Worried About Stocks? Get Over It

05/10/2010 12:00 pm EST

Focus: MARKETS

Daniel Wiener

Editor, The Independent Adviser for Vanguard Investors

Daniel P. Wiener, editor of the Independent Adviser for Vanguard Investors, says investors' rush into bonds is short-sighted and will prove costly in the end.

I have always believed that the way to grow an investor’s portfolio is to focus on stocks—an ownership right in the profits (and sometimes losses) and dividends generated by what we hope are well-managed companies making goods and providing services that companies and people want.

By contrast, bonds, and their yields, are a welcome diversifier, income generator and counterweight in our portfolios. But bonds don’t typically provide the growth we’re looking for—and the growth they do generate often comes at the price of much higher tax burdens when used in non-advantaged accounts.

And the coming decade almost certainly will belong to stocks.

The bond market has, since 1982, been in one very, very long bull market. Treasury yields that were once near 20% are now closer to 4%, having risen from even lower levels during the depths of the 2008 financial crisis. The tailwind of falling bond yields and rising bond prices created outsized and almost unmatchable bond returns for nearly 30 years.

Long-Term Investment-Grade (VWESX), Vanguard’s oldest bond fund, and one of only a handful that was even around during the early 1980s, produced a whopping 9.4% annualized return from the end of 1980 through March 2010. That’s huge. Consider that the long-term annual return for the stock market is roughly 10%. Vanguard 500 Index Investor (VFINX) earned 10.5% annualized over the same period.

I just don’t think the [tail] winds are going to be blowing [bonds’] way over the next decade, for sure, and maybe not over the next two. We simply won’t see bond yields falling from 4% to 0% or even 1% any time soon.

[Yet] investors are continuing to shun stocks and buy bonds. In the early stages of the stock market rally, this would have been quite understandable—it takes fortitude to hold on to, much less add, money to stocks when the recent history suggests it’s a one-way ticket to losses.

But 14 months later, and with strong signs of economic recovery at hand, it’s amazing that investors are still clinging to old and destructive habits. During March, investors put a net $41 billion into bond funds, while adding just $9 billion to stock funds. So, investors put more than four times as much money into bonds as they did stocks.

So, there’s a dynamic in the bond market today from which investors will eventually wake up. When they do, I think they are going to once again focus on the stock market. Not only will money move from bonds into stocks, but there will also be a wave of money moving from cash accounts into stocks.

It’s only a matter of time before that money begins flowing into the stock market, rather than the bond market. When it does, this will provide yet another boost to stock prices.

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