Conventional wisdom says that stocks will most likely outperform government bonds for long-term investors. But how long is long enough?

Pu Shen, a senior economist at the Federal Reserve Bank of Kansas City, examines the rates of return for stocks and bonds to answer the question in her article “How Long is a Long-Term Investment?” The article is featured in the first quarter edition of The Economic Review.

Stocks, which confer partial ownership of a private corporation, are generally considered to be riskier than government bonds. Bonds are essentially loans to the federal government and are backed by government tax receipts. Because of the associated risk, stocks must yield higher average returns to be attractive to investors.

Shen reviews historical patterns to show how the riskiness of stocks and bonds can change as an investor’s holding pattern lengthens. The article confirms the long-held belief that stocks historically have been safer than long-term government bonds for investors with long holding periods. However, she finds that the conventional wisdom has only been true for investors who held their portfolios more than 25 years.

“For practical purposes, that may be too long a holding period for most investors,” the author writes. “Over the years, for investors who have held their portfolios for shorter periods, both stocks and bonds were exposed to substantial risks, and stocks did not necessarily outperform government bonds.”

Shen writes that investors should think carefully about how long they will be able to hold their portfolios undisturbed and how much risk they are willing to bear.

The article is available on the Bank’s web site at www.kansascityfed.org.

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