Return Spreads for Primary Classes: Cash, Bonds Stock

Cash, bonds and stocks are the three primary asset classes for securities investors. They point to the three basic things you can do with your money other than spend it or donate it . You can hold it in reserve (cash). You can loan it (basically bonds). Or, you can own something with it (stocks for operating companies, or to hold non-operating stuff such as gold or oil).

This article looks at total returns (price plus investment income) for 3-month Treasuries to represent cash reserves, the Barclay’s U.S. Aggregate Bond index to represent loaning money, and the MSCI All Country [stock] index to represent owning something.

Prior to 1988, the MSCI World index is used as a proxy for the MSCI All Country index, which did not come into existence until 1988. The World index did not include emerging countries, but they weren’t so important a factor back then.

For long-term investment planing, the average total return point spread of stocks over bonds, and of bonds over cash, is an important investment attribute to understand when selecting and allocating portfolio assets.

Young people in periodic savings programs, such as 401-k plans, should know about the difference, and favor stocks.

The 34 -year average total return for cash, bonds and global stocks shows the spread over the very long-term. Stocks have returned approximately 4 points above bonds, and bonds have returned approximately 3 points above cash.

click image to enlarge


The fly in the ointment, is that not everybody is so young that they can wait for long periods to capture the long-term return spreads.

If you don’t have 30+ years for your investments to work out, and if you might have to draw upon those investments for lifestyle reasons before the long-term spreads work out, you may have to withdraw assets during an adverse period. That would have a larger negative impact on future portfolio value than a withdrawal during a favorable period.

This chart shows the 5-year average point spread between stocks and bonds, and between bonds and cash. It paints a picture that is of concern to investors with intermediate-term time horizons. They cannot rely on historical or expected long-term average returns for each class over intermediate periods.

The annual return point spreads are yet more unreliable for short-term planning, although they create opportunities to benefit rebalancing programs, particularly in tax-deferred or tax-exempt accounts.

This next chart shows the actual annual total return used to generate the point spreads in the previous charts.

The 3-month Treasuries have generated a low, but positive returns throughout the 3+ decades (with almost zero returns as of late, and with major questions about how long that will last — a few months or a few years). The U.S. aggregate bond returns have been positive almost all of the time (with minor dips into negative territory in 2 out of 34 years: down 2.92% in 1994 and down 0.82% in 1999). The global stocks are way up and way down in an irregular pattern.

The mean, worst and best total returns for the period 1976 through YTD 2009 are:

• Cash: 5.70%, 0.33%, 14.03%
• Bonds: 8.59%, -2.92%, 32.60%
• Stocks: 12.43%, -41.85%, 42.80%.

Proxy ETFs for those three asset categories are:

• SHV for cash (3-Month Treasuries)
• BND or AGG for bonds (Barclay’s U.S. Aggregate Bond index)
• VT for global stocks (MSCI All Country index).

Disclosure: We own BND and AGG in some managed accounts.