Treasuries

Last week we looked at historical returns on gold and showed that, despite widely-held beliefs about the commodity, it’s a risky investment that barely keeps up with inflation. We showed that over time, gold has proven itself to be significantly riskier and far less profitable than stocks.

This week we look at treasuries, which by their nature are not as risky as stocks or commodities, but are still perceived to be far safer than they truly are when you look at real (inflation-adjusted) return. Treasuries are unique in being fully guaranteed by the US government. If you buy a $1,000 10-year treasury bond with a 6.8% coupon, you will undoubtedly receive $34 semi-annually until the bond matures, at which point you get your $1,000 back. The total interest earned over this period (before reinvestment) is $680. But even with the ultra-safe, guaranteed return, you could still lose money!

You may be wondering how it’s possible for an investment with guaranteed returns to lose value. The answer is inflation. For example, $1,000 in 1970 had spending power equivalent to over $2,160 in 1980. If you collected any less than $1,160 in interest payments over the life of the bond, your real (inflation-adjusted) return was negative. In the example above, you would actually have lost $480 over the 10-year period.

Let’s compare treasury bills, which mature in one year or less, treasury bonds, which mature between 20 and 30 years, and common stocks. Since 1871, stocks have returned +6.3% annually after inflation, compared to +1.9% for treasury bills and +2.4% for treasury bonds. So stocks provided far better returns over the long term.

Now let’s look at risk. Over the past 110 years, the worst decades for stocks were the 2000s, when they returned –2.2% annually, and the 1910s (–2.1% annually). Treasury bills, on the other hand, returned –4.5% per year during the 1940s, while treasury bonds dropped –4.8% per year in the 1910s and –3.2% in the 1940s. Not so safe after all it seems.

So while treasuries fluctuate less than stocks in the short term, their worst-case performance over a decade is lower than for stocks. And stocks’ best-case performance is far better: +15.7% in the 1990s vs. +8.1 for treasury bonds and +3.7% for bills in the 1980s. So while bonds are an important part of a diversified portfolio, and usually yield a positive real return, it is important to understand that risk is inherent in any potentially profitable endeavor. US treasuries are no exception.