Treasury bonds are risk-free. Buy one, and you are guaranteed to get your money back plus interest if held to maturity. Furthermore, the 6-month Treasury has averaged a 4.9% annualized yield this year, the highest since 20071. Combine these two facts together, and it’s no wonder why investors are asking why they shouldn’t just put all their money into Treasuries right now. While tempting, there are three reasons to reconsider such a bold move.
The first is that Treasuries are still losing money safely because they can’t beat inflation. As in, a guaranteed return of 4.9% is the same as a guaranteed loss of 1.1% based on the government’s measure of inflation at 6%1. For retirees and investors approaching retirement, it’s likely that inflation is even higher.
Some may argue that a guaranteed small loss is better than the risk of a bigger loss, but the bar chart below shows that the odds of losing in stocks falls dramatically as time goes on.
Stocks also have a good track record of beating inflation. Since 1980, inflation has averaged 3.4%, and the average S&P 500 total return is 12.9%1. Even the bond market has done better, with an average of 7.0%1. Compare that to the average yield of a 6-month Treasury over the same period at 3.8%, and it will probably take more than risk-free assets to generate real wealth in this environment.
The second is opportunity cost. Last year was unique in that both stocks and bonds were down. The chart below shows that when this has happened in the past, the subsequent 1-year and 3-year returns for both asset classes have been attractive and consistent. For example, the average return of the bond market one year later is 10.7% and has been positive 100% of the time. Stocks were up 9.6% and positive 73% of the time.
Let’s assume this year is average for both stocks and bonds. If so, a 6-month Treasury purchased today would earn $2,450 for every $100,000 invested. Assuming the yield does not change (more on this below), the total return after one year would be $104,960.03, or 4.96%, before taxes if the proceeds were reinvested. That’s stellar when compared to the 6-month Treasury’s average yield of 0.80% since 20101.
But the story changes when compared to a 60/40 portfolio of stocks and bonds using the average 1-year returns from the table above. This hypothetical portfolio would rise to $110,400. That’s more than double the return. Additionally, most of the 60/40 portfolio would have the opportunity to compound over time and be subject to long-term capital gains. Yield from Treasuries is taxed as ordinary income.
Admittedly, these are average returns after rare occurrences, and while stocks and bonds combined have never recorded two consecutive years of losses over the last four decades, anything could happen. But what could get left on the table if history repeats itself?
The third is “reinvestment risk,” or what happens after the Treasury bond matures. There’s ample evidence to suggest that the Fed is either done raising rates or very close (they mostly said so last week)2. Markets are even pricing in rate cuts by year-end3.
If so, two outcomes are likely. First, yields on short-term Treasury bonds should fall because the Fed has a lot of control over what these bonds pay. Hence, reinvesting in the same vehicles could be done at a lower yield than what is offered today.
Second, stocks would probably rise higher. It’s hard to think of any catalyst better for stocks than falling interest rates, and the early innings tend to be (1) quite profitable and (2) measured in weeks or even days. Miss this window and getting back on track could require taking on even more risk to catch up.
Said another way, while trading into Treasuries right now will protect against volatility, it could also create unintended risks to your longer-term financial plan.
The bottom line
To be abundantly clear, there is nothing wrong with buying Treasury bonds. Most of our diversified strategies own them in every economic environment. Treasuries are arguably safer than keeping money under the mattress, and at current yields, they are the most attractive they’ve been since the iPhone was invented.
The “all” part of the original question is the problem. It’s hard to think of any situation where “putting it all” into Treasuries, stocks, bonds, real estate, cash, and/or gold is optimal. Diversifying across these asset classes to target goals within a specified risk tolerance is almost always better. Over time, these allocations should be adjusted but almost never abandoned.
The bottom line is that Treasury bonds are incredibly powerful tools, but they’re not the only game in town. Diversification is the only free lunch in this business.
Sources
1 Bloomberg.
2 https://www.cnbc.com/2023/03/28/dollar-steady-after-feds-rate-pause-hints-yen-rises.html
3 https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
Disclosures
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. Richard W. Paul & Associates does not provide tax, legal, investment, or accounting advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.