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Posted by Will Trice on September 23, 2006, 3:48 am
Elle wrote:
> It shrinks for stocks, yes, but I think the bigger point of
> contention is what it does for bonds. After a lot of
> searching, I can't turn up a whole lot on this, even though
> it seems like something worth really driving home to long
> term financial planners of all stripes. (Even less on
> housing volatility is available.) Maybe it's obvious? Jim's
> comments on why he expects bond volatility to rise the
> longer the term may be right on the money. Also, I agree
> factoring in inflation makes the volatility differences
> between stocks and bonds even greater as the term gets
> longer.
I thought the inflation thing might be worth investigating so I've been
playing around with Shiller's data at:
http://www.irrationalexuberance.com/shiller_downloads/ie_data.xls
Using the long bond data in his spreadsheet, I constructed an index (I'm
unable to locate any freely available bond index data that contains more
than 10 years worth of values) and computed 30 year annualized returns
and volatilities, with and without adjusting for inflation, for both
long bonds and the S&P.
Here's what I turned up:
S&P (dividend adjusted)
Nominal 30 year average annualized return: 9.2%
Standard deviation: 2.23%
Real 30 year average annualized return: 6.47%
Standard deviation: 1.72%
Long Bonds
Nominal 30 year average annualized return: 4.6%
Standard Deviation: 1.9%
Real 30 year average annualized return: 2%
Standard deviation: 1.3%
Keep in mind that using a bond index approach like this artificially
increases volatility because it does not allow for holding bonds until
maturity.
I did the same for home returns using Shiller's data at:
http://www.irrationalexuberance.com/Fig2.1Shiller.xls
With this we have:
Home prices
Nominal 30 year average annualized return: 3.4%
Standard deviation: 1.7%
Real 30 year average annualized return: 0.27%
Standard deviation: 1%
Thus showing that stock risk > long bond risk > home risk, defining risk
as the standard deviation on 30 year annualized returns.
As always, check my math...
-Will
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Posted by Elle on September 23, 2006, 1:53 pm
Because of quotations like the following, the truth about
the relationship between stock and bond long term
volatilities remains to me an exploration.
"Research shows clearly that over periods of 20 years or
more, stocks are no more risky -- in fact, less risky --
than bonds or Treasury bills." -- Congressional Testimony,
James K. Glassman, 1998
http://www.aei.org/publications/pubID.15543,filter.all/pub_detail.asp
"It is widely known that stock returns, on average, exceed
bonds in the long run. But it is little known that in the
long run, the risks in stocks are less than those found in
bonds or even bills." -- Siegel, as quoted by Glassman
above.
"Siegel notes that the risk inherent in stocks never
disappears no matter how long you are invested. What does
diminish over time is the risk of holding stocks versus that
of bonds. The relative risk of stocks is below that of
bonds. Over long periods of time, stocks were more stable
than would have been expected from their year-to-year
volatility. However, that was not true for bonds. Stocks,
being claims on real assets, respond much better to
inflation risk."
http://www.antandsons.com/traderscorner/stocksforthelongrun/
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Posted by Will Trice on September 26, 2006, 3:20 am
Elle wrote:
> Because of quotations like the following, the truth about
> the relationship between stock and bond long term
> volatilities remains to me an exploration.
Well it seems that all your cites and the sites that you cite and all
the quotes you quote quote Siegel eventually. Yet Siegel contradicts
himself in a debate with Shiller, "If stocks and bonds offered the same
returns, investors would choose bonds, because they are safer." (at:
http://www.jeremysiegel.com/index.cfm/fuseaction/Resources.ViewResource/type/article/resourceID/6223.cfm)
However, from the many other articles available on the cite above,
Siegel clearly claims that stocks are less risky than bonds. It seems
that, for the quotes you've quoted, Siegel is not defining risk as
volatility (unlike the debate I quoted above, where it seems he is
referring to risk as volatility). Instead, he is defining risk as the
probability that an investment will not beat inflation. This is an
unusual, but not necessarily invalid, way of defining risk. In some
sense, the definition is trivial, for if you look at the narrow standard
deviations that any asset with near-Gaussian returns has over the long
run, you can generally safely say that x asset is more likely to beat y
constant percentage than z asset if the average return for x is higher
than z. Admittedly, inflation is not constant, but the same idea holds.
So while this definition may be trivial in this sense, it may also be
important from a planning sense. Yet, if it is important, then what
does it mean for asset allocation for long term investors in the savings
phase (i.e. those not drawing down their savings)? They should have all
stocks! Yet this is not the prevailing wisdom of many on this
newsgroup, nor the various asset allocation tools that are out there,
mostly based on risk (with the volatility definition).
-Will
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Posted by Elizabeth Richardson on September 26, 2006, 12:28 pm
> However, from the many other articles available on the cite above,
> Siegel clearly claims that stocks are less risky than bonds. It seems
> that, for the quotes you've quoted, Siegel is not defining risk as
> volatility (unlike the debate I quoted above, where it seems he is
> referring to risk as volatility). Instead, he is defining risk as the
> probability that an investment will not beat inflation.
This seems perfectly reasonable to me, as there is more than one kind of
risk. If you only define risk as volatility and construct a portfolio which
minimizes (or, horrors, avoids) volatility, you may place yourself square in
the path of the risk of losing purchasing power. This is why asset
allocation is so important. I realize Will and Elle, that you know this, but
you seem to have been ignoring it in this discussion.
Elizabeth Richardson
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Posted by Will Trice on September 27, 2006, 1:50 am
Elizabeth Richardson wrote:
>>Instead, he is defining risk as the
>>probability that an investment will not beat inflation.
>
>
> This seems perfectly reasonable to me, as there is more than one kind of
> risk. If you only define risk as volatility and construct a portfolio which
> minimizes (or, horrors, avoids) volatility, you may place yourself square in
> the path of the risk of losing purchasing power. This is why asset
> allocation is so important.
But typical asset allocation methodologies ignore Siegel's definition of
risk, right?
-Will
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