Stocks have historically returned the most, but the price is volatility you may not be able to stomach
Over the past century, U.S. stocks have returned an average of roughly 10 percent per year, before inflation and taxes. That is higher than bonds (around 5 to 6 percent), Treasury bills (around 4 to 5 percent), or savings accounts (currently 4 to 5 percent at high-yield providers). But "average" is the key word. In any given year, stocks can fall 20, 30, or 40 percent. In 2022, the S&P 500 fell 18 percent. In 2008, it fell 37 percent. If you needed that money in either of those years, you would have locked in a loss.
The reason stocks return more is that they are riskier. You own a piece of a company, and companies fail, shrink, or disappoint. Bonds are a loan to a government or corporation, and you get paid back whether the borrower thrives or struggles (unless they default, which is rare for government bonds). Savings accounts are insured by the FDIC up to $250,000, so you cannot lose the principal. The higher the return, the more of your money you can lose.
The right investment for you depends on three things: how long you can leave the money alone, how much you can afford to lose, and what you are saving for. A 25-year-old saving for retirement can ride out stock market crashes because they have decades to recover. A 65-year-old who needs the money in five years cannot.
Key Takeaways
- Stocks have returned an average of about 10 percent annually over the long term, but individual years can see losses of 20 to 40 percent.
- Bonds, Treasury securities, and high-yield savings accounts return less but lose less, and are insured or backed by the government.
- Your time horizon — how many years until you need the money — is the single biggest factor in choosing between high-return and stable investments.
- Diversification across stocks, bonds, and cash reduces the damage from any single investment falling, but does not eliminate it.
- Returns are measured after inflation and taxes, which can cut your real gain by half or more depending on your tax bracket and how long you hold the investment.
How stocks deliver higher returns than other investments
When you buy a stock, you own a fractional share of a company's future profits. If the company grows, the stock price rises and you can sell for more than you paid. If the company pays dividends, you receive cash while you hold it. Over decades, this compounds: a $10,000 investment in the S&P 500 in 1980 would have grown to roughly $1 million by 2020, even accounting for inflation.
But that return came with years of stomach-churning drops. The 1987 crash erased 22 percent in a single day. The 2000–2002 bear market cut stocks in half. The 2008 financial crisis cut them in half again. If you sold during any of those periods, you locked in the loss. If you held, you eventually recovered and went higher.
Bonds and savings accounts do not offer that upside because they do not give you ownership. A bond is a fixed contract: you lend $1,000 to a company or government, they pay you interest (usually 3 to 6 percent now), and they return your $1,000 at maturity. You cannot gain more than the interest rate, but you also cannot lose your principal unless the borrower defaults. A savings account works the same way, except the bank is the borrower and the FDIC insures your money.
Why time horizon is the most important factor in your choice
If you are saving for something you need in two years, stocks are the wrong tool. The market could fall 30 percent in year one, and you would be forced to sell at a loss to get your money. If you are saving for retirement 30 years away, stocks are the right tool because you can wait out the crashes and capture the recoveries.
Financial advisors use a simple rule: subtract your age from 110 (or 120 if you are comfortable with risk), and put that percentage in stocks. The rest goes in bonds and cash. A 30-year-old would put roughly 80 to 90 percent in stocks and 10 to 20 percent in bonds and cash. A 60-year-old would put roughly 50 to 60 percent in stocks and 40 to 50 percent in bonds and cash. This is not a law, but it reflects the fact that younger people have time to recover from crashes and older people do not.
Your time horizon also affects which type of stock investment makes sense. If you have 20+ years, a low-cost index fund (which holds hundreds of stocks) is simpler and cheaper than picking individual stocks. If you have 5 to 10 years, you might mix index funds with bonds. If you have less than 5 years, bonds and high-yield savings are usually the better choice.
The real return after inflation and taxes
A 10 percent stock return sounds great until you remember that inflation erodes it. If inflation is 3 percent and stocks return 10 percent, your real return is about 7 percent. If you are in the 24 percent federal tax bracket and hold the stock for one year before selling, you owe capital gains tax on the profit, which cuts your after-tax return further. A $10,000 gain taxed at 24 percent leaves you with $7,600 in profit instead of $10,000.
Long-term capital gains (stocks held over one year) are taxed at 0, 15, or 20 percent depending on your income, which is lower than short-term rates. Bonds held in a regular taxable account are taxed as ordinary income, which can be 24 to 37 percent depending on your bracket. High-yield savings accounts are also taxed as ordinary income. This is why tax-advantaged accounts like 401(k)s and IRAs matter so much: the money grows without being taxed each year, and in some cases (Roth accounts) you never pay tax on the gains.
After inflation and taxes, a 10 percent stock return might become 5 to 6 percent in your pocket. A 5 percent bond return might become 3 to 4 percent. A 4.5 percent savings account return might become 3 to 3.5 percent. The gap narrows, which is why your time horizon and risk tolerance matter more than chasing the highest headline number.
Diversification reduces but does not eliminate risk
Holding only one stock is riskier than holding 500 stocks in an index fund, because one company's failure can wipe you out. Holding only stocks is riskier than holding stocks, bonds, and cash, because a market crash hits all three differently. In 2022, when stocks fell 18 percent, bonds also fell (because interest rates rose), but high-yield savings accounts held steady. A portfolio split 60 percent stocks, 30 percent bonds, and 10 percent cash would have fallen less than 60 percent stocks alone.
Diversification smooths the ride but does not eliminate the risk. In a severe recession, stocks, bonds, and real estate can all fall together. In 2008, a diversified portfolio still lost 20 to 30 percent. The benefit of diversification is that you recover faster and sleep better during the crash, not that you avoid crashes entirely.
Other investments that compete with stocks for returns
Real estate (through REITs or direct ownership) has returned roughly 8 to 10 percent historically, similar to stocks but with different timing. When stocks crash, real estate sometimes holds up better because people still need housing. When interest rates rise, real estate often falls because mortgages become more expensive. Commodities (gold, oil, wheat) are highly volatile and have returned less than stocks over the long term, but they sometimes rise when stocks fall, which is why some portfolios hold a small amount.
Cryptocurrency has returned more than stocks over some periods and less over others, with much higher volatility. It is not insured or backed by anything, so you can lose everything. It is not suitable for money you cannot afford to lose or money you need within five years.
Small-cap stocks (companies with market value under $2 billion) have returned more than large-cap stocks over the long term, but with higher volatility. Emerging market stocks (companies in developing countries) have similar characteristics. Both are riskier bets that can pay off over decades but can also underperform for years at a time.
How to choose based on your situation
Start by listing what you are saving for and when you need it. Retirement in 30 years? Stocks and index funds. A house down payment in five years? Bonds and high-yield savings. An emergency fund? High-yield savings only, because you need it to be there when you need it.
Next, ask yourself how much you can afford to lose without changing your life. If a 30 percent drop in your portfolio would force you to delay retirement or cut spending, you are taking too much risk. If a 30 percent drop would be annoying but not catastrophic, you can handle more stocks. This is not a math problem; it is a personal one.
Finally, consider your tax situation. If you have a 401(k) or IRA, put money there first because the tax deferral is worth more than the difference between a 10 percent stock return and a 5 percent bond return. If you are in a high tax bracket, tax-loss harvesting (selling losing investments to offset gains) can save you thousands. If you are in a low tax bracket, a Roth IRA lets you lock in that low rate forever.
Frequently Asked Questions
What if I want the highest return possible and I can afford to lose money?
You can tilt your portfolio toward small-cap stocks, emerging markets, or individual growth stocks. Expect higher returns over 10+ years, but also expect 40 to 50 percent drops along the way. Most people overestimate how much loss they can tolerate until it actually happens. Start with a smaller amount and see how you feel during the next market crash.
Is it too late to invest if I am close to retirement?
No, but your mix should shift. A 60-year-old with $500,000 saved should not put it all in stocks hoping for a 10 percent return. A market crash in year one could cost $150,000, and you might not have time to recover. A mix of 50 percent stocks, 40 percent bonds, and 10 percent cash is more appropriate, even though it returns less.
Should I try to time the market and buy before it goes up?
No. Timing the market consistently is not possible, even for professionals. The cost of being out of the market during the best days (which are often right after the worst days) is huge. A $10,000 investment in the S&P 500 from 1980 to 2020 returned roughly $1 million. If you missed just the 10 best days, it returned $300,000 instead. Those best days are unpredictable.
Can I get high returns without high risk?
Not in the long run. High-yield savings accounts and short-term bonds are safe but return 4 to 5 percent, which barely beats inflation. If you want 8 to 10 percent returns, you have to accept that some years will be negative. The trade-off is unavoidable.
What is the difference between a stock and a mutual fund?
A stock is one company. A mutual fund or index fund holds hundreds or thousands of stocks, so one company's failure does not hurt you much. Mutual funds are easier for beginners because you get instant diversification, and they charge a small fee (usually 0.03 to 1 percent per year) to manage the holdings.