When people think about investing for the long run, they often look to average market returns. For example, the broad U.S. stock market has delivered a 10.4% average annual return over the past 30 years, while the average annual return for bonds was 6.8%. However, stocks rarely deliver the average return in any given year—in fact, they have done so only twice since 1986. Instead, as shown in the chart below, returns have swung widely, from up nearly 40% to down nearly 40%.
By contrast, bonds generated close to their average return about five times over the 30-year period, and showed much less variance from year to year—returns ranged from a gain of approximately 18% to a decline of about 3%. Additionally, bonds were occasionally up when stocks were down, and vice versa.
Given their different characteristics, including bonds along with stocks can help to diversify a portfolio and potentially generate a smoother pattern of returns over time.
The right mix may include many asset classes
U.S. stocks and bonds aren’t the only potential ingredients in the recipe. Other asset classes, such as international stocks, real estate investment trusts (REITs), gold and other precious metals, and cash each have their own unique characteristics that can help diversify a portfolio. Of course, they each come with different investing risks, as well.
As shown in the chart below, a hypothetical portfolio that held a mix of U.S. and international stocks, bonds, commodities and cash delivered strong growth over time, but with less volatility than stocks alone.
Stay diversified: Don't try to chase short-term performance
Short-term performance across asset classes can vary significantly from year to year. It can be tempting to look at the best-performing asset class in any given year and question why you're invested in asset classes that haven't performed as well recently. But leadership across asset classes tends to vary from year to year, so generally a better strategy is to diversify across a mix of stocks, bonds, commodities and cash to benefit from exposure to whichever asset classes are performing well at any given time, while also helping to dampen the volatility of your overall portfolio.