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This is something I really wonder about. Presumably, there's a tradeoff between risk and interest rate, right? If you buy national bonds at 1.5%, you're accept

This is something I really wonder about. Presumably, there's a tradeoff between risk and interest rate, right? If you buy national bonds at 1.5%, you're accepting very low growth presumably in exchange for near-zero risk. If you park your money in a bank account earning 2%, you're getting a bit more, presumably at some higher risk. If you're earning 10% or 15% on the stock market through a balanced profile of index funds, doesn't that suggest that there must fundamentally be some significantly higher risk associated with that? How much exactly? Otherwise I assume nobody would be buying bonds at the available interest rates. Why do I see so many people these days giving financial advice that the only responsible thing to do with your money is invest it in the market? Undoubtedly that's been great advice over the past 10 years, but past returns are no guarantee of future performance, right? Is it mainly post-2008 that it became common sense that the average person should park their savings in the market? What does the market think the actual risk level of an index fund is? Or else why does anyone buy 10-year bonds? I'm really curious to hear thoughtful responses about this.

dgcupps 7y ago
Why does anyone buy 10-year bond? It's because they value stability in returns over absolute returns. While it is true that over the long run the stock market will outperform current bonds, it isn't always true that it will in the short-term. If your a pension fund, a retiree, or anyone else who will need to spend money in the short-term, it often makes sense to forgo some long-term returns for short-term stability. You're correct that past returns are no guarantee of future performance; however, there is 100 years of history (not to mention economic theory) that supports the assumption that equities will outperform current interest rates over the long run.
- jbay808 7y ago
  I guess I didn't think of 10 years as the short term. Let's say the 30 year bond then. The 30 year bond rate is something like 2.5%... Who would buy that if it was vanishingly unlikely that equities would return less than that after 30 years? I guess what I'm trying to get at is, is there a way I can estimate the probability that equities will return less than 2.5% over the next 30 years, given the information that the 30-year bond rate is 2.5% and the expected return on stocks is, say, 10%, and the market is efficient and some people buy bonds anyway?
  - dgcupps 7y ago
    One thing to keep in mind is that people who are buying 30 year bonds often aren't planning on holding them to maturity; rather, they are looking for an asset that is relatively stable in value while also generating a small return. Can you estimate the probability of your scenario? Sure, you could use the historical volatility of equity returns to calculate the chance of that happening. However, unless you add in other factors that you think could realistically hurt future equity returns, I think you'll find that probability to be very small.

dgcupps 7y ago

Why does anyone buy 10-year bond? It's because they value stability in returns over absolute returns. While it is true that over the long run the stock market will outperform current bonds, it isn't always true that it will in the short-term. If your a pension fund, a retiree, or anyone else who will need to spend money in the short-term, it often makes sense to forgo some long-term returns for short-term stability. You're correct that past returns are no guarantee of future performance; however, there is 100 years of history (not to mention economic theory) that supports the assumption that equities will outperform current interest rates over the long run.

jbay808 7y ago
I guess I didn't think of 10 years as the short term. Let's say the 30 year bond then. The 30 year bond rate is something like 2.5%... Who would buy that if it was vanishingly unlikely that equities would return less than that after 30 years? I guess what I'm trying to get at is, is there a way I can estimate the probability that equities will return less than 2.5% over the next 30 years, given the information that the 30-year bond rate is 2.5% and the expected return on stocks is, say, 10%, and the market is efficient and some people buy bonds anyway?
- dgcupps 7y ago
  One thing to keep in mind is that people who are buying 30 year bonds often aren't planning on holding them to maturity; rather, they are looking for an asset that is relatively stable in value while also generating a small return. Can you estimate the probability of your scenario? Sure, you could use the historical volatility of equity returns to calculate the chance of that happening. However, unless you add in other factors that you think could realistically hurt future equity returns, I think you'll find that probability to be very small.