Starting With Stocks
Wednesday, November 29th, 2006
We talked yesterday that if aggressive growth is what you are looking for, stocks are the best option. A quick comparison of portfolio returns would make it clear why.
Take a look at the Money 65 list of best actively managed funds. Go to the column that says “5 year return”, and look at the returns that different types of funds have returned.
Why 5 year? It’s possible that one year had a stock market boom, or a particular sector like oil or technology had a spectacular up or down. Over a number of years, these individual variations will get averaged out, and a comparison makes more sense.
The average range for stock funds is between 3.7% to 25.7%, excluding the foreign funds; if you don’t consider large cap / blue chip funds, you’d find the range even better - 8.2% to 25.7%.
Contrast that with the bond funds - the range is between 4.3% to 10.9%.
To understand why, you’ll have to remember that bond funds have a return rate, that usually tracks with the market rate. On the other hand, stocks can vary due to a number of other factors; individual performance, market sentiment or rumors, or even just general market fluctuation like bonds. Couple this with the fact that most businesses need to generate returns higher than the cost of borrowings, and the chances of getting a better return increase. A third factor is that growth oriented stocks typically reinvest earnings into growth, rather than distributing it by way of yearly returns; you get the benefit of compounding.
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