Why would anyone own bonds for holding periods longer than seven years?
Posted on August 23, 2024
I generally think of STOCKS ONLY for holding periods longer than seven years if I were in the Save and Invest phase of life. The conventional advice might be 60% stocks and 40% bonds. A popular Target Date fund for 2030 (VTHRX) – a six-year investment horizon – holds 38% bonds. I run the data for all seven-year holding periods since 1871 and conclude that one would pick STOCKS ONLY for a seven-year or greater holding period.
== Holding Period ==
A holding period is how long you hold on to an investment before you sell it for your spending.
I’d argue that those in the Save and Invest phase of life have a very long holding-period for each investment that they are make in their retirement accounts. Someone 40 years old who plans to retire at age 65 has at least a 25-year holding period for each year’s contribution and investment in their retirement plan. In concept, the amount invested this year (2024) will be sold for spending in 2049. The amount invested next year will be sold until 2050. And so on.
== Stocks: eventually RISK-FREE ==
For long holding periods, stocks are RISK-FREE. They have NEVER lost money. They ALWAYS beat bonds in a head-to-head competition. On average, they grow multiples more than bonds.
I’ve posted a graph for 35-year holding before, but here is the graph of the multiple earned in 25 years for stocks and bonds for investments made each month starting January 1871.
• Stocks are RISK-FREE. They’ve never lost money. They have ALWAYS returned more in spending power than the initial investment. Bonds are NOT risk-free: they have lost money 22% of the time with an average loss of -16%.
• Stock returns are risk-free – for all practical purposes – relative to bonds. They haven’t ALWAYS returned more than bonds, but the odds are nearly 200 to 1 that stocks beat bonds.
• On average, stocks grew six times more than bonds. Stocks grew more than the average for bonds 99% of the time. Bonds returned less than the worst multiple for stocks about half the time. (The most recent multiples for bonds are well below the worst multiple for stocks.)
== Stocks are not RISK-FREE at 20 years ==
The risk of loss increases for both stocks and bonds as the holding-period shortens. The lines for stocks and for bonds compress (The values on the Y-axis are less.) and drift lower on the graph.
You need to spend some time to judge whether you should invest in stocks or bonds for all holding-periods less than 21 years: the first time a sequence of return for stocks loses money is for a 20-year sequence; they are not absolutely risk-free. That is one sequence out of about 1,600 20-year sequences of return. That’s a 99.94% probable that an an investment in stocks will make money, but that’s not totally risk-free.
== How to judge ==
In all sequences less than 21 years, it’s a judgment – a bet – as to what to invest in based on two factors: I emphasize loss over gain.
1. The rate that stocks and bonds lost money – failed to return the initial investment – and the depth of losses. (I call this absolute risk.)
2. The frequency and degree that one outperforms the other. (I call this relative risk.)
== Seven Years ==
I keep shortening the holding-periods to the breakpoint that I’ve had in my head – seven years.
1. The rate that stocks and bonds lost money and the depth of losses.
• Both stocks and bonds have lost money over seven years; both have risk of loss. Stocks have lost 13% of the time and bonds have lost 29% of the time. Bonds lost more than twice as often as stocks. `(Note: bonds are underwater for all sequences of return starting after January 2015. Because of the steep drop in 2021+2022 and lack of rebound since then, returns will remain underwater for a few more years – perhaps quite a few years.)
• The depth of losses are similar. Nothing here makes me lean toward bonds:
2. The frequency and degree that one outperforms the other.
• Stocks outperform bonds 75% of the time: the odds favor stocks 3:1. On average stocks grow about 3½ times that of bonds. Stocks have returned more than the average for bonds 80% of the time.
This isn’t much of a debate or a tough call. I would not invest in bonds for a seven-year holding period.
Conclusion: The conventional adviced for relatively short holding periods is a mix of 60% stocks and 40% bond. A popular target date fund 2030 has a mix of 62% stocks and 38% bonds.
This mix makes no sense to me. I graph the rolling seven-year return for stocks and bond for monthly investments starting in 1871 and conclude that you would pick STOCKS ONLY for a seven-year holding period: stocks lose less than half as often for bonds; stocks outperform bonds three-fourths the time; on average stocks grow 3 times the amount for bonds; stocks return more than the average for bonds 80% of the time.