Expected return of stocks equals EE savings bonds

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patrick
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Expected return of stocks equals EE savings bonds

Post by patrick »

I estimated the expected return on stocks and found it about the same as EE bonds held 20 years. Of course, the actual return from stocks could be very different (in either direction) than the expected return.

I start with the Credit Suisse Yearbook, which shows a historical global equity premium (versus 10 year government bonds) of about 3.1% from 1900 through 2019, including both price return and dividends. Accounting for the losses this year, the historical equity premium from 1900 to present is more like 2.9%.

The current yield on 10-year nominal treasuries is 0.62%, so their expected nominal return should be 0.62%. Combine this with the 2.9% expected equity premium and we get an expected nominal return on equities of a little over 3.5%. This is almost exactly equal to the 3.53% nominal return you get on EE savings bonds held 20 years.

What does this mean for investors?

If you are sure you will stay invested for 20 years, you might as well buy the maximum amount of EE bonds, even if that means you'd use money that otherwise would go in stocks. Why take equity risk when it doesn't give a higher expected return?

The purchase limit on EE bonds is low enough that most of us can't put our whole portfolios in them. So we'll have to prepare for low returns in the rest of our portfolios. This applies not only to stocks which have the same expected returns as EE bonds but much higher risk, but also to bonds which have only slightly higher risk but much worse expected returns.
Last edited by patrick on Wed Apr 29, 2020 2:45 pm, edited 1 time in total.
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grabiner
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Re: Expected return of stocks equals EE savings bonds

Post by grabiner »

This actually makes EE bonds look even better, because the interest on EE bonds is tax-deferred and exempt from state tax. If you hold stocks instead, you will pay tax on the dividends every year, and then pay capital-gains tax on the rest of your return when you sell the stocks.
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anon_investor
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Re: Expected return of stocks equals EE savings bonds

Post by anon_investor »

patrick wrote: Wed Apr 29, 2020 10:52 am I estimated the expected return on stocks and found it about the same as EE bonds held 20 years. Of course, the actual return from stocks could be very different (in either direction) than the expected return.

I start with the Credit Suisse Yearbook, which shows a historical global equity premium (versus 10 year government bonds) of about 3.1% from 1900 through 2019. Accounting for the losses this year, the historical equity premium from 1900 to present is more like 2.9%.

The current yield on 10-year treasuries is 0.62%, so their expected return should be 0.62%. Combine this with the 2.9% expected equity premium and we get an expected return on equities of a little over 3.5%. This is almost exactly equal to the 3.53% you get on EE savings bonds held 20 years.

What does this mean for investors?

If you are sure you will stay invested for 20 years, you might as well buy the maximum amount of EE bonds, even if that means you'd use money that otherwise would go in stocks. Why take equity risk when it doesn't give a higher expected return?

The purchase limit on EE bonds is low enough that most of us can't put our whole portfolios in them. So we'll have to prepare for low returns in the rest of our portfolios. This applies not only to stocks which have the same expected returns as EE bonds but much higher risk, but also to bonds which have only slightly higher risk but much worse expected returns.
I though that estimate was over the next 5 years not 20? Does that make the math different?
muffins14
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Re: Expected return of stocks equals EE savings bonds

Post by muffins14 »

It seems that a typical boglehead balanced portfolio is still simple and good enough, no? Today the market is up 3%, so hopefully it won't be all the gains for the remainder of the year ;)
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Re: Expected return of stocks equals EE savings bonds

Post by aristotelian »

Shouldn't you base the estimate off the 20 year Treasury for apples to apples comparison? That would make the expect return on stocks a bit higher albeit perhaps not enough to justify the risk.

Also do you have any evidence that estimating returns in this way has any predictive power?
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Re: Expected return of stocks equals EE savings bonds

Post by rascott »

This is not a reliable way to calculate expected returns.
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Re: Expected return of stocks equals EE savings bonds

Post by Coltrane75 »

I will stay with a stock/bond portfolio for me of 60/40 for the long-term because:
1. My timeframe is longer than 20 years; I'm fairly certain I will stay with this allocation for the rest of my days on the planet.
2. I have too much money to meaningfully allocate my long-term money to EE bonds.
3. I do not like the steep penalty one would have to pay if I needed to liquidate before 20 years for EE bonds; loosing most of the return.
4. Uncertainty: (1) stock market could give a higher return than expected (2) Treasury could change the terms of EE doubling time at somepiont over the next 20 years.
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Re: Expected return of stocks equals EE savings bonds

Post by asif408 »

Why not just dump all your money in EM Value?: https://www.gmo.com/americas/research-l ... t-1q-2020/
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Re: Expected return of stocks equals EE savings bonds

Post by HomerJ »

You forgot dividends (and I'm not sure if you are accounting for inflation either)

I think your calculations are incorrect.
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Re: Expected return of stocks equals EE savings bonds

Post by anon_investor »

Coltrane75 wrote: Wed Apr 29, 2020 2:04 pm I will stay with a stock/bond portfolio for me of 60/40 for the long-term because:
1. My timeframe is longer than 20 years; I'm fairly certain I will stay with this allocation for the rest of my days on the planet.
2. I have too much money to meaningfully allocate my long-term money to EE bonds.
3. I do not like the steep penalty one would have to pay if I needed to liquidate before 20 years for EE bonds; loosing most of the return.
4. Uncertainty: (1) stock market could give a higher return than expected (2) Treasury could change the terms of EE doubling time at somepiont over the next 20 years.
I do not think the treasury can change the terms of an already issued EE Bond, the same way they cannot change the interest on an already issued nominal treasury bond.
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Re: Expected return of stocks equals EE savings bonds

Post by patrick »

HomerJ wrote: Wed Apr 29, 2020 2:09 pm You forgot dividends (and I'm not sure if you are accounting for inflation either)

I think your calculations are incorrect.
Although I didn't initially note this, the historical equity premium from the Credit Suisse Yearbook is based on total returns, so it already includes dividends. The returns I estimated for stocks aren't adjusted for inflation, but the same applies to the EE bond returns, so the comparison is still valid.
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Re: Expected return of stocks equals EE savings bonds

Post by JoMoney »

I remember a time when a often suggested strategy was put half your money in EE Savings Bonds and half your money stocks.
At that time, in 10 years the Savings Bonds guaranteed to double, anything stocks did was gravy, in the worst case scenario and stocks went to zero you still got all your money back from bonds.
I suppose that still works, but now it takes 20 years :annoyed
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Re: Expected return of stocks equals EE savings bonds

Post by KlingKlang »

anon_investor wrote: Wed Apr 29, 2020 2:11 pm I do not think the treasury can change the terms of an already issued EE Bond, the same way they cannot change the interest on an already issued nominal treasury bond.
The interest rate for an EE Bond is fixed for 20 years at the time it is issued. The government may adjust the rate after the 20th year.
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Re: Expected return of stocks equals EE savings bonds

Post by anon_investor »

KlingKlang wrote: Wed Apr 29, 2020 3:15 pm
anon_investor wrote: Wed Apr 29, 2020 2:11 pm I do not think the treasury can change the terms of an already issued EE Bond, the same way they cannot change the interest on an already issued nominal treasury bond.
The interest rate for an EE Bond is fixed for 20 years at the time it is issued. The government may adjust the rate after the 20th year.
I thought if you bought an EE Bond today, the doubling at 20 years was guranteed, not at the government's discretion.
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Re: Expected return of stocks equals EE savings bonds

Post by KlingKlang »

anon_investor wrote: Wed Apr 29, 2020 4:18 pm
KlingKlang wrote: Wed Apr 29, 2020 3:15 pm
anon_investor wrote: Wed Apr 29, 2020 2:11 pm I do not think the treasury can change the terms of an already issued EE Bond, the same way they cannot change the interest on an already issued nominal treasury bond.
The interest rate for an EE Bond is fixed for 20 years at the time it is issued. The government may adjust the rate after the 20th year.
I thought if you bought an EE Bond today, the doubling at 20 years was guranteed, not at the government's discretion.
Correct. The doubling at 20 years is guaranteed. For years 21 - 30 the rate can be changed.
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Re: Expected return of stocks equals EE savings bonds

Post by anon_investor »

KlingKlang wrote: Wed Apr 29, 2020 5:33 pm
anon_investor wrote: Wed Apr 29, 2020 4:18 pm
KlingKlang wrote: Wed Apr 29, 2020 3:15 pm
anon_investor wrote: Wed Apr 29, 2020 2:11 pm I do not think the treasury can change the terms of an already issued EE Bond, the same way they cannot change the interest on an already issued nominal treasury bond.
The interest rate for an EE Bond is fixed for 20 years at the time it is issued. The government may adjust the rate after the 20th year.
I thought if you bought an EE Bond today, the doubling at 20 years was guranteed, not at the government's discretion.
Correct. The doubling at 20 years is guaranteed. For years 21 - 30 the rate can be changed.
EE Bonds are interesting, but probably not optimal for me as I am likely more than 20 years from retirement.
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Re: Expected return of stocks equals EE savings bonds

Post by Call_Me_Op »

patrick wrote: Wed Apr 29, 2020 10:52 am I estimated the expected return on stocks and found it about the same as EE bonds held 20 years.
Yes, but with EE bonds, you miss out on all the excitement. :)
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Re: Expected return of stocks equals EE savings bonds

Post by anon_investor »

Call_Me_Op wrote: Wed Apr 29, 2020 6:00 pm
patrick wrote: Wed Apr 29, 2020 10:52 am I estimated the expected return on stocks and found it about the same as EE bonds held 20 years.
Yes, but with EE bonds, you miss out on all the excitement. :)
If you want excitement with your fixed income go with LTT :D .
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Re: Expected return of stocks equals EE savings bonds

Post by rascott »

In 2008... using the same formula.... you would have seen expected returns of 5.1% for stocks over the next 10 years.

Perhaps this would be valid calculation in a non QE world.... but that's not the one we've lived in for 12 years.
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Re: Expected return of stocks equals EE savings bonds

Post by Call_Me_Op »

anon_investor wrote: Wed Apr 29, 2020 6:05 pm
Call_Me_Op wrote: Wed Apr 29, 2020 6:00 pm
patrick wrote: Wed Apr 29, 2020 10:52 am I estimated the expected return on stocks and found it about the same as EE bonds held 20 years.
Yes, but with EE bonds, you miss out on all the excitement. :)
If you want excitement with your fixed income go with LTT :D .
I get enough excitement from my stocks, thank you. :)
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Re: Expected return of stocks equals EE savings bonds

Post by JoMoney »

Call_Me_Op wrote: Wed Apr 29, 2020 6:00 pm
patrick wrote: Wed Apr 29, 2020 10:52 am I estimated the expected return on stocks and found it about the same as EE bonds held 20 years.
Yes, but with EE bonds, you miss out on all the excitement. :)
$10,000 for 19 years and 11 months in EE bonds at 0.10% would grow to $10,200
A few days later it would suddenly jump to $20,000 ... if you can make it that long, it's at least a little exciting ;)
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Re: Expected return of stocks equals EE savings bonds

Post by Angst »

JoMoney wrote: Wed Apr 29, 2020 6:11 pm
Call_Me_Op wrote: Wed Apr 29, 2020 6:00 pm
patrick wrote: Wed Apr 29, 2020 10:52 am I estimated the expected return on stocks and found it about the same as EE bonds held 20 years.
Yes, but with EE bonds, you miss out on all the excitement. :)
$10,000 for 19 years and 11 months in EE bonds at 0.10% would grow to $10,200
A few days later it would suddenly jump to $20,000 ... if you can make it that long, it's at least a little exciting ;)
That's still too much excitement for me, especially some 20 years from now when I will surely have become even more frail and confused than I already am! So in my spreadsheets I book the 3.53% annually. No surprises. :)
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Re: Expected return of stocks equals EE savings bonds

Post by Coltrane75 »

anon_investor wrote: Wed Apr 29, 2020 2:11 pm
Coltrane75 wrote: Wed Apr 29, 2020 2:04 pm I will stay with a stock/bond portfolio for me of 60/40 for the long-term because:
1. My timeframe is longer than 20 years; I'm fairly certain I will stay with this allocation for the rest of my days on the planet.
2. I have too much money to meaningfully allocate my long-term money to EE bonds.
3. I do not like the steep penalty one would have to pay if I needed to liquidate before 20 years for EE bonds; loosing most of the return.
4. Uncertainty: (1) stock market could give a higher return than expected (2) Treasury could change the terms of EE doubling time at somepiont over the next 20 years.
I do not think the treasury can change the terms of an already issued EE Bond, the same way they cannot change the interest on an already issued nominal treasury bond.
The Treasury could change the doubling time of EE bonds in the future; at somepoint in your 20 year investment horizon. For example, the Treasury could announce that effective May 1 or Nov 1, the doubling time for newly issued EE bonds will change from 20 to 25 years. They've done it in the past a couple of times I believe. I think they certainly could do it again.
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Re: Expected return of stocks equals EE savings bonds

Post by anon_investor »

Coltrane75 wrote: Thu Apr 30, 2020 7:10 am
anon_investor wrote: Wed Apr 29, 2020 2:11 pm
Coltrane75 wrote: Wed Apr 29, 2020 2:04 pm I will stay with a stock/bond portfolio for me of 60/40 for the long-term because:
1. My timeframe is longer than 20 years; I'm fairly certain I will stay with this allocation for the rest of my days on the planet.
2. I have too much money to meaningfully allocate my long-term money to EE bonds.
3. I do not like the steep penalty one would have to pay if I needed to liquidate before 20 years for EE bonds; loosing most of the return.
4. Uncertainty: (1) stock market could give a higher return than expected (2) Treasury could change the terms of EE doubling time at somepiont over the next 20 years.
I do not think the treasury can change the terms of an already issued EE Bond, the same way they cannot change the interest on an already issued nominal treasury bond.
The Treasury could change the doubling time of EE bonds in the future; at somepoint in your 20 year investment horizon. For example, the Treasury could announce that effective May 1 or Nov 1, the doubling time for newly issued EE bonds will change from 20 to 25 years. They've done it in the past a couple of times I believe. I think they certainly could do it again.
Sure for future issues, I was referring to already issued EE Bonds.
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