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  • Sure, Treasury bond yields have risen substantially.
  • Yet, it wouldn't take much for stocks to outperform T-Bonds over time.
  • Owning stocks can be key to achieving long-term financial goals because of compound earnings.

Buying a long-term U.S. Treasury bond (T-bond) and holding it until maturity is a pretty safe bet, and because interest rates are rising, locking in the current 3.4% yield on a 30-year T-bond seems pretty smart, given that yields were only about 1.4% two years ago.

However, concentrating the entirety of your portfolio in Treasury bonds means subjecting yourself to a significant amount of opportunity cost during your career because you’re earning interest at a fixed-rate over the entire bond term. Although the principal is guaranteed as long as the U.S. government remains in business and you hold until maturity, the potential to reap much higher returns by owning stocks due to compound earnings could make owning them the best way to reach your retirement goals.

Comparing Bonds to Stocks Over 30 Years

In “Creating Wealth,” Real Money Pro’s Paul Price does the math to illustrate why stocks should be a part of investors' portfolios. He writes:

“Most people tend to look for guaranteed results. Historically, though, that guarantee comes with a very expensive price tag - a much smaller than necessary accumulation of wealth.

Let's compare two examples to illustrate that point…Both investors are 40 years old and have IRA accounts worth $100,000 currently…The ultra-conservative person wasted no time locking in the best available long-term U.S. Treasury bond rate…As of Aug. 30, 30-year T-bonds were yielding 3.22%. Choosing that means taking no principal risk, no repayment risk, and an assured rate of return…If held until retirement at age 70, the nest egg would be worth just shy of $261,000.”

That’s a fair amount of money. However, inflation means that $261,000 in 30 years won’t buy nearly the same goods and services as today. Remember, the average home price was $121,500, and gasoline cost $1.13 per gallon in 1992 (30 years ago). Moreover, inflation averaged 3.8% per year between 1960 and 2021.

Back to Price: 

“Now let's see what a more adventurous investor could do over that same time span with non-guaranteed investment choices [i.e. you could lose your money]…

Investor No. 2 divided his $100,000 into five piles of $20,000 each. One-fifth of the money was vaporized via horrible stock picking…The second fifth never earned a dime over a full thirty years…40% of the entire second portfolio thus shrank 50%, dropping from $40,000 to $20,000. That is absolutely horrible and is very unlikely to happen…The middle piece of the pie simply matched the 3.22% T-bond rate…The fourth segment, at a 6% annualized rate, turned $20,000 into $117,832…Only the final fifth achieved a standard long-term equity rate of return [note: 9%]. It morphed $20 grand into $280,548.”

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Overall, despite the second investor having lousy luck with 40% of their investment, they still wound up with a portfolio valued at $470,526, or 80% more than the bond investor. As Price points out, the tranche earning just 6% eclipsed the entirety of the initial investment, and just 20% of the money invested in stocks earning 9% per year eclipsed the whole of the bond investor’s value at retirement.

Price’s calculation is a powerful reminder that you don’t need to always be right in the stock market. You only need to be right enough of the time for the power of compounding to build wealth for you.

When to Buy Bonds

Of course, bonds can play a valuable role in your portfolio, especially when you’re older. Their steady-eddy profile can dampen volatility, which can help you stay the course when bear markets cause stocks to fall. Also, interest earned from them can supplement other income in a pinch, providing you with a backstop if life throws you a curveball. As a result, financial advisors often recommend stocks and bonds in portfolios.

The Smart Play

Historically, financial advisors advocated the “rule of 100” as a starting point for asset allocation. Using this rule, a 40-year-old invests 60% in stocks (100-40 = 60) and 40% in bonds, while a 60-year-old invests 40% in stocks and 60% in bonds.

Recently, some advisors have shifted their thinking to account for longer lives, increasing the rule of 100 to 120. Using that formula, a 40-year-old would subtract 40 from 120, leaving 80, resulting in 80% of their portfolio in equities and 20% in bonds.

Target-date funds are another asset-allocation option that has won widespread use. An investor selects a target retirement date, and the portfolio automatically decreases exposure to stocks and increases exposure to bonds as the investor ages. Over $3.2 trillion is invested in target-date funds as of 2021. If this type of set-it and forget-it product is intriguing, ensure you understand the formula to determine allocations before investing because they can differ from fund to fund.

Both strategies allocate a significant percentage of portfolios to stocks because it’s tough to match their positive impact on performance over time. In short, owning stocks can be key to achieving long-haul goals. 

However, remember, stock market returns don’t happen in a straight line. Instead, returns can take frustratingly confusing paths up and down, so you’ll likely spend at least some time underwater. When that happens, be careful how you react. Selling all your stocks could reduce the amount you’ll wind up with in retirement. After all, nobody rings a bell signaling the end of a bear market, and the market’s most significant returns usually occur at the beginning of a bull market rather than the end. If you don’t time your repurchase correctly, you might miss out.

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