Wednesday, August 3, 2011

Some Unpleasant Bonds Arithmetic

At a 2.66% yield (today), a 10 year Treasury will appreciate 30% throughout its lifetime. Naturally, it could appreciate faster than 2.66% per year during the initial years or months, but it would mean that, later on, the yield would have to be lower than 2.66%. The accumulated appreciation throughout 10 years cannot surpass 30% anyway.

From this simple arithmetic, there can only be two scenarios: (1) bonds are extremely overpriced or (2) America is heading to a Japanese-style lost decade.

Now, in your typical retirement portfolio you may find guaranteed-return funds that promise (yet) to pay 3% per year or more, depending on the binding rules. Under the assumption that these funds will keep their promises and remain solvent, the return over ten years accrues to at least 34%. So you have a guaranteed ten-year bonus of 4% or more over the 10-y Ts. On the other hand, guaranteed-return funds provide valuable insurance against a bonds market collapse. If it happens, then you'd be well positioned to do some bargain hunting.

No matter what happens, and unless you're planning to play short-term dice with the pros, the 3% (or more) guaranteed-return account is a clear winner.

That's why I'm saying: bye-bye bonds, see you next time!

2 comments:

Chutando a Lata said...

Consegue encontrar alguma correlação com o índice geral de preços?

Pedro H. Albuquerque said...

Esta è a grande questão: a apreciação dos TIPS poderia ser explicada pelo aumento esperado da inflação, mas neste caso é difícil explicar a apreciação simultânea dos títulos pré-fixados...