment fads, and the like. Stocks exhibit much greater swings in value than do bonds. Here are the (geometric) average appreciation for stocks and bonds.

Average appreciation on stocks: 5.38%
Average appreciation on bonds: 0.73%

Total return. An investment’s total return is the sum of its yield plus its appreciation or minus its depreciation. That total return can be positive or negative. Total return is much more important than yield in assessing the role of stocks and bonds in your retirement planning. The (geometric) average annual total return of stocks has historically exceeded the average annual total return of bonds.

Average total return on stocks: 9.62%
Average total return on bonds: 5.44%

In my opinion, for the most part the distinction between yield and appreciation should be ignored. The only thing that really matters is total return. Why? That’s a subject for another post.