Statistical and Graphical Example

Example 2:  Historical risk and return for selected asset classes,1926 -2008 

 

The table below shows risk and return characteristics for different asset classes in the U.S. from 1926 through 2008. The data are average annual geometric returns. We immediately see the risk/return tradeoff: those assets having higher standard deviations are associated with those assets producing a higher rate of return. 

Small company stocks are stocks of new firms just starting out. As such they are very risky and the return necessary to attract investors has to be quite high. This fact is demonstrated in small stocks posting an average annual rate of return of 11.7% with a very high standard deviation 33.0%.  Large company stocks represent the S&P 500 index. These are stronger, more established companies and their risk/return profile represents this fact. Bonds show an intermediate level of risk and return. At the low end of the spectrum is T-bills. They show a very low return and very low risk. The low risk comes from the fact that they are considered "default free" and trade in a short-term, very liquid market.

The last line of the table shows inflation. This rate grew at 3.0% and had a standard deviation of 4.2%. It should come as no surprise that inflation can eat into the nominal returns of all asset classes. In fact after you adjust T-bill rates for inflation you have very little return relative to the risk of owning T-bills.

Source: Ibbotson SBBI Classic Yearbook, 2009 (Morningstar)

 

 

 

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