to earn a higher yield than you can with a money market or savings account. You’re taking more risk, after all. Companies can and do go bankrupt, in which case you may lose some or all of your investment.
Generally, you can expect to earn a higher yield when you buy bonds that
Are issued for a longer term: The bond issuer is tying up your money at a fixed rate for a longer period of time.
Have lower credit quality: The bond issuer may not be able to repay the principal.
Wharton School of Business professor Jeremy Siegel has tracked the performance of bonds and stocks back to 1802. Although you may say that what happened in the 19th century has little relevance to the financial markets and economy of today, the decades since the Great Depression, which most other return data track, are a relatively small slice of time. Figure 2-4 presents the data, so if you’d like to give more emphasis to the recent numbers, you may.
© John Wiley & Sons, Inc.
FIGURE 2-4: A historical view of bond performance: Inflation has eroded bond returns more in recent decades.
Note that although the rate of inflation has increased since the Great Depression, bond returns haven’t increased over the decades. Long-term bonds maintained slightly higher returns in recent years than short-term bonds. The bottom line: Bond investors typically earn about 4 to 5 percent per year.
Stock returns
Investors expect a fair return on their stock investments. If one investment doesn’t offer a seemingly high enough potential rate of return, investors can choose to move their money into other investments that they believe will perform better. Instead of buying a diversified basket of stocks and holding, some investors frequently buy and sell, hoping to cash in on the latest hot investment. This tactic seldom works in the long run.
Going all the way back to 1802, the U.S. stock market has produced an annual return of 8.3 percent, while inflation has grown at 1.4 percent per year. Thus, after subtracting for inflation, stocks have appreciated about 6.9 percent faster annually than the rate of inflation. The U.S. stock market returns have consistently and substantially beaten the rate of inflation over the years (see Figure 2-5).
Stocks don’t exist only in the United States, of course (see Figure 2-6). More than a few U.S. investors seem to forget this fact, as they did during the sizzling performance of the U.S. stock market during the late 1990s and 2010s. As discussed in the earlier section “Diversify for a smoother ride,” one advantage of buying and holding overseas stocks is that they don’t always move in tandem with U.S. stocks. As a result, overseas stocks help diversify your portfolio.
© John Wiley & Sons, Inc.
FIGURE 2-5: History shows that stocks have been a consistent long-term winner.
© John Wiley & Sons, Inc.
FIGURE 2-6: Plenty of investing opportunities exist outside the United States.
In addition to enabling U.S. investors to diversify, investing overseas has proved to be profitable. The investment banking firm Morgan Stanley tracks the performance of stocks in both economically established countries and so-called emerging economies. As the name suggests, countries with emerging economies (for example, Brazil, China, India, Malaysia, Mexico, Russia, and Taiwan) are “behind” economically but show high growth and progress rates.
Real estate returns
Consider what has happened to the U.S. population over the past two centuries. In 1800, a mere 5 million people lived within U.S. borders. In 1900, that figure grew to 76.1 million, and today, it’s more than 330 million. All these people need places to live, and as long as jobs exist, the income from jobs largely fuels the demand for housing.
Businesses and people have an understandable tendency to cluster in major cities and suburban towns. Although some people commute, most people and businesses locate near major highways, airports, and so on. Thus, real estate prices in and near major metropolises and suburbs generally appreciate the most. Consider the areas of the world that have some of the most expensive real estate prices: Singapore, Hong Kong, Vancouver, San Francisco, Los Angeles, New York, and Boston. What these areas have in common are lots of businesses and people and limited land.
Contrast these areas with the many rural parts of the United States where the price of real estate is relatively low because of the abundant supply of buildable land and the relatively lower demand for housing.
Compounding Your Returns
During the past century,
