Abstract
In the U.S., the geometric return on stocks has been higher than the geometric return on bonds over long periods. We study whether balanced portfolios have a larger geometric return (and expected log return) than stock portfolios when the risk premium is low. We use a theoretical model and historical data and find that this is the case. This low-risk premium is often observed in other developed countries. Further, in the past two decades, a balanced portfolio with 70% or 90% invested in the U.S. stock market (with the remainder invested in U.S. government bonds) performed better than a 100% stock or bond portfolio. The reason for this is that a pure stock portfolio loses a large fraction of its value in a downturn. We show that this result is not driven by outliers, and that it occurs even when the returns are log normally distributed. This result has broad policy implications for the construction of pension systems and target-date mutual funds.
Highlights
In the last two decades, a stock portfolio had a higher geometric return than a bond portfolio in the U.S a balanced portfolio with 70% or 90% invested in stocks performed better than a 100% stock or bond portfolio in the last two decades
This paper shows that balanced portfolios have a larger geometric return than pure stock or bond portfolios when the risk premium is low
Using the historical variance and/covariance of the S&P 500 returns and the 10-year government bond returns6 from the last 50 years (1970–2019), we find that a balanced portfolio of 90% stocks and 10% bonds always has a higher geometric return if the equity premium is 2% or lower
Summary
In Stocks for the Long Run, Jeremy Siegel documents that the geometric return on stocks has been historically higher than the geometric return on bonds. In accordance with this, in the last two decades, a stock portfolio had a higher geometric return than a bond portfolio in the U.S a balanced portfolio with 70% or 90% invested in stocks (with the remainder invested in U.S government bonds) performed better than a 100% stock or bond portfolio in the last two decades. This paper shows that balanced portfolios have a larger geometric return (and expected log return) than pure stock or bond portfolios when the risk premium is low. This paper shows that balanced portfolios have a larger geometric return (and expected log return) than pure stock or bond portfolios when the risk premium is low. The reason for this is that a pure stock portfolio can lose a large fraction of its value in a downturn. We show that this result is not driven by outliers and that it occurs even when the returns are log normally distributed. A low-risk premium is more likely to occur than the U.S stock market data might suggest
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
