When investing in any asset class, such as stocks, bonds or cash equivalents (U.S. 30 Day Treasury Bills), an investor assumes some level of risk. Securities with higher return potential typically carry more risk of not meeting return expectations or even possibly losing some or all of the amount invested. Stocks, for example, are typically more risky than bonds or cash equivalents, but have historically offered higher return possibilities. The graph above illustrates the relationship between risk and reward in different asset classes between February 1982 and February 2012.
We can see the growth of inflation and of a $1 invested in three different asset classes beginning at the end of February 1982. After 30 years, the $1 invested in stocks, as measured by the S&P 500 Index, would have grown to $26.56. If that same $1 was invested in bonds, as measured by the U.S. Long-Term Government Index, the investment would be worth $22.03. If the $1 was allocated completely to cash equivalents, represented by U.S. 30 Day T-Bills, its value would be $3.84, only slightly better than inflation. As a result of inflation, $2.40 is needed in February 2012 just to buy what $1.00 bought in February 1982.
Over the 30 year period, stocks outperformed bonds and cash equivalents, and stayed well ahead of inflation. However, stocks carried the most risk as demonstrated by the volatility in the blue line and if the chart stopped in December 2008, bonds outperformed stocks. Depending on your risk tolerance, time horizon, and investing goals, each investor should balance risk and reward to create their own portfolio. Remember the next 30 years may not look like the last 30 years.
© Copyright 2012 ICMA Retirement Corporation, All Rights Reserved. This information is intended for educational purposes only and is not to be construed as investment advice or a solicitation to buy or sell securities. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed here. Past performance is not necessarily indicative of future performance.
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