Risks of equity indices and sovereign bonds in the long term

Historically, stocks have delivered superior returns in the long term. Bonds, on the other hand, are less volatile, have a fixed income and priority in the event of bankruptcy, and are safer in the short term.

Historically, stocks have delivered superior returns in the long term. Bonds, on the other hand, are less volatile, have a fixed income and priority in the event of bankruptcy, and are safer in the short term. The uncertainty of stocks is associated with company performance, the economic cycle and investor sentiment. However, when held for more than five years, stocks tend to generate superior returns. Investing in diversified stock indices, such as the S&P 500, the Stoxx 600 or the MSCI World, reduces the risk of bankruptcy, reflecting the global economy.

In an economic downturn, even high-quality sovereign bonds would suffer, as governments rely on the economy for revenue. Investing in a diversified global equity index is therefore a sound strategy for achieving long-term returns with reduced risk, especially when compared to individual stocks.

While equity is more risky in the short term, diversification and a longer time horizon smooth out volatility, providing superior returns. Historically, global equity indices have been shown to have similar long-term risk to sovereign bonds, but higher returns.

Younger investors are advised to invest more in equities, especially in diversified global indices. A 20-year-old investor with a 45-year retirement horizon should focus on investing in global equity indices diversified by sector and geography.

However, including sovereign bonds in a portfolio provides stability and protection against sudden declines and unexpected events, such as health problems in midlife, requiring early access to savings. Economic crises can penalize indexes in the medium term (10, 15 or 20 years), as happened during the Great Depression of 1929. Therefore, it is wise to combine stocks with bonds and maintain an emergency reserve.

Just as young people should allocate most of their savings to stocks, pension funds in countries with normal demographic pyramids and healthy and sustainable population growth should prioritize stocks. In countries with inverted demographic pyramids, where the need for liquidity may be a reality in the short term, the allocation to stocks should be smaller.

Similarly, an investor close to retirement should prioritize bonds to protect themselves from short-term declines, since an investment only in stocks may not recover from a stock market crash, compromising savings. In the long term, investing in diversified global stock indices tends to be more efficient in terms of return when compared to bonds. In an extreme economic collapse, even high-quality bonds suffer, as without an economy, governments cannot raise revenue and pay their debts.

The Bloomberg US Treasury Total Return Unhedged USD Index (LUATTRUU) reflects the performance of US Treasury bonds since 1973 and has accumulated a gain of 2,250%, while the S&P 500 (capital gains only) has gained 5,000% in the same period. The S&P 500 Total Return, which includes dividend reinvestment, has risen 5,000% since 1988, the year it was officially compiled, while the LUATTRUU has gained only 509% in the same period.