Time to Dump Stocks and Buy Bonds?

Many people are questioning the effectiveness of long-term stock investing after the steep drops of the past two bear markets. Conventional wisdom holds that equities consistently outperform bonds when held for 20 or more years, with only slightly more risk.

But some experts claim that bonds deserve a second look, pointing to the 38% decline of stocks in the past 18 months. They argue that bond-only portfolios can provide returns that are comparable to or even greater than those of equities without the price gyrations.

Bonds look pretty darn appealing these days. The Barclays Capital Aggregated Bond Index has returned 5.2% a year in the five years through May 11, while the S&P 500 Index has lost an average of 1.7%. On average, bonds have also outperformed broad stock indexes during the past 10 years.

Michael Herbst, an analyst with Chicago-based research firm Morningstar(MORN), recommends that investors keep the unique circumstances of the past year and a half in mind when comparing fixed-income and equity returns.

"Last year was one of the worst years on record for the S&P and one of the best years on record for the bond index," Herbst says. "Government bonds aren`t going to look great when the stock market is rallying, but they'll often look a lot better when stocks tank."

Investors buy bonds as a source of income and to diversify their portfolios, which helps protect them from the ups and downs of stocks, Herbst says. That's assuming your portfolio relies on stocks to drive its growth.