Many investors -- myself included -- have only been active investors at a time when Treasury bonds and notes have been practically non-factors. For example, since 2000, the two-year Treasury rate has rarely exceeded a 4% yield. But that changed as of the Treasury note auction on Sept. 30.
This yield may leave many investors (especially those seeking income) wondering if Treasury notes and bonds are worth adding to their portfolios instead of high-yielding dividend stocks.
Treasuries are much more intriguing than they have been for some time, but there are a few things investors must be aware of, as they may not be the best choice in some situations.
Bond basics
First, you need to understand how bonds work. Bonds can be issued by any entity (a city government, a company, or the U.S. government), but investors are almost always discussing U.S. bonds in this context. They are issued to raise money, and the bondholder is paid an interest rate in return for the money that is borrowed. Essentially, Treasuries pay for the deficit in the U.S. budget.
Although sometimes used interchangeably, a bond and a note are slightly different. Notes mature in more than a year but not more than 10. Bonds mature more than 10 years from the issue date. Besides that, each pays the holder interest every six months until that maturity date, so the difference is purely notational.
Investors can purchase bonds or notes directly from the government, and many brokerages offer this option, so they are easily accessible to many investors. They also can be bought and sold in secondary markets.
Now that the basics are out of the way, let's discuss why you might want to buy them.
Guaranteed income
Unless the U.S. government defaults on its loans (in which case we'd have much bigger problems than investment portfolios), you will always get paid interest from your bond. Additionally, if you hold a bond to maturity, you will get back the money you initially invested.
This guarantee is something that cannot be said about a high-dividend-paying stock like AT&T (T -0.44%). Since 2010, AT&T has maintained about a 7% yield, but its stock price has fallen almost 25% in the past year. So even though you get to keep all of the dividends AT&T has paid, the underlying asset has deteriorated in price. Additionally, AT&T's dividend payout was cut in half in early 2022 after multiple decades of growth.
So despite an alluringly high yield, AT&T ended up hurting investors. However, investors can lose money on Treasuries too.
There's only one way to lose (or make) money on Treasuries: Sell them before their maturation date. Bonds and note prices fluctuate according to the current yield of new bonds. If the rate is higher on new bonds, then your lower-yielding bond is worth less. On the flip side, if the rate for new bonds is lower, your bond, which has a higher yield, is worth more.
This mechanism is precisely why U.S. Treasury bond indexes are down this year -- no one wants to buy old bonds and notes with rock-bottom yields.
With general market uncertainty, bonds and notes look attractive, as many investors love the idea of guaranteed income without worrying about the underlying asset prices (assuming they hold the Treasury to its maturity date). However, bonds and notes aren't for all investors.
Stocks are better long-term
As stated before, the primary reason for owning a Treasury bond or note is to capture yield without risk. However, one unaccounted-for risk is the lack of returns. While the two-year note yields above 4%, the current inflation rate is roughly twice as high. Time will tell if the inflation rates are peaking, but if they aren't, you're losing money with bonds.
Another consideration is how much stocks outperform bonds over the long term.
Time Period | Large-Cap Stock Returns | U.S. Long-Term Bond Returns |
---|---|---|
October 1929 to Present (Great Depression) | 9.59% | 5.59% |
October 1987 to Present (Black Monday) | 10.34% | 8.09% |
March 2000 to Present (Dot Com Bubble) | 7.48% | 6.74% |
September 2008 to Present (Great Recession) | 10.32% | 5.79% |
Over the long term, stocks consistently outperform bonds. Sacrificing upside for stability is something many people do, but if you're trying to maximize your portfolio returns, then bonds don't make as much sense.
If you're looking for yield with growth, many real estate investment trusts (REITs) offer both. Additionally, other businesses like Texas Instruments (3% yield) have paid great dividends, all while crushing the market, something AT&T can't say.
Every investment situation is different, but I think there are much better investments than notes and bonds, despite their alluring yield. Long-term performance isn't on the side of Treasuries, and I think investors should utilize that precedent to their advantage.
However, those nearing or in retirement could consider putting some of their portfolios in Treasuries, especially if the money is needed in the near future.