Investors may think their bond investments are safe, even though inflation-adjusted yields on 10-year Treasury notes have been less than zero since January 2012.
“Treasuries and other traditional bonds are widely assumed to be ‘safe,’ but are just as subject as any other fixed-income investment to losses in value should interest rates rise,” said Nathan Rowader, director of investments and author of the study by Forward Management, “The 5% Problem: Double Jeopardy for Bond Investors.” The title of the study refers to the 5% long-term average annual yield for U.S. government bonds from 1926 through 2012.
Rowader cited current market conditions—low yields, moderate inflation and high public debt levels—which he claims are almost identical to those of 1941, as evidence that bonds are entering a bear market climate. While he does not expect to see the bond bubble burst, Rowader said that they are likely to gradually “melt away” as returns from traditional bonds erode and investors are unable to meet their investment goals.
According to Forward’s study, a rise in interest rates could cause investors to lose even more value in their existing bond portfolios than they stand to gain in annual after-tax return. The total return from a traditional government bond index averaged 8.8% annually from 1981 through the end of 2012.
The report is available for download here.