Question

Your great grandparents placed $1 in an investment in 1925. Which of the following securities would have given them the highest average annual return over the past eight decades?

O Small stocks
O Large stocks
O U.S. Treasury
O bills

Answer 1

Over the past eight decades, small stocks would have given the highest average annual return compared to large stocks or U.S. Treasury bills. While they carry higher risk, they also have higher potential rewards, and historically, stocks outperform bonds and savings accounts in terms of average return.

Step-by-step explanation:

Over the past eight decades, choosing between small stocks, large stocks, and U.S. Treasury bills, small stocks have typically provided the highest average annual return. This is because stocks, especially small stocks, have the potential to grow more than the other securities mentioned, though they come with higher risk. A well-diversified stock portfolio could expect a 7% real annual rate of return above the rate of inflation in the long run, which is significantly more than what Treasury bills would yield.

U.S. Treasury bills are considered low-risk and thus have lower returns compared to stocks. The idea that high risk necessitates low returns is a misconception. While high-risk investments can lead to low returns, they can also result in much higher returns, as is the case with small stocks.

This correlation is not a strict rule, as high risks can be associated with high rewards. The historical data indicates that over time, stocks tend to outperform bonds and savings accounts in terms of average return.