Which has a higher average return over time: stocks, bonds,...

Key Concepts

Risk and Return Trade-Off

The concept of risk and return trade-off is fundamental in finance, indicating that higher potential returns are generally associated with higher risks. This principle helps investors understand why stocks, despite their volatility, tend to yield higher average returns compared to more conservative investments like bonds and savings accounts.

Savings Account

Savings accounts are deposit accounts provided by banks and typically offer very low interest rates, resulting in minimal average returns. Although they provide high liquidity and are insured, their low yield often does not keep pace with inflation, making them less effective as long-term growth investments.

Bonds

Bonds are debt securities issued by governments or corporations that pay fixed interest over time and return the principal at maturity. They generally offer lower average returns than stocks but are considered less volatile, with more predictable income and value changes, making them a key component of diversified investment strategies.

Stocks

Stocks represent ownership shares in a company and historically have provided some of the highest average returns among various investment options over long time horizons. This asset class, however, comes with higher volatility and risk, which can lead to substantial fluctuations in value over shorter periods.

Transcript

00:01 Hey everyone.

00:02 Today we're solving problem number four from chapter 17 financial markets of the textbook, which asks, which has a higher average return over time, stocks, bonds, or a savings account.

00:15 And it also asks us to explain our answer.

00:18 So over a sustained period of time, stocks will have a higher average return than bonds, and bonds will have an average return higher than the savings account.

00:30 So based off of that much we know, and also based off of this table right here, we know, actually i should be doing this in black, sorry about that.

00:40 This is a table from chapter 17, and we look at our return column for stocks.

00:46 Return is very high, and thus stocks will end up winning out.

00:52 I will explain briefly down here in a second, but the answer here is going to be stocks.

00:58 That would be number one, and then number two would be bonds.

01:02 And then number three would be the savings account.

01:06 As we can see, also, the return on a savings account is low, and then for bonds, it's medium.

01:12 So this table from chapter 17 of your reading will give you the answer as well.

01:17 So why is it that stocks have the highest rate of return over sustained time? well, the rationale is that stock values can grow or decline by a very large amount.

01:34 They can grow or decline by large amounts.

01:46 And i'll give you a few examples.

01:48 I think examining depressions and economic booms are kind of the best ways to see how these three really fluctuate.

02:02 I'll just say they grow and decline a lot, by a lot rather, or largely is better.

02:16 And i'll list an example.

02:17 For example, as we were coming out of the recession from 2007 to 2008, the s &p 500 increased 26 % in 2009 after declining 37 % in 2008.

02:34 So down 37 % in 08.

02:41 That's probably one of the best examples in 2008.

02:54 And then after it went down a lot, it went back up a lot.

02:59 So it grows and declines by largely...