Originally published in the Financial Times
Two reminders of the age-old debate over the merits of equities versus bonds emerged almost simultaneously in recent days.
First, Warren Buffett argued in his latest annual letter that shares are not only a better investment than fixed income instruments but are also superior to gold, the darling of many seasoned investors.
Just as that was being digested, the Financial Times reported that the Ford Motor Company had decided to put 80 per cent of its pension plan assets into bonds, up from 45 per cent previously.
While Ford makes great cars, I believe they got this decision wrong. In doing so, they fell prey to the classic mistake that many investors make: basing decisions on recent past performance rather than a more balanced view of long-term history and a clear vision of the future.
I’m betting that Mr Buffett will be proved correct. Over a reasonable period of time, shares will almost surely outperform fixed income instruments. (If they don’t, centuries of finance theory will have to be discarded.)
It’s easy to see why some investors might be tempted to go down Ford’s path. Over the past five- and 10-year periods, the US stock market (as measured by the Standard & Poor’s 500 index) has substantially underperformed the fixed income market (as measured by the BarCap index).
How dispiriting it must be for an investor to have endured the stomach-wrenching rollercoaster of equities over these periods, only to find himself at the short end of the stick. But as painful as a decade of only marginal share price gains must feel, the longer term picture is quite clear. Go back, for example, 35 years. Stocks have risen an average of 10.8 per cent per year since then, while the bond index has risen by 8.2 per cent annually.
That might not sound like a huge difference but as Mr Buffett regularly observes, the power of compounding can be immense. An investment of $10,000 in shares 35 years ago would be worth $366,756 today. The same sum put into bonds would be worth less than half that at $157,234.
Personally, I don’t imagine that either stocks or bonds will match the past 35 years over the next 35 years (or even a shorter period). Both investment routes benefited enormously from a steady reduction in interest rates as the stagflationary environment of the 1970s was dealt with.
But by almost any measure, stocks today are cheaper than bonds. For example, the S&P index trades at a 14.1 times multiple of most recent 12-month earnings, compared to an average of 16.8 times since 1977. Meanwhile, thanks to de minimus inflation and accommodating monetary policy, bond yields are near an all-time low.
Perhaps most dramatically – and almost without historical precedent – the dividend yield on the S&P index is currently higher than the 10-year Treasury yield. Either stocks are cheap or a lot of companies will soon be reducing their payouts.
If proved wrong, Ford would be among a lengthy and illustrious list of investors who turned away from shares at the wrong moment. In August 1979, for example, BusinessWeek magazine emblazoned “The Death of Equities” across its cover. An extraordinary US bull market began just seven months later.
Why is investing perhaps the only profession that non-professionals think they can do themselves? Few of us would try to be our own lawyers or doctors.
Mr Buffett shouldn’t be making cars and Ford shouldn’t be making investment decisions.