When it comes to building a portfolio, there are three major asset classes - stocks, bonds, and cash. The most common measures of these asset classes are the S&P 500 index (large cap stocks), Barclay's long-term government bond index, and Barclay's 3-month T-bills index. Below is a table that shows the average annual total return, best year, worst year, and risk of each of these indices.
|Avg. Annual Return||9.9%||5.5%||3.8%|
As would be expected, moving from left to right shows a declining level of return and risk. In addition, it's helpful to know that inflation has averaged roughly 3.1% over the same period of time. This means that the real return (total return minus inflation) are 6.8%, 2.4%, and 0.7% for stocks, bonds, and cash, respectively.
In addition to the standard deviation measure, the best and worst year ranges offer up some valuable information. Investors have never lost investing in T-bills over the course of a year while stock investors have suffered through substantial losses over time. Another interesting footnote to this table is that 2009 was the worst year on record for holders of long-term bonds.
What we would like for you to takeaway from this is that risk and return characteristics vary greatly among these three major asset classes. For this reason, they are a great place to start when deciding how to assemble your investment portfolio. As we'll see later, finding the right combination of these asset classes is perhaps the most important factor in determining your portfolio's level of risk and return over the long run.