COMMENT

Shares Still Beat Bonds

By Ed Bowsher (TMFArkle)
March 16, 2006

I've been reading the 2006 edition of the Barclays Equity Gilt Study, and one message comes through loud and clear. Share prices are often volatile, but in the long-term shares tend to perform better than bonds or cash.

If your great grandfather had invested £100 in UK shares in 1899, that sum would now be worth £22,426, and that figure is adjusted for inflation. Wow! But there's one crucial caveat; you would only be sitting on that kind of profit if your relatives had reinvested all the dividends since 1899.

If the dividends had been spent, the original £100 investment would now be worth £197 in real terms. So dividends make a huge difference.

I can hear the sceptics groaning already. Yes, it's true, 106 years is a very long time and we'll all be dead in 2112. But shares have also done well over shorter time periods and they've frequently beaten bonds and cash.

This table shows today's value of £100 invested in three different asset classes at the end of 1945, gross income reinvested:

	Nominal £	Real (inflation- adjusted) £
Equities	107,487	4,061
Gilts	4,329	164
Cash	5,213	197

What's more, shares have been victorious since 1990. Here's a table showing today's value of £100 invested at the end of 1990, gross income reinvested:

	Nominal £	Real (inflation- adjusted) £
Equities	234	160
Gilts	161	110
Index-Linked Gilts	205	140
Corporate Bonds	189	129

Shares also had a great year in 2005. The real total return for shares was 18.9% compared to 6% for gilts and 2.7% for cash.

However, you shouldn't assume that shares always do best, even over ten-year periods. Over the last hundred years, shares have been the best performing asset class for most decades, but not all of them. Look at this table:

UK Real investment returns (% pa)

	Equities	Gilts	Cash
1905-15	-0.2	-2.2	-0.5
1915-25	3.9	-1.1	0.8
1925-35	8.7	10.8	4.7
1935-45	2.4	0.3	-2.3
1945-55	5.3	-5.4	-3.0
1955-65	7.3	-1.0	1.8
1965-75	0.1	-5.4	-1.4
1975-85	11	5.2	1.5
1985-95	9.9	6.8	5.2
1995-2005	5.0	5.6	2.9

As you can see, shares won out in eight of the ten periods, so they aren't always the best investment.

What's more, shares have done particularly badly over the last six years. Had you invested £100 in UK equities at the end of 2000, you would have had an inflation-adjusted £98 at the end of 2005 -- and that includes dividends. An identical investment in gilts would have left you with £117.

However, I think we're coming to the end of an exceptionally strong run for the gilts market. Gilts did well in the 1990s as the world entered a period of unexpectedly low inflation. More recently, valuations have moved higher still as many pension funds swung away from shares and into gilts. In my view, the gilts bubble will have to burst sooner or later.

Barclays Capital has trawled through the data to see how well gilts have performed when purchased at particular yields. If you buy gilts at today's yields, history suggests there's a strong chance that your investment will fail to beat inflation in the medium-term.

Barclays reckons that the outlook for shares is more promising -- even after recent rises in the market -- and I agree. The FTSE-100 index is still trading on a yield of 3.1%, which suggests there's a good chance that shares can deliver a positive real return over the next decade and beat gilts too.

I think these figures mean that all Fools should at least consider investing in the stock market. That's if your circumstances permit. If you don't own any shares and you think might like to, read this article to see if you're ready to take the plunge.