The 1 Chart Bond Investors Need to Worry About

According to the Investment Company Institute, $215 billion has flooded into bond mutual funds over the last year. Add in the amount invested into exchange-traded funds, and it's even greater.

With interest rates at all-time lows, what are these people thinking? They've been burned by stocks twice in the last decade, and think they're safer in bonds. Even though bonds yield close to nothing, at least they'll get their money back, the thought likely goes.

But that's probably not the case. Not only do bonds yield a measly amount, but after you add in inflation, the yield is negative in many cases.

Take the benchmark 10-year Treasury bond. This chart shows its yield minus the annual rate of inflation (or the "real" yield):

Source: Federal Reserve, author's calculations.

No way to sugarcoat this: Unless inflation plunges, or interest rates fall even more than they already have (both unlikely), you will likely lose money on your bond investments. If not in actual dollar terms, then in purchasing-power terms.

Here's what Warren Buffett said about it in this year's Berkshire Hathaway (NYSE: BRK-B  ) shareholder letter:

Most of these currency-based investments are thought of as 'safe.' In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge. Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as the holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control. Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as 'income.'

If you're about to retire and can't afford an ounce of volatility from stocks, bonds might be the right move. For everyone else, there are options. Good, high-quality companies like Johnson & Johnson (NYSE: JNJ  ) , Coca-Cola (NYSE: KO  ) , and Procter & Gamble (NYSE: PG  ) have dividend yields significantly higher than the yield on Treasury bonds, have been making dividend payments for decades, and grow their dividends year after year, usually at a rate faster than inflation.

For some more ideas, check out The Motley Fool's special report, "Secure Your Future With 9 Rock-Solid Dividend Stocks." It's free. Just click here.

Fool contributor Morgan Housel owns shares of Berkshire, Johnson & Johnson, and Procter & Gamble. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Johnson & Johnson and Coca-Cola. Motley Fool newsletter services have recommended buying shares of Coca-Cola, Procter & Gamble, and Johnson & Johnson. Motley Fool newsletter services have recommended creating a diagonal call position in Johnson & Johnson. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (7) | Recommend This Article (42)

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  • Report this Comment On May 15, 2012, at 3:33 PM, TMFDarwood11 wrote:

    Even if you are about to retire, sinking 100% of one's assets into bonds sounds like a big mistake.

    I'm assuming the investor is planning on a 30 year retirement and a compounded rate of 5-7%.

    If treasuries are yielding a negative number after inflation, then I assume that in 15-20 years, such an investor had better plan on trimming their diet.

  • Report this Comment On May 16, 2012, at 6:44 PM, xetn wrote:

    I think it is rather odd that Buffett talks about loss of purchasing power of fiat currencies but hates gold.

  • Report this Comment On May 16, 2012, at 7:06 PM, CoreAndExplore wrote:

    @xetn - because the actual utilitarian value of gold is actually far, far below the current market price, making it another sort of "fiat" currency. Though gold is tangible and does represent a certain level of "intrinsic value," over 2/3 of the current market price is based on faith that others will continue to pay such a premium. It's also important to note gold's high correlation to equity markets over the last few months - it is currently the opposite of a "safe haven" or "hedge" against a falling stock market. Gold has fallen from nearly $1,900/oz to a little over $1,500 as of today's close (05/16/2012).

    Also, Buffett has always been quick to point out that the surest way to combat inflation is to invest in strong businesses that pass on costs to the consumer, raise dividends, and continue to grow earnings at a clip that beats the CPI, even during periods of high inflation.

  • Report this Comment On May 16, 2012, at 7:14 PM, mikecart1 wrote:

    There is no one good thing and everything bad or vice versa. Mix it up. Long-term bond funds are decent and usually give a monthly dividend plus the price of the bond yield has one up the past 3-5 years. For a decent long-term bond, you can get 4-5% returns annually which is about the same as owning a Coke company. Bottom line, don't just put all your money in bonds. Don't put all your money in gold. Don't put all your money in stocks. Don't put all your money in CD's. Mix it up based on your age and risk and stick with what you know and never forget... stick with CRAMMMMMmmmmmmmeR!

    (joking about one of the above ;) )

  • Report this Comment On May 16, 2012, at 7:28 PM, ershler wrote:


    It isn't odd at all, Buffett is just saying that inflation happens and you need to account for it.

  • Report this Comment On May 16, 2012, at 9:38 PM, actuary99 wrote:

    People responding to @xetn:

    All this guy does is make comments bashing anything and anybody not supporting Austrian economic theory. He doesn't appear to be open-minded. He will either ignore your responses or rationalize them as invalid.

    I'm sure he has some genius response to your point about it being a fiat currency. Because surely central governments would have no way to

    to artificially increase its price.

    Also the price of gold would surely not further artificially increase because the value of our collective assets, as population increases and technology improves, would never increase at a rate faster than gold is mined.

    (BTW, I've never actually read much about Austrian economics, I have just observed it's proponents thoroughly enjoy mentioning "fiat money", how horrible the FED is, the horrors and treachery of "money-printing", how taxes are theft/coercion*, et cetera)

    *not sure this is an actual tenet of Austrian economics, or just has a high correlation with its supporters

  • Report this Comment On May 18, 2012, at 11:08 AM, WishToRetire2 wrote:

    The buffet comments were about losing purchasing power. You can lose that with stocks too.

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