The long-term investment case for stocks and bonds

Jonathan Schreiber, Senior Investment Director, and Daniel Lahrman, Investment Director, 07/07/22


  • Over a nearly 100-year sample, intermediate-term government bonds have offered risk-adjusted returns that slightly exceeded domestic large-cap stocks.
  • High-quality bonds are valuable to reduce portfolio volatility and maximize risk-adjusted returns.
  • These results are possible through the “free lunch” of portfolio diversification. Combining these two uncorrelated asset classes provides a more efficient return.
It is fair to say the first half of 2022 has been tough for bond investors. The 10-year U.S. Treasury note yield has moved from 1.52% to start the year to more than 3.47% in mid-June. Since bond prices move in the opposite direction of yields, most fixed income investments have experienced negative returns year-to-date. Understandably, this has led some investors and plan sponsors to ask: “Is it still an appropriate time to own bonds?”

In this post, the first of a three-part series, we will make a case for long-term investment in both stocks and bonds. Subsequent pieces will consider related questions: “Are bonds too risky right now?” and “Can active management help navigate a rising-rate environment?”

Below, we share insights gained from studying long-term performance and what they mean for portfolio allocations.

The 100-year perspective

It’s easy to see why investors might question a bond allocation in the current interest-rate environment if they’re viewing bonds on a stand-alone basis. However, it is important to view high-quality bonds with a broader perspective. Aside from performance, they serve a valuable role in portfolio construction to reduce portfolio volatility and maximize risk-adjusted returns.

We believe a study of the history of capital markets may generate insights that can help investors in the future. When studying stocks and bonds, we are fortunate to have nearly a century of data to judge. The following table includes the performance of U.S. intermediate-term government bonds (measured by the Ibbotson U.S. Intermediate Term Government TR Index) and large-cap stocks (measured by the Ibbotson U.S. Large Stock TR Index).

Government bonds have better long-term risk-adjusted returns (Sharpe ratio) than stocks

1/1/1926–3/31/2022 Intermediate government bonds Large-cap stocks
Average annualized return 4.97% 10.38%
Annualized standard deviation 4.30% 18.61%
Sharpe ratio 0.40 0.37
Stock-bond correlation 0.05

Sources: Morningstar, Putnam.

Over long cycles of both rising and falling interest rates, bonds delivered positive, mid-single-digit returns for investors. Also, bonds delivered these returns with a relatively low annualized standard deviation. In fact, when comparing these two asset classes individually, intermediate-term government bonds have offered risk-adjusted returns that slightly exceed those of domestic large cap stocks.

The optimal multi-asset portfolio

While a stand-alone look at each asset class provides some insight, investment managers must also understand how various asset classes interact with each other in a combined portfolio. Because stocks and bonds do not tend to move in the same direction over full market cycles, owning them together may provide a more efficient return than an investor could achieve by owning either asset class individually. Some investors call this the “free lunch” of diversification. Combining these two uncorrelated asset classes provides a more efficient portfolio return.

Again, using our 100-year sample, we examine various combinations of stocks and bonds to determine which allocation maximizes the portfolio’s risk-adjusted return.

Combining bonds and stocks in a portfolio has historically generated higher risk-adjusted returns

Combining stocks and bonds leads to higher risk adjusted returns

Sources: Morningstar, Putnam. Returns from January 1, 1926–March 31, 2022.

Among the allocation combinations charted above, we observe that the point of maximum portfolio efficiency (or highest Sharpe ratio) is roughly 80% bonds and 20% stocks.

In summary

Informed by nearly 100 years of data, we see evidence that intermediate-term government bonds have offered risk-adjusted returns slightly higher than domestic large-cap stocks. In addition, these bonds have proven valuable when combined with large-cap stocks. Through the power of diversification, high-quality bonds have historically helped managers improve portfolio efficiency by increasing risk-adjusted returns.

Retirement plan investors seeking portfolio efficiency can access diversified strategies in target-date funds. These funds use a glide path design to adjust allocations to stocks and bonds over a long time horizon.

Next in the series

Many investors believe we are destined for a prolonged period of rising interest rates. In our next article, we will examine the topic “Are bonds too risky right now?” We will take a critical look at the historical experience of the early 1960s through the early 1980s to glean possible insights for bond investors today.

Link to learn more about our target-date strategies

330365