As the following table demonstrates, not only have stocks outperformed bonds, they’ve also trounced other major asset classes. Any diversification away from stocks over extended holding periods has resulted in vastly inferior portfolio performance.The preceding table begs the question: why don’t all investors just hold all-stock portfolios? However, there are valid reasons that render such a strategy less than ideal for many investors.
With respect to the emotional fortitude required to stand pat through bear markets, there is considerable evidence that many investors are simply incapable of doing this. One of the best illustrations of this fact is Fidelity Investments Inc.’s flagship Magellan Fund, under the stewardship of legendary investor Peter Lynch. From May 1977 to May 1990, Lynch managed to achieve an annualized return of 29.06 per cent as compared to 15.52 per cent for the S&P 500 index.
Even if investors have the emotional fortitude to stay the course through bear markets, there may be other reasons that compel them to liquidate stocks, whether it be to fund living expenses, help their children buy homes, or invest in other opportunities. Unfortunately, the markets pay no heed to the convenience of mortals. If you are lucky, the need for cash will materialize at market peaks.
In his 2012 annual letter to Berkshire Hathaway Inc. shareholders, Warren Buffett said: “Bonds are among the most dangerous of assets. Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal … Right now, bonds should come with a warning label.”
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