The Myth of "Safe" Money
I would like to argue against the perception that bonds are "safer" than stocks, especially when considering long-term financial goals like retirement which can last 20-30 plus years.
Historical Returns
For approximately 100 years the average return of large company stocks in the United States (assuming dividends were reinvested) has been about 10% per year. For those same 100 years, bonds that are comparable to those same companies have averaged a return of 6% per year.
Over those same 100 years, inflation has averaged around 3% per year, so to calculate the real return on both of the aforementioned investments, we need to take their average return and subtract inflation to get a net return also known as a real return.
Real Returns (After Inflation)
For large company stocks that is 10% minus 3% which equals 7%. For bonds that is 6% minus 3% which equals 3%. SImply stated that the real return of large company stocks is over twice the return of comparable bonds in the last 100 years.
I use this fact often when talking to potential clients and still yet on occasion, I will have someone look me dead in the eye and declare that bonds are “safer” than stocks.
I guess that could be the case if one thinks that it is possible that all the largest companies in the United States will go bankrupt at the same time and since bond holders hold a lien on those companies they would get paid first before any stockholders receive anything.
I mean I guess that is possible. So is a meteor hitting earth today and vaporizing all of us in seconds. It’s possible, but is it likely? Probably not.
Defining Safety
If you think bonds are “safer” than a diversified portfolio of stocks made up of the largest and best companies in the United States and the world, I would ask you this question. Tell me what you mean when you say they are “safer?”
Typically the answer to that question is “I won’t lose any money.” That is sort of true since bonds return on average 3% net return and inflation averages around 3%, you’re not losing money in regards to your principal balance, but you are losing purchasing power over time. And honestly in retirement, maintaining and increasing purchasing power is the primary goal.
Impact of Inflation
Just the last few years, we all witnessed what inflation has done to our purchasing power. Inflation over the last 5 years is in the neighborhood of 25% total, which means one dollar five years ago has the purchasing power of 75 cents today. That’s why if you didn’t receive a 5% raise each year over the last 5 years you feel like you have less money today even if your salary is higher. Your salary would have needed to increase 25% over the last five years to feel like you weren’t losing ground.
Definition of Wealth
Wealth by definition is growing your purchasing power faster than the rate of inflation. If you are not doing that then you are getting poorer without realizing it. Bonds are not designed to do that. The stocks of successful companies are designed to do that. They are the only investment that has a history of outpacing inflation over time with consistency.
With the stocks of great companies you increase your purchasing power over time to outpace inflation and with bonds you maintain your purchasing power at best.
Conclusion
So now that you know this fact, you tell me what is safer over a 30 year retirement? Investing in a diversified portfolio of great companies that have historically (which is our only guide) outpaced inflation or owning debt of successful companies that has basically kept even with inflation over time?
I know which one I’m picking.
You need a plan
Retiring - without a plan - is simply a plan to run out of money. Your NRECA R&S Pension is not a plan. Your NRECA 401k is not a plan. Your Social Security is not a plan. Those are only pieces in the retirement planning puzzle.
At 80/20 Financial Services we specialize in helping cooperative employees plan their retirement. We can show you how to turn your 401k and your R&S lump sum into a stream of income just like when you were working while also helping you achieve your desired financial outcomes in retirement.
The consultation is free and without obligation. Contact us to set up a consultation.
For more articles about retirement planning and investing click here.
Brian Coleman/Electric Cooperative Retirement Specialist
80/20 Financial Services is an Independent Registered Investment Advisory Firm. We help electric cooperative employees retire with a plan, not just a portfolio.
Photo by Jametlene Reskp on Unsplash
