The sky is falling... the sky is falling!!!
Well, not exactly, but investors globally are certainly concerned about Spain's growing economic woes, Greece's inability to stand on its own two feet, China's growth slowdown, and the United States' sudden reversal of fortune as evidenced by May's jobs report.
Very simply put, fear begets risk-aversion for many investors, and flocking to the safest investments available is not always the best choice. In fact, sometimes it can be downright toxic for your portfolio.
Not as safe as you think
Take, for example, U.S. Treasury bonds, which have been in a 30-year bull market, give or take a few minor corrections. As the price of U.S. Treasury bonds rises, the underlying yield the owner of that bond would expect to receive falls. You may wonder what would cause a bond to rise in value. Pretty much the same concept that governs a stock: considerably more buying demand than selling demand. And, wow, have we been seeing buying demand.
The demand to buy Treasury bonds has been so strong over the past two-and-a-half months that the U.S. 10-year T-bond has lost roughly 90 basis points off its yield and is now sitting at about 1.5% -- a record low. To put it another way, buyers are lining up around the block to purchase extremely safe bonds issued by the U.S. government.
But is this a good move for investors? You might be thinking, "This is as guaranteed a return as I can get on my money. Plus, it's backed by the U.S. government, so I don't have to worry about the risk of default!"
True, the chance of default is very slim, and you will get a nominal "return." But in real dollars that investment in U.S. Treasuries could wind up costing you nearly your entire investment.
The reason is really simple: inflation!
Inflation, or the rising costs of goods sold, has historically risen at a faster rate than the current yield of every last T-bond you can currently purchase. That means investors who are running for the hills away from the stock market are trading in $1 for something much less down the road. Utilizing the average inflation rate of 3.61% since 1914, let's take a look at what an investment of $1,000 would look like in nominal dollars and real dollars if it were continuously rolled over until it doubled.
Length of Time to Double
Real Dollar Value (inflation adjusted)
|30-Year T-Bond||$2,000||2.57%||28 years||$2,699|
|10-Year T-Bond||$2,000||1.53%||47 years||$5,295|
|5-Year T-Bond||$2,000||0.68%||106 years||$42,912|
|2-Year T-Bond||$2,000||0.25%||288 years||$27,269,805|
|1-Year T-Bond||$2,000||0.18%||400 years||$1,447,669,688|
|6-Month T-Bond||$2,000||0.13%||554 years||$340,821,694,569|
|3-Month T-Bond||$2,000||0.08%||900 years||> $10 Trillion|
|1-Month T-Bond||$2,000||0.04%||1,800 years||> $10 Trillion|
Source: Bureau of Labor Statistics, U.S. Department of the Treasury, author's calculations.
No, these figures are not misprints; it's just an in-your-face example of what a poor investment Treasury bonds make right now. With the one-year Treasury bond, for example, it would take 400 years of constantly rolling over your compounding investment to double your return. In that period, the real dollar value of $1,000 would be worth more than $1.4 billion – a 99.999% real-money depreciation! If you were purchasing that bond for your descendants to use, you'd have pretty much bought them the equivalent of a soda from a vending machine.
Buy this instead
So what can you do if you're scared to death of these market plunges and you want a relatively safe return on your money that will outpace inflation? Here are three solid ideas instead of turning to Treasuries.
1. Buy necessity stocks
In January, I shared a portfolio of five stocks that could help prevent your portfolio from disaster in case of corrections like the one we're experiencing now. The secret to all five stocks is that they supply a necessary product that sees little weakness in demand when the global economy weakens. As you can see from the dividend-adjusted performance since then, they've done quite well:
Dividend Adjusted Return Since 01/19/2012
|Duke Energy (NYSE: DUK )||8.3%|
|American Water Works||4.3%|
|Coca-Cola (NYSE: KO )||10.0%|
|Wal-Mart (NYSE: WMT )||10.4%|
Source: Yahoo! Finance, author's calculations.
Despite the market's fall, four of the five companies have decisively outperformed the broader market S&P 500. Wal-Mart has shaken off a bribery scandal and hit a 12-year high on stronger earnings results all while the market has dipped. Duke Energy is also tipping the scales at a new high as its diverse portfolio of electricity-generating fuels (natural gas, wind, and hydroelectric) is keeping its energy production costs low and its margins up. Coca-Cola has been a bottle-rocket in the past four-plus months as it has an easily recognizable brand image and emerging-market exposure that has buoyed stagnant domestic sales. The point is that solid companies that provide necessity goods will tend to outperform over the long haul.
2. Buy high-yield dividend stocks
Just like low-yield Treasury bonds are a bad investment, you also don't want to rush out and grab the highest-yield possible without doing your research. In order to find a dividend that offers a quick payback you need to find companies with strong, sustainable, cash flow that are also in sectors that tend to be resistant to economic downturns. According to CNBC, 55% of all S&P 500 companies have a dividend yield higher than the 10-year Treasury bond, so that is a great place to begin your research.
One company that strikes me as a good example that will outpace the historical average of inflation is AT&T (NYSE: T ) . Neither AT&T nor Verizon is going to give you exceptional growth, but the cash flow of dividend-paying telecoms is matched by few businesses. With a yield north of 5%, AT&T would crush what you would receive from buying a Treasury bond.
3. Buy a corporate bond
When in doubt, if you absolutely can't get up enough courage to buy stocks, then consider buying a highly rated corporate bond. Microsoft's (Nasdaq: MSFT ) corporate bonds are rated AAA and its 30-year bonds have a current yield very close to 5%. With $45 billion in net cash and a very stable business, Microsoft's bonds appear to be a strong bet to outperform.
Whatever you do, do something else
The main point here is this: Whatever you do, don't buy Treasury bonds. The trading action in bonds can only be described as speculative with the yields tracing so far below the historical inflation rate that you'd be throwing money away to make a nominal profit.
Do you have a plan to beat inflation? Tell your fellow Fools about it in the comments section below.
If high-yielding dividends are your path to success, then you might appreciate the latest special report from Motley Fool Stock Advisor detailing nine dividend-paying companies, including Wal-Mart, which could help you retire comfortably. Click here to get your free copy.
Editor’s note: A previous version of the bond table in this article contained erroneous figures. The Motley Fool regrets the error.