Should you use bonds to save FOR retirement?

This article was posted on September 1, 2001.

Whenever the stock market experiences a decline, many investors seek the safety of fixed income securities. Unfortunately, bonds make poor long-term investments. While it's true that you can get guaranteed returns with US Treasury securities, what's being guaranteed is a "worst case" return when compared to equities.

For example, the table below shows the best, worst, and median compounded annual growth rates (CAGR) for the S&P500 for various holding periods from 1871-2000. A 30-year 9.37% compounded annual growth rate means a $1,000 investment grows to $14,687 in 30 years. The current yield on the 30-year US Treasury bond is 5.42% just slightly more than the worst case 5.13% average annual return of the S&P500.

-------Nominal S&P500 Returns (1871-20000 Shiller database)----------
...
Holding Period	10-Year	20-Year	30-Year	40-Year	50-Year	60-Year
...	
Maximum		19.08%	17.14%	13.40%	12.03%	13.23%	12.53%	
Median		 8.33%	 7.81%	 9.37%	 9.14%	 8.98%	 9.18%	
Minimum		-1.23%	 3.30%	 5.13%	 5.44%	 5.65%	 5.91%	

The news isn't any better for inflation-adjusted returns. The yield on the 30-year Treasury Inflation Protected Security (TIPS) is 3.38% -- just slightly ahead of the worst case 30-year return on the S&P500 of 3.35%. It's even worse if you buy I-bonds today since their yield is only 3.00%.

---Inflation-Adjusted S&P500 Returns (18871-2000 Shiller database)----
...
Holding Period	10-Year	20-Year	30-Year	40-Year	50-Year	60-Year
....	
Maximum	      17.72%	13.06%	10.14%	9.84%	9.31%	8.28%	
Median	       7.12%	 6.76%	 6.35%	6.58% 	6.54%	6.77%	
Minimum	      -3.87%	 0.89%	 3.35%	3.67%	4.83%   5.26%	

Once you're retired you should keep a minimum of 5 years' worth of living expenses in fixed income securities, but you shouldn't do that while you're saving for retirement. Stocks or other assets with higher long-yerm average returns are more appropriate while you're accumulating your retirement portfolio.