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Bonds: We've Seen This Movie Before. It Doesn't End Well

Investors have short memories. Our recollections about five years ago are hazy. Ten years, and lessons are forgotten. Thirty years ago might as well have been the Big Bang.

Bonds have been in a 30-year bull market, so even some of the most grizzled professionals haven't experienced a prolonged period of pain. But history doesn't forget. The bond market has been here before. And it didn't end well.

Interest rates were kept incredibly low in the 1940s and 1950s to help manage the national debt after World 2. Ten-year Treasury bonds yield almost the exact same today as they did in 1950.

What happened to Treasuries after that? Those who held to maturity received their principal back. But inflation eroded all of the value of interest payments, and then some. And as interest rates rose in the 1970s, the value of existing bonds plunged. The result in real (inflation-adjusted) terms was three decades of sheer misery:

Average annual real returns


10-Year Treasuries

30-Year Treasuries

Corporate Bonds













Source: Deutsche Bank Long-Term Asset Return Study.

These losses might seem small, but they add up fast. $100 invested in 10-year Treasury bonds lost 40% of its value in real terms by the early 1980s:

Source: NYU, Federal Reserve, author's calculations.

Inflation was out of control in the 1970s and early 1980s -- that wasn't a normal period by any means. But even before the inflation spike, those who purchased Treasuries in 1950s went 20 years without earning a penny in real terms. That's what you get for buying when rates are so low. 

Short-term bonds might still make sense for those who need ready access to their money. For all else, the last century gives us a reasonable set of expectations going forward: Bonds are possibly a way to maintain the value of your assets, almost certainly not a way to grow them, and potentially a way to lose a lot of them.

Interest rates have risen over the last month, offering a taste. Pimco High Income Fund (NYSE: PHK  ) is down 10% in the last month. The Vanguard Long Term Corporate Bond Fund (NASDAQ: VCLT  ) lost 4.6%. Mortgage REITS sensitive to the same interest rate risk have been pummeled; Annaly Capital Management (NYSE: NLY  ) shares are off by one-fifth over the last year.

How bad can this get? It can't be stressed enough that we have no idea. Many investors thought Japanese bonds were toast in the early 1990s. Twenty years and dozens of ruined careers later, we're still waiting for the crash.

But when interest rates are this low, the best-case scenario becomes not getting hurt, and getting hurt becomes pretty likely.

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Comments from our Foolish Readers

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  • Report this Comment On June 13, 2013, at 6:08 PM, prginww wrote:

    That's truly a central question of our time: are we 1950 USA? Or are we 1990 Japan? If the latter, we're all screwed. If the former, bondholders are screwed. Either way, bondholders are screwed.

  • Report this Comment On June 13, 2013, at 6:11 PM, prginww wrote:

    whether stocks or bonds, inflation is the enemy and high inflation that is viewed as likely to last can easily cut the value of stocks or bonds in half as it has in the past. I agree that the current yield on bonds doesnt even come close to compensating for its risk. I would highly recommend taking 1% yielding short term CDs or savings accounts versus accepting the risk of 10 year or higher treasuries barely above 2%. Even TIPS are probably a better option than that. The 10 year TIPS real rate is barely positive at 0.15% but I believe thats better than youll do in the bond market

  • Report this Comment On June 13, 2013, at 6:42 PM, prginww wrote:


    Yes, stocks are subject to inflation. However, good companies paying consistent dividends usually keep pace with inflation and, with, dollar-cost averaging and dividend re-investment programs, even beat inflation every year. So if your investing for the long haul (40, 50 and even 75 years), who cares about inflation. Inflation goes up, it goes down, it goes sideways!! Yet, your stock investments go up and that's what it's all about.

  • Report this Comment On June 13, 2013, at 7:55 PM, prginww wrote:

    You've been screwed if you sat in USD's for the last 5 years and you've done very well in bonds. So uf you started selling bonds 3-6 months ago and buying stocks you're in pretty good shape. Now if you start selling stocks and buy gild and USD we'll have to see how that turns out won't we.

  • Report this Comment On June 14, 2013, at 11:13 AM, prginww wrote:


    Beware of overbroad conclusions. I suggest you acquaint yourself with this article from the May 1977 issue of Fortune, written by Mr. Warren Buffett, titled, "How Inflation Swindles the Equity Investor":

    Best wishes,


  • Report this Comment On June 14, 2013, at 11:06 PM, prginww wrote:

    I am not convinced we are facing inflation. We are in a deflationary time I believe. The computer is the first major advance in technology that is a long term job destroyer. Look across the economy, whether it is manufacturing or government the computer is improving efficiency and taking jobs. When you call a government office you don't get a person you get a menu. When you walk into a factory you see people programing and monitoring computers and robots. Do you buy books online or do you go to a book store? I am not convinced that bonds will take the hit that many are predicting. No big big hit. That is not to say that some government bonds will lose value. Those units of government that have been badly managed will default. That is not a result of inflation, though.

  • Report this Comment On June 18, 2013, at 5:50 AM, prginww wrote:


    I'm familiar with the article. Granted, Mr. Buffett speaks of the money robbing power of inflation, yet he belies his own words by councilling anyone who will listen, in other articles, to invest in equites! Don't beleive me? Look at his own investing record!!! What did he invest in? Equites (i.e. good businesses and buying what? Whole Businesses!!!) So Mr. Buffett undoes his own words by acting in direct opposition to his own counsel!

  • Report this Comment On June 22, 2013, at 9:55 AM, prginww wrote:


    Could you do us all a big favor and look back through your archives and tell us the date when you first published an article making (more or less) this argument?

    I've seen several from you in the last few years, and I think it would be instructive to see how long you've been barking up this tree, particularly given the actual track record of long-dated Treasuries in the last few years alone.


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