April 26, 2015

Stocks vs Bonds vs Gold Returns for the Past 200 Years

General Electric Stock from the 1940s

Over the past 200 years, real inflation-adjusted returns from stocks have crushed returns from bonds, which have crushed returns of gold.

I write a lot about investing in stock and investing in bonds over at Investing for Beginners at About.com, a division of The New York Times.

There is a reason I tend to be far more favorable to equity investments (stocks) than fixed income investments (bonds) when it comes to long-term investing and why much of my content is focused on the stock market.  History has shown that owning businesses – which all a share of stock is; a piece of ownership in a business – generates the best long-term returns as long as you don’t overpay.  Most investors don’t have the experience to pick individual stocks so low-cost index funds are a better choice, which I explained in my most recent article, Top 5 Reasons Index Funds Might Be a Better Choice for the Average Investor.

For the more advanced among you, I thought it might be useful to look at long-term inflation-adjusted compounding rates for stocks, bonds, and gold based upon the work of Dr. Jeremy Siegel and John Bogle, the founder of Vanguard.

Inflation Adjusted Returns of Stocks, Bonds, and Gold

Going back nearly two hundred years, if you had invested $10,000, reinvested any dividends, interest, or other gains, and left the money alone, how much wealth would have today in real, inflation-adjusted terms based upon the asset class you selected?

Stocks vs Bonds vs Gold

The stock investor would have turned his $10,000 into $5.6 billion.  The bond investor would have turned his $10,000 into $8 million, and the gold investor would have turned his $10,000 into $26,000.  That is statistically significant.

For nearly two centuries, stocks have generated an average return of 7% in real, inflation-adjusted dollars.  Historical returns show that stocks almost always adjust to inflation over the long-term.  After all, if the dollar became worthless and the United States were forced to switch to a different currency – be it gold, silver, or sea shells – companies like Coca-Cola are still going to be generating large piles of excess surplus as people turn in some of their currency in exchange for the product or service the firm provides.

Bonds, on the other hand, have generated average real returns of 3.5% but these are far less uniform than stock returns.  In fact, it isn’t unusual to have extended periods where bonds generate negative real returns, something that stocks just haven’t been prone to do.  For example, during 1966 to 1981, bond returns on an inflation-adjusted basis were -4.2%.  From 2000 through 2010, on the other hands, bonds exceeded the stock market returns (which wasn’t difficult to predict when you look at the incredibly low earnings yield on the S&P 500 relative to Treasury bond yields at the beginning of the decade; you can’t pay 50x earnings for an enormous company such as General Electric or Johnson & Johnson and expect to do well).

If Stocks Are Clearly a Better Long-Term Investment Than Bonds, What Is the Catch?

Both stocks and bonds fluctuate significantly.  But stocks tend to fluctuate more than bonds, all else being equal.  In the past 200 or so years, we can actually look at the highest and lowest real (inflation-adjusted) gains or losses generated by stocks and bonds in any given calendar year:

Real Stock Returns vs Real Bond Returns

Depending Upon How You Define Risk, Stocks Can Be Less Risky Than Bonds

John Bogle, legendary founder of Vanguard, puts it this way in his book Common Sense on Mutual Funds:

The data make clear that, if risk is the chance of failing to earn a real return over the long term, bonds have carried a higher risk than stock.

If you consider risk to be short-term market fluctuations, then stocks are riskier than bonds.  As periods grow longer, though, stocks begin to beat bonds more and more frequently until any period of outperformance from bonds becomes a statistical anomaly.  If the stock market is fairly valued or under valued, it makes no sense for the average investor who is young and has a long-time horizon to be stuffing his or her portfolio with fixed income securities such as bonds.

A Final Word on Gold Investing as an Asset Class

Why has gold generated such pathetic inflation-adjusted returns over the long-run?  Because gold has no intrinsic value.  It isn’t a productive asset.  When you own a share of stock, you own a piece of a business that produces goods and / or services to consumers.  A good business generates a profit.  Every year that passes, gold remains sitting in the vault, but the owner of a company such asProcter & Gamble or Colgate-Palmolive might have a giant pile of cash from the profit generated over that same year by selling dishwashing soap, laundry detergent, and toothpaste.

From a financial standpoint, gold has one purpose: Rank speculation.  It can fluctuate wildly and generate huge opportunities for those who are paying attention to gamble – and that is what it is – on governmental fiscal policy.  It can serve as a flight mechanism during times of total catastrophic national collapse, such as a Jewish family fleeing Germany during the second world war who wanted to be able to start over with some capital in a new country.  But in terms of productive growth, gold is a dead asset that will eventually return to its baseline.  It produces nothing.  It creates nothing.  The inflation-adjusted returns of the past 200 years reflect this reality.

  • Austin Hill


    Have you read “More Money than God” by Sebastian Mallaby. I’m about 25% of the way through the book and have really enjoyed the analysis. It has a lot of random walks vs. ‘family of coin flipper’ arguments in regards to hedge fund performance. It also articulates that each wildly successful hedge fund has had some type of advantage, be it quant, loose inside knowledge, or the idea of hedging (simultaneous long/short) in general.The author is pro hedge fund, and I’m curious to see if he makes any recommendations later in the book after his walk through the historical successes and failures of hedge funds and the characters behind them.Great article. I read from a viewer on some site, somewhere, that “All of you guys are suckers, I’m putting 100% of my savings in Gold, in 20 years we’ll see who wins.” I didn’t feel like wasting my keystrokes to respond. If I had the gonads to short, I think I would short in the near future. I don’t follow gold at all, but when I see people in the streets with signs to “Sell your gold” and magazines saturated with “GOLD INVESTMENTS” I think the market is bound for a correction. Then again, it seems the government has no plans in slowing down it’s printing of money.Hope all has been well,Austin

    • Joshua Kennon

      I have not read it but I am about 80% certain it is sitting my library. I think it was part of my mass book buying 2 years ago when I spent $2,000 or $3,000 at Barnes & Noble and had it all shipped to my home. I’m working my way through John Bogle’s body of work now but I imagine I will get to it before long.

      I’m not a big fan of shorting just because there is no end to man’s folly. There is no reason a stock priced at 2x intrinsic value can’t go to 5x intrinsic value in the short-term before the greater fool chain collapses. With theoretically unlimited losses, I wouldn’t want to be a part of it. The only way I would be open to doing a quasi-short was in my speculation fund if I bought puts on highly overvalued companies hoping for a crash so I could acquire the sinking stock, exercise the put, and pocket the difference. That way, my maximum loss could be calculated from the very beginning unlike the unlimited loss that could happen in a shorted stock. Just look at the Northern Pacific short squeeze of 1901. That is an Armageddon scenario for a short seller.

  • Steff

    Great post, we all can see the ‘gold bubble’ before our very eyes but the lemmings will continue to buy, even at this unsustainable price. 

    • Mike_templar

      All you guys look pretty silly now in a world of ZIRP forever policies! 

      • MoEffingFiveStarStunna

        Stop it with your zero hedge crap Mike Templar. By the way, would you like an ATM machine to go with your ZIRP policies?

  • Stunna

    Great stuff fo sho playa

  • http://www.joshuakennon.com/ Joshua Kennon

    A majority of the long-term stock data was taken from the academic gold standard, Ibbotson & Associates Yearbook, which covers longer periods of time, but really strips out things like survival bias, etc all the way back through 1926. It’s a wonderful resources that breaks down various portfolio mixes, asest class returns, inflation ranges, Treasury bond yields, etc. It’s meant for professional investors and academia but I think everyone who is serious about money should have a copy in their library.

  • http://www.joshuakennon.com/ Joshua Kennon

    The past decade was included in the figure because we were talking about long-term returns. Or would you prefer that I ignore the data and, instead, give you the confirmation bias you seem to desire so fervently by excluding all prior periods and simply talk about a particular stretch of outperformance following decades of underperformance that falls perfectly in line with reversion to the mean? There are plenty of blogs out there that will do that for you.

    Furthermore, gold was not restricted everywhere else in the world. Contrary to the typical American obliviousness, we represent a mere 5% of the population on the planet.

    By all means, if you want your entire net worth in fixed piles of gold, who is stopping you? It’s a faulty economic analysis as lumps of gold are always crushed in real terms over long periods of time by productive assets given the fixed nature of the commodity (a lump of gold can’t multiply itself, whereas productive assets such as a farm can grow a new crop every year or a gold mine can produce more gold until the reserves are depleted). If you feel like it, pile up those coins. Melt them down and build yourself a gold toilet. Cast them into candlesticks. Turn it into doorknobs for your home. Build your golden calf and bow down to it with the same zeal of a secular religion.

    Meanwhile, if I wanted to trade gold – which is a perfectly reasonable thing to do if you are a speculator – I’d rather own the gold mine so I can dig it out of the ground and sell it to customers like you. In the long-run, it’s a much more lucrative situation in which to find yourself.

    The only time I would be a net buyer of gold bullion would be:

    1.) If I believed the civilization were about to fall and I needed to flee rapidly with whatever I could get my hands on, though I’d be more likely to want to stockpile silver, copper, and ammunition as they would be more useful than gold.

    2.) I believed inflation were going to accelerate to levels in excess of 15% per annum, though I’d be more inclined to find a high quality collection of cash generating real estate – such as hotels or apartment buildings – and buy them used long-term, fixed rate debt so that the inflation effectively repaid the principal, transferring the real economic value of the land from the bank to me. That way, when the inflation ended, I’d still own a productive asset pumping out real purchasing power every year instead of a pile of worthless metal.

    3.) The cost of mining gold were to exceed the current market value of gold; a situation that cannot exist in the long-term, resulting in significant upward price momentum. Short of those three scenarios, gold is not an investment. It is a speculation. I’m conservative by nature, so I can’t imagine I’d ever use leverage or futures, but rather prefer to buy the gold outright and have it stored in vaults in London or something.

    I’ve occasionally purchased gold reserves at some of my businesses simply because I felt like, though we don’t own so much as a single ounce at this particular moment and haven’t for several years.

    For what it’s worth, I hope you do extremely well, all your financial dreams come true, and you make a lot of money.

    • FratMan

      “Furthermore, gold was not restricted everywhere else in the world. Contrary to the typical American obliviousness, we represent a mere 5% of the population on the planet.”

      I’m likely wrong, but I thought the whole purpose of Bretton Woods was to tie non-American economies to the US dollar and the convertability to gold that it represented. Wouldn’t that make it hard for gold to “float” or trade freely before Nixon, well, nixed the system?

  • harry smith

    Great article but surprised you would give the inflation adjusted returns of $10,000 instead of what would actually be in the account. Tell me, would $10,000 compounded in the stock market over 200 years be over a trillion or something?

  • Andrew

    Would you consider Gold miners undervalued at this point?

  • alan

    Who cares what the rate of return is over 200 years, no one lives long enough to see that profit anyway. Why don’t you use a more realistic time period.

    • http://www.joshuakennon.com/ Joshua Kennon

      Studying the nature of long-term relationships between different things is still useful in an academic sense when attempting to measure the underlying productivity of the thing itself.

      The purpose of the post isn’t to tell you what gold will do in the next six months or five years, it’s an examination of the long-term benefits of certain asset classes over others due to certain asset classes possessing a degree of internal productivity.

      Regardless, as to your point: If you pick any 25 year time period with dividends reinvested, equities still crushed gold for this very reason. Most investors have two 25-year periods in their life as they can hope for no more than 50 years of active compounding if they start early enough and live an ordinary life expectancy so it is unnecessary to repeat it with the shorter time spans as the outcomes still stand. It would have been a waste of digital ink, so to speak, especially when anyone could have checked it themselves with a copy of the latest Ibbotson & Associates data.