Last week I highlighted an article about the long-term performance of stocks vs. bonds. The upshot was that, while stocks hold a slight long-term edge, bonds can (and do) outperform stock over significant time periods. Today we’re turning our attention to certificates of deposit (CDs).
CDs vs. Stocks
Did you know that CD outperformed stocks* from 1994-2008? It’s true. Check out the graph below:
In fact, if you had invested $10k each year on January 1st, you would’ve had accumulated $207, 509 worth of CDs and $178, 253 worth of stocks.
Once again, these sorts of conclusion are highly dependent on the time frame under consideration. After all, the second half of 2008 included of the worst bear market declines in recent history. Moreover, CD rates were considerably higher during the late 1990s and early 2000s than they are right now.
Regardless, as with the stocks vs. bonds analysis, this study makes an important point… Yes, the long-term performance of stocks is typically better than that of other investment types. However, it’s very possible for stocks to underperform over shorter time periods, even when compared to the much more conservative investments.
*Note: Based on six month CD rates vs. S&P 500 performance including dividend reinvestment.
I believe there are a great many people brainwashed by academia and financial planners in stocks. For one thing, the return out of a financial asset cannot outrun the nominal growth of an economy for very long. At best it can over shoot the mark or make up for delayed time. The SPX at a 3% dividend has never done well over a 30 year period, thus we have a situation where at best a 3% dividend market exceeds the real rate of interest by 1/2% to 1%. Being the risk premium on stocks is closer to inflation plus 6%, we are well short and thus the formula, P=d/(1+k) would have to be adjusted. Thus, we are actually looking at a situation where dividends being 3%, that in order to cover the risk premium the current k would have to be increased by 2% or more. I would bet that if you took the CD versus stocks back to the peak in 1987, you would find the same thing, that CD’s outperformed stocks.
Few understand what asset inflation does for stocks. Had we not had the housing bubble to create even more cash for the system, stocks would have performed even worse. We have seen 12 figure companies go to zero or near zero over and over again since 2000. The drop in the value of CSCO or INTC alone would swallow the summed value of AAPL and GOOG.
If you understand financial functions and compound functions, you can go to Robert Shillers site at Yale university and download his historical data on stocks and do your own study. I can tell you that on a principal basis, it took from 1966 to roughly 1995 to get even on stocks if you held the SPX from 1966. Someone mentioned taxes and to liquidate in 1995, you would have had to pay all the taxes on the inflated gains, gains which otherwise were not even real. Capital or regular, this was a loss.
They never tell you the trillions that wash down the drain over time in stocks, only work on what is left.
CDs are fantastic in rough and good times. The key is to build THE NUT first. A 4% guaranteed return on a 5 year CD doesn’t sound like much, but if you have $500,000… that’s $20,000/yr and you 5 years, your $500,000 will have GUARANTEED to have grown to over $630,000.
Build the nut, and get the guarantee.
Rgds,
RB
Rich By 30 Retire By 40
I need to go get a CD. I have been putting it off forever.
If nothing else, this analysis should underscore the importance of a truly diversified investment portfolio. That largely went out the window in the 80s, 90s and early 2000s, as it does in all manias. A few years back Time magazine even ran a spread that reported that middle class investors had come to view mutual funds as the new savings accounts.
One other factor in favor of a large position in stocks is human nature. The majority of people will sell their stock positions in a declining market, and buy at or near market tops. If we could truly have the emotional fortitude to buy when everyone else is selling, and sell when everyone else is buying, we’d probably all be millionaires. Most stock market investors aren’t, so read into that what you will. Most don’t fully understand the risk they’re taking on with majority stock positions.
The great thing about CDs, not only vs. stocks but also vs. bonds, is that you always know what you have. Call that “sleeping money”–we all need some of that. Not that we need to abandon stocks, only that they should be part of a persons portfolio, not most of it, and certainly not all of it.
I understand the need for these articles, but saying CDs out perform stocks is like kicking a man while he is down.
Diversification though.. that is the key!
Great article.
I have said many times in postings over the past few years that the number one rule regarding money is….
NEVER “INVEST” YOUR MONEY IN ANTHING YOU DON”T UNDERSTAND OR CONTROL.
I can’t stand mutual funds. Because you can’t control the purchase or sales of the individual stocks. Mutual funds are “opiates for the masses” Most of them underperform the benchmark, and the benchmark underperforms risk weighted fixed income much of the time.
I do appreciate individual stocks, but only for those that fully understand the specific stock they are buying. And only when you buy companies, not stocks.
However, I think true pro’s invest in other avenues. Their own businesses. Real property, etc. Things they control.
I think insured CD’s are one of the best invenstments that exist. Stable predictible guaranteed return.
What I find amusing with the opponents of this post are the general comments of “if it wasn’t for the two down years” or “13 of the 15 years outperformed”
But you must ask yourself, why did the S&P outperform most of those years, or why was there a steep correction twice in 15 years.
Reversion to the mean. The same reason that allows for inflated return requires the contraction to revert to the average.
they provide a bit of balance to the “you can never go wrong with stocks†mentality.
I applaud you, Nickel.
What I like about this comment is that your other comments show that you do not go along with the position set forth in my comments above. Yet you are showing with the words quoted above that you have an open mind, that you can at least consider some new ideas.
That’s important. I have participated in many discussions of the issues being raised here and in a good number of cases I have not seen that sort of openness among Passive Investing advocates. I believe that we need a national debate on these questions to figure out once and for all how stock investing really works (today’s “experts” are putting forward dramatically different takes and all seem to think that their views are supported by the historical data — that obviously cannot be so). When more Passive Investing advocates become a bit more open-minded, I believe that we are going to see the biggest learning experience we have ever seen in the personal finance field.
I have had a lot of bricks thrown at my head in recent years and I need to be encouraged from time to time. Your words above (because they come from a Passive Investing advocate) encourage me. I am grateful.
Rob
tom: I absolutely agree that the results of these sorts of analyses need to be viewed with caution, and didn’t mean to suggest otherwise. I do, however, think that the results of these sorts of analyses are worth keeping in mind, as they provide a bit of balance to the “you can never go wrong with stocks” mentality.
CJ: Taxes are an excellent point, though you can (and many do) hold CDs in an IRA. The point that I’m “going for” isn’t that CDs are a better bet than stocks, but rather that stock performance is far more variable than many people are willing to admit.
For the record, our portfolio is stock-heavy, though we have a reasonable chunk of bonds as well as some cash (largely in CDs). As far as I’m concerned, proper diversification is the key.
It’s all about risk / reward and locking in gains when you can. A smart investor would have both components in his portfolio, along with others: precious metals, real-estate, bonds (corp & muni), treasuries, cash, etc.
There are pros and cons to every investment. Different risk / reward profiles, and time periods where an investment does best (recessions or bull markets).
The graph is nice because it shows how two investments can start at the same place, take wildly varying paths, and end up in almost the same finishing point. The stock investor took on more risk, to get potentially higher gains — but if he did not sell in 2007, what was the point?
Torn –
“I’m not a big fan of this analysis.” – I think you’re not a big fan of the results of the analysis
“First, look at the timespan… 15 years. Most long-term investors hold their equity for 30+ years.” – But i think a lot of folks think when investing for 15 years, stocks is a no brainer, well maybe they are not. Look at 529s.
“Second, look at the actual performance. Of the 15 years, only 2 yielded higher CD returns. The remaining 13… the S&P 500 was well ahead.” – You just said most long term investors hold their investments, so the balance of this account over time is much more important to any of these invetors than fact the S&P usually beat it. Every knows that is the case, the point is that the years the S&P loses 50% can cancel out a lot of good years.
“These are dangerous statistics, as a financially uneducated person might see this, bail out of stocks and start investing in CDs.” – this is information that educated people. an uneducated person is one that would continue to follow blanket statements (like stocks always beat other investments over time) instead of delving into the details (like what amount of “time” we are talking about.
Given the rarity of stocks losing over a 15 year period, I think stocks are the better bet over a 15 year time frame. But this chart reminds everyone that this is a “bet”. It is the no worries buy-and-hold mantra that has led to the problems we hear about today of people’s retirement being ruined, they bought the “no worries” part and weren’t saving enough to start with because of it.
I know that most investors are surprised to see that CDs have been beating stocks for a long time. That’s because The Stock-Selling Industry has spent hundreds of million of dollars promoting the Passive Investing concept (which may or may not be a plus for The Stock-Selling Industry but which has caused the greatest loss of middle-class wealth in the history of the United States). The reality is that there is nothing at all surprising about these numbers for those who have looked at the historical stock-return data dating back to 1870.
Super-safe asset classes always beat stocks when stocks are selling at the sorts of prices that applied from the mid-1990s through the price crash. It’s not hard to understand why. Stock prices went to three times fair value at the top of the bubble. Imagine that you were buying a car that was properly valued at $20,000 and the dealer asked you to pay $60,000. Would you buy? The promoters of the Passive Investing concept say that we all should buy stocks in those circumstances and lots of them. We can never buy enough overpriced stocks, in the view of The Stock-Selling Industry.
The reality is that stocks are like anything else that can be bought and sold. There are some prices at which they offer a wonderful deal. There are some prices at which they offer a good deal. And there are some prices at which buying them is all but certain to cause you to delay your retirement by five years or longer.
We need to begin buying stocks rationally. That is, non-passively. We should take price into consideration before putting money on the table. We should put our interests first and the interests of The Stock-Selling Industry second.
Rob
How about taxes? Taxes on a CD are taxed at ordinary income tax, which could easily be 25% or 28% federal plus your state taxes. Meanwhile depending how you invest in the S&P you might never pay more than 15% taxes on divdends and when you sell. I think by taking one more factor into account this will not paint as bright a picture for CDs as you are going for. This chart reminds me of tradition financial planning. Let’s focus on one area to make it nice and rosy and we’ll ignore all other eroding factors. This is why financial planning is failing so many people.
I’m not a big fan of this analysis.
First, look at the timespan… 15 years. Most long-term investors hold their equity for 30+ years.
Second, look at the actual performance. Of the 15 years, only 2 yielded higher CD returns. The remaining 13… the S&P 500 was well ahead.
These are dangerous statistics, as a financially uneducated person might see this, bail out of stocks and start investing in CDs.