Bonds – Income Generator or Dead Weight?
I remember setting up my first bank account when I was 14 years old after landing my first job at Quizno’s. With great anticipation that my money would grow exponentially, I deposited my hard-earned paychecks into my bank account and transferred excess cash into my savings account. I was able to accumulate a few hundred dollars in my savings account. When I viewed my statement after months of diligent sandwich artistry, I found that my money earned a meager $0.01 of monthly interest. This felt like a slap in the face. I almost would have preferred to earn zero interest, rather than to pretend that my savings account was earning meaningful money. With the interest my money was generating, I couldn’t even pay for a can of worms for fishing. Thinking back on my teenage bewilderment, I wonder if this is how bond investors felt in 2020.
Five-year treasury yields fell to 0.3% in the middle of 2020. A $1 million bond portfolio earning 0.3% would yield just $3,000 in annual income. Now that feels like a slap in the face. Even at low yields, bonds still serve a purpose as a more stable alternative to equities, but bond investors must have been disappointed with these paltry yields. However since 2020, bond yields have crept upward and increased rapidly in 2022. In the short term, bond prices go down when yields increase, but the good news is that investors earn more interest on new bond issuances. In 2023, five-year treasury yields reached almost 5%. While yields have fallen somewhat since 2023, an investor earning a return equal to the five-year treasury rate can generate $40,000 of interest on a $1 million bond portfolio. Much better than $3,000 only five years ago. For a $1 million bond portfolio yielding the five-year treasury rate, a proxy for conservative intermediate-term bond yields, here is what annual income might have been since 2020:
Since they are less volatile than stocks, Bonds are still a good vehicle to help preserve wealth. The exciting news for bond investors is that they are now providing more meaningful income compared to near-zero yields just a few years ago. Bond yields haven’t been this high since 2007, the onset of the Great Recession.
Chart Source: YCharts