Fisher Investments Editorial Staff
Investor Sentiment, US Economy

Getting a Grip on Bonds

By, 08/19/2010
 

Story Highlights:

  • From January 2008 through June 2010, bond funds reportedly received $559 billion in inflows while equity funds saw $232 billion in outflows.
  • Safety-seeking investors have recently been especially fond of US government securities, likely due in part to renewed investor fears over global economic growth.
  • Though government securities do serve a legitimate strategic purpose for many, investors frequently forget bonds sometimes carry significant risks.
  • The probability stocks outperform bonds—and by a wide margin—over long time periods is significantly higher than vice versa.

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In a decade nearly bookended by a bursting tech bubble and a financial crisis, it's no surprise there are doubts over long-term equity performance. And that doubt is clearly illustrated by equity vs. bond funds' inflows and outflows: From January 2008 through June 2010, bond funds reportedly received $559 billion in inflows while equity funds saw $232 billion in outflows. 

Safety-seeking investors have recently been especially fond of US government securities, and the wave of buying has pushed down yields on 10-year notes to a 17-month low (2.6%), 30-year bonds to a 16-month low (3.7%), and 10-year Treasury Inflation-Protected Securities (TIPS) to below 1%.  

The current rush into Treasuries is likely due in part to renewed investor fears over global economic growth—first stoked by concerns about eurozone sovereign debt contagion, then slowing Chinese growth, and now slowing US growth. Investors may also be buying government debt on speculation the Fed may increase its Treasuries purchases in another wave of quantitative easing following its weaker economic outlook. 

Though government securities do serve a legitimate strategic purpose for many investors (and payment of coupons and the return of capital is reassuringly backed by the full force and credit of the good old US of A), investors frequently forget bonds sometimes carry significant risks. 

If bond yields rise from their current exceptionally low levels, the prices of bonds will fall. Investors looking to sell their bonds prior to maturity might get less than they invested. Even investors who hold onto their bonds until maturity may be dinged. When inflation is taken into account, bonds can have negative real yields and the purchasing power of the investment can fall. 

Additionally, the opportunity cost of favoring bonds over stocks could hurt long-term portfolio performance. The probability stocks outperform bonds—and by a wide margin—over long time periods is significantly higher than vice versa.  

Historically, in the rare occasions bonds beat stocks over a 20-year time period, the outperformance wasn't by much and stocks were still net positive. In fact, stocks have outperformed bonds in 95% (or 62 of 65) 20-year rolling periods since 1926, with an average total return of 909% vs. 254%.* And bonds have never bested stocks over 30-year periods.  

Some equity investors may wish to forget the last decade. But rather than rashly switching gears, long-term investors should take a reasonably long-term view of stocks vs. bonds performance and how portfolio allocations to each might impact investing objectives. 

*As of 12/31/2009. Stocks as measured by the S&P 500 total return index. Bonds as measured by the Ibbotson US Long-term Government Bond Index.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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