Over time, bonds do not beat inflation, at best they barely keep up. You get interest payments for the life of the bond and in the end get your principal back. Studies of historical returns of various investment classes show that bonds, in return for their "risk-free" status, do not award investors with returns sufficient to generate significant real returns.
As Lynch points out, in the history of finance no company has ever rewarded its bond-holders with an increase in interest payments, however successful they may become. Shareholders, however, can have dividends increased year after year, and retained earnings increase the intrinsic value of the share itself. While bonds have historically beaten inflation 50% of the time over 5 years, for any 10 year period they only have a 40% chance of beating inflation, and over 20 years bonds have beaten inflation less than 10% of the time (source: Fortune Strategy by Higgins and Abey, page 29, originally sourced from the Frank Russell Company). The corresponding returns of stocks are much better, and the historic probabilities of beating inflation for stocks are 78%, 80% and 95% respectively, also quoted are United States treasury bills (T-bills) which beat inflation 55%, 45% and 45% of the time.
| 1920s* | 1930s | 1940s | 1950s | 1960s | 1970s | 1980s | |
| S&P 500 | 19.2% | 0.0% | 9.2% | 19.4% | 7.8% | 5.9% | 17.5% |
| Small-company stocks | -4.5% | 1.4% | 20.7% | 16.9% | 15.5% | 11.5% | 15.8% |
| Long term govternment bonds | 5.0% | 4.9% | 3.2% | -0.1% | 1.4% | 5.5% | 12.6% |
| Long term corporate bonds | 5.2% | 6.9% | 2.7% | 1.0% | 1.7% | 6.2% | 13.0% |
| Treasury bills | 3.7% | 0.6% | 0.4% | 1.9% | 3.9% | 6.3% | 8.9% |
| Inflation | -1.1% | -2.0% | 5.4% | 2.2% | 2.5% | 7.4% | 5.1% |
With a very low probability of even beating inflation bonds are definitely not a long term investment.
Lynch suggests investing in shares instead, even for retirees, and shows some very interesting calculations on the performance over 1 year, 2 years, 10 years and 20 years for an average portfolio of 100% bonds, 50% bonds/50% shares and 100% shares.
$10,000 inititially invested in bonds will give $14,000 in income over 20 years and you then get your $10,000 back. In the 50:50 portfolio, which has to be rebalanced frequently by selling shares and buying bonds will give $17,286 in income, which is the fixed interest as well as dividends and proceeds of shares sales, the principal and the value of the stocks ends up as $21,911. The 100% stocks portfolio returns $13,729 in income over the 20 years through dividends, and the stocks end up worth $46,610. Lynch says that it is better if you rely on investments for income to take dividends and make up the cash shortfall by selling packets of shares.
The tax system makes the situation even better for investors in stocks. Dividend imputation means that certain dividends may be tax-free, and instead of paying income tax on income through share selling you pay capital gains tax. Someone with a moderately large shares portfolio may well pay no tax at all by living off their shares, due to the relative cheapness of capital gains tax and franking credits. If you are in bonds all income will be taxed at the usual marginal rate, and any capital gains you make by trading bonds is also treated as income, not as capital gain the way they would be when selling stocks.
Lynch's example makes certain assumptions about the average yields of bonds and stocks based on long term averages, by making purchases of stocks at times of very high dividend yields (or in other words, low prices, like after a correction), these results can be improved. The returns of bonds right now are very unspectacular because of low interest rates, until we start to see interest rates climb up again it is going to be very hard for anyone to make a decent living off bonds, of course if interest rates do rise so will inflation, which also works against bond holders.