Stocks and bonds have always been considered two of the most popular asset classes for investors to choose from. But which one is more volatile? The general consensus has always been that stocks are more volatile due to their higher risks and rewards. This is because stock prices are determined not only by market sentiment but also by changing earnings expectations, leading to higher volatility.

Elroy Dimson of the University of Cambridge, along with Paul Marsh and Mike Staunton of the London Business School, have conducted extensive research on asset returns dating back to 1900. Their findings show that stocks are indeed more volatile than bonds. In developed markets, the standard deviation of real annual returns for equities is higher than that of bonds. This is why investors often combine stocks and bonds in a balanced portfolio to lower overall volatility.

However, Ken Fisher, a well-known analyst and author, challenges this notion in his recently published book, “The Little Book of Market Myths.” Fisher claims that when looking at longer-term investment horizons, the volatility profiles of stocks and bonds actually flip. He argues that for rolling periods of 20 years or more, the annualized volatility of stocks can fall below that of bonds. Over a 30-year horizon, an all-equities portfolio can have half the standard deviation of an all-bond equivalent.

Fisher’s claim has significant implications for investors, especially those planning for the long term. He suggests that based on historical precedent, there may be little reason to hold any fixed income investments for US investors with a two-decade outlook. This challenges traditional rules of thumb like the ‘100 minus your age’ rule for asset allocation.

While Fisher’s findings seem compelling, experts like Dimson caution against drawing definitive conclusions based on long-term periods. Dimson argues that Fisher’s standard deviations are not meaningful for assessing long-horizon risk due to the limited sample size of historical data. Without a robust distribution of probabilities, it’s challenging to accurately assess long-term risk based on a few distinct 30-year periods.

In conclusion, while the debate continues on whether stocks or bonds are more volatile, it’s essential for investors to consider their investment horizon and risk tolerance when building a diversified portfolio. Both asset classes have their advantages and drawbacks, and a balanced approach may be the best strategy to weather market fluctuations over time. When it comes to analyzing investment risk, looking at volatility in conjunction with long-term rolling returns can provide a more comprehensive understanding of the overall picture. According to financial expert Fisher, standard deviation alone is not enough to assess risk effectively. Factors such as periodicity, persistence of gains, inflation, and opportunity cost all play a role in determining the total risk of an investment.

Applying these risk factors to bonds, traditionally seen as a safer asset class, reveals that they may not be as risk-free as once thought. By examining rolling returns over longer periods, investors can gain a better perspective on how different asset classes have performed across various market environments. This historical data can help investors make more informed decisions when it comes to portfolio allocation.

Financial advisers often use historical rolling returns in back-tests of long-term portfolio performance to assess how different investment strategies would have fared in the past. While measures of standard deviation provide insight into volatility, they also give a sense of how risky an investment strategy may have been over the past few decades.

It’s important to note that volatility does not equate to returns. For example, the years 2020 and 2022 were highly volatile for the S&P 500, yet one year ended with stocks up 18% while the other ended down 18%. Past volatility is not a perfect predictor of future performance, but historical data can offer valuable insights into how assets have behaved over time.

When it comes to long-term asset allocation, there is a tension between the potential for higher returns from stocks and the lower risk associated with bonds. While stocks have historically produced superior positive real returns over the long term, bonds offer lower near-term risks. Some investors may prioritize capital preservation and cash flow timing, making a heavier allocation to bonds a suitable choice.

However, Fisher warns that relying too heavily on bonds may lead to a short-term view of returns, which could be detrimental for investors with a longer time horizon. While a balanced portfolio may seem appealing in the short term, it may not be the most effective strategy for long-term wealth accumulation.

In conclusion, considering both volatility and long-term rolling returns can provide investors with a more holistic view of risk and return potential. By analyzing historical data and understanding the trade-offs between different asset classes, investors can make more informed decisions when it comes to building a diversified portfolio for the future.