Saturday, December 31, 2011

Everything you need to know about investing, almost.

Almost everything you need to know is in this chart. It's worth looking at for a few minutes.

The chart above shows the last 15 years of investment returns by asset class. On the far right I have calculated the 20-year average for each asset class and pointed out the best and worst annual returns for the past 20 years for each asset class.  I love this chart - which is why I put it on the back cover of every book I have written.  Almost everything you need to know about investing can be learned from this chart:

  1. Stocks beat bonds over the long-run.  In the far right columns of the chart you will notice that all 4 of the major stock classes have a higher 20-year average return than all 4 of the major bond classes. You will notice that the various stock classes averaged 9-13% annual returns over 20 years while the various bond classes averaged just 5-8%.  
  2. Stocks don't beat bonds EVERY year, but they win about 75% of the time.  You will also notice that a stock class claimed the top spot in 11 out of the past 15 years (and 16 out of the past 20 years).
  3. Stock returns are much more variable or volatile than bond returns.  In the far right column of the chart you will notice that while Mid Cap Stocks have the highest Average Return of 13% annually, the returns have ranged from a high of +40% to a low of -42%.  This tells you that while you are better off in stocks over the long run, you must have much patience during the wild ups and downs. 
  4. Bond returns are much less volatile than stock returns.  In the last 20 years, the worst year in any bond class was just a loss of -2% while the worst annual return in stocks was -46%.  But, the safety in bonds comes with the trade-off of lower long-term returns as stated in #1 above.
  5. Every one of the 8 different asset classes in the chart have finished first AND last at least once in the past 22 years (I only show 15 years in the chart here due to space constraints).  Quite often an asset class will go from first to worst and back again.  Sometimes an asset class will stay first or worst for several years.  Just take a look at Foreign Stocks in the black boxes in the chart.  Foreign Stocks have been the best asset class in 5 of the past 15 years, but also the worst asset class in 5 of the past 15 years.  The patterns are obviously quite random and impossible to predict.  Despite what the talking heads blabber on CNBC - no one really knows which asset class will be best in any given year.    

So, after studying the chart it should be obvious that your investment strategy should include:

  • Put as much money in stock funds as you can possibly tolerate.
  • Put only as much money in bond funds as needed to keep your sanity when stocks fall.
  • Diversify your assets across ALL 8 asset classes above no matter your age.
  • Rebalance your portfolio exactly once each and every year (don't do the Hokey Pokey).
  • Buy only index funds (this is not obvious from the chart, but the reasons can be found all over my blog - try here, here, and here).
  • Want help determining how much to put in each of the 8 asset classes? Get help in 15 minutes or less with one of my books. You can buy them on Amazon or go to

In the chart you will notice that bonds beat stocks in 2011.  That is a rare occurrence.  Thus, when you rebalance your portfolio, almost everyone should need to reduce their bond fund holdings and add to your stock funds.  Buy low, sell high, got it?

1 comment:

  1. That's a great post and an excellent chart. The one major takeaway from this is how much bouncing around in the asset classes there are. I think recent research has shown that something like 95% of investment returns come from the selection of asset classes, NOT individual stocks and funds. Its amazing the amount of money spent/wasted trying to beat the market.