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What Defines an Investment as “Safe”? A Look at Real Long Term Treasury Bond Returns

Let’s begin with an example - Which of the following investments look “safer” based on the last 137 years of data? 

  • Investment 1: 10-year average annualized real (inflation-adjusted) returns of 1.84%, with negative 10 year total returns 28% of the time.


  • Investment 2: 10 year average annualized real (inflation-adjusted) return of 5.56%, with negative 10 year total returns 8% of the time.


It may come to a surprise for most that investment 1 is a “safe” 10-Year Treasury Note, while investment 2 is the “risky” S&P 500. Historically that “safe” treasury bond has resulted in losses for an investor 3.5x more often than the stock market!


While Treasuries certainly have a place in an investor’s portfolio, I think we need to come to an agreement on what a “safe” or “risk free” asset really is. Because for many investors today, the trade-off for this perceived reduction in risk may be a significant reduction in future purchasing power.  



Treasury Bonds are Hardly “Risk Free”

It is commonly said there is “no risk” to owning a treasury bond since the government can always print money to pay your principal back. And while that is true, that does not mean that investments in treasury bills are “risk free”. This assumption still neglects a very significant risk to fixed income investors – inflation risk.


When you purchase a $1,000 10-year treasury bond with a 3% coupon today, you will get $30 in interest payments (3% of $1,000) each year for the next 10 years, and then after 10 years, you get your $1,000 back.

In total your $1,000 investment will turn into $1,300 – all “risk free”. Risk adverse investors, or those who are able to live largely off of a 3% return may find the idea of investing heavily in treasury bonds very appealing.


But in reality, after inflation you are likely barely breaking even.

If inflation is 2.7% per year over the next 10 years, what does this investment now look like?

After the first year, your $30 interest payment is reduced just slightly, by 2.7%, to be $29.19.

Not that big of a deal, right? But it gets worse (and worse, and worse).

Year 2 sees a further 2.7% reduction. Now adjusted for inflation, this year’s interest payment is just $28.40. This pattern continues for the life of the bond:



And then it comes time to get your $1,000 back. But, $1,000 is not the same 10 years later under 2.7% annual inflation. In fact, 10 years later that $1,000 is equivalent to just $760.55 adjusted for inflation.

Add up all the interest payments received adjusted for inflation ($258.87) and the $760.55 and you get $1,019.42. Adjusted for inflation, this bond did not even make you $20!


And before you think this data is cherry picked to show a poor outcome. This is exactly what today’s 10-year treasury interest rates and inflation numbers are today!


This example begins to show a very real risk when investing in treasury bonds, especially with today’s low interest rates. Many investors are comforted knowing that their investment in a treasury bond is safe, but they are neglecting the chances of realizing significant losses when accounting for inflation.

In fact, we find that the risk of losing money in treasury bonds has historically been much higher than the risk of losing money in stocks.


It Gets Worse - Taxes


Unfortunately for our fixed income investor, the example above left out an important caveat - Taxes.


Exactly how much taxes affect your fixed income returns will depend on your household income. But for now, let’s assume our fixed income investor falls in the 22% income tax bracket with taxable household income between $77,400 and $165,000.

Our investor will pay 22% tax on all of their interest payments. Since each interest payment is $30, that means they owe $6.60 per year in taxes.

Note that taxes are based on the nominal interest paid ($30 in this case), not any inflation adjusted value. Over time, the tax rate based on the real return of this bond is going to go up significantly. Year 1, when the inflation adjusted interest payment was $29.19, that $6.60 in taxes represented a “real tax rate” of 22.6%. But by year 10, after inflation has done its damage, the $6.60 tax on the inflation adjusted $22.82 represents a real tax rate of 29%!

Here is what the tax and inflation adjusted interest payments on this treasury bond look like:


Now, after accounting for taxes and inflation, our fixed income investor received just $192.87 in interest payments. Add that to the $760.55 inflation adjusted principal return and our investor received a grand total of…


This fixed income investor lost $46.58 investing in a 10-year treasury bill, even though it paid a 3% coupon.

So much for a “risk free investment”.


Are Treasury Bonds a Safe Investment? – Here is The Long Term Data

Is this loss unusual for a fixed income investor?

We took a look at the last 137 years of data available on Nobel Prize winner Robert Shiller’s website http://www.multpl.com/, and the results were pretty surprising.


Over the last 137 years, if you purchased a 10 year treasury bond at the end of the year, you had a negative inflation and tax adjusted return 46 times. (And this assumes a 22% tax rate, historically, that was much higher and I would imagine would make this worse.)

In other words, historically 33% of the time a 10 year treasury bond has returned a negative real, after-tax return for investors.


How does this compare to the “risky” investment that is the stock market?


Stocks – The “Risky” Alternative to Bonds


This assumes a 15% tax rate on capital gains and dividends.


In total, there have been 16 times that the S&P 500 has produced negative real, after-tax returns over a 10 year period. That is half the number of periods as a 10-year treasury bond. On top of that, the worst real, after-tax returns are about the same for stocks and treasury bonds (about -4%).

A few observations:

Obviously, stocks are much more volatile than bonds. There were individual years where the S&P 500 was down 40%+, but those years have usually been followed by sharp rises later, which makes 10-year returns less volatile.


Here are the two charts overlaid:


The real returns from Treasuries are without a doubt skewed lower.

Once you factor in taxes and inflation, it appears the actual risky investment is Treasury Bonds!



We will not argue that Treasury Bonds do not have a place in an investor’s portfolio. However, we argue that Treasuries should not be considered risk-free investments. In fact, we find that Treasuries have resulted in real, after-tax losses for investors much more often than stocks.

The risk that inflation poses on a retiree maintaining their quality of life is very understated. This risk has a potential to greatly effect many people today. From retirees today who are invested in bonds with low interest rates, to millennials planning for a long retirement. There is a very real chance that a “safe” investment in treasury bonds will lose you real money over the next 10 years.

I think this data is significant for a few different types of investors:

Retiring Baby Boomers – Someone retiring today needs a plan for their nest egg to last 30+ years. Many retirees immediately jump to “safe” investments like treasury bonds thinking that they can not afford to take risks in the stock market. Although a portion of their portfolio should be allocated to safer investments, it would be a mistake to be invested too conservatively. Over 30 years, it is very likely that inflation will reduce the purchasing power of your dollars by 50%, it is also very unlikely that today’s interest rates will make up for that.

Early Retirees – For those in the early retirement camp, inflation is your number one risk. Because of your need for a source of income over a very long period of time, “safe” treasury bonds may prove to be a terrible investment.

Investors Waiting for the Next Crash - This data should also be eye-opening for investors currently choosing to be invested “safely” in treasury bonds due to the elevated stock market. In all but a very few number of times, stocks have produced higher long term returns than bonds. With today’s low interest rates, it is tough to imagine 10 year bond returns being much higher than stocks, even with an oncoming stock market decline.


This also begs the question. Is there a better “safe” investment than 10-year treasury bonds?

We took a look in a prior blog post about the historical returns in highly rated corporate bonds, to see if the added risk is worth the higher interest rates.

Besides corporate bonds, there are many inflation protected securities available today that can help investors reduce the risk of inflation. TIPS (treasury inflation protected securities), and I-Bonds are generally the most popular.




A few other observations from the data that were a bit random, but I wanted to include:


A)    The Great Depression – Did Stocks Really Have Positive Real Returns?

I immediately thought the data above has an error in it when I noticed positive 10-year returns during the great depression.

During the great depression, stocks declined 80%+, and it took 24 years for the market to return to its 1929 peak. So how could 10 year annualized returns possibly be positive?

A couple things after digging into the numbers:

First, there was massive deflation during the great depression. 1931 and 1932 both saw nearly 10% deflation. This helps offset the real inflation adjusted returns during the period. If stocks lost 50%, but inflation was -25% over the same period, stocks lost much less than 50% on an inflation adjusted basis.

Next, these returns include dividends, and even in the Great Depression, companies paid dividends. In fact, the dividend yield of the S&P 500 reached its highest in history during the great depression:

Source: Shiller’s  Multpl

Source: Shiller’s Multpl


$100 invested in the S&P 500 in 1929 received $54 in total dividends over the next 10 years. Put another way, the inflation adjusted value of the S&P 500 was about 24 at the end of 1928. Over the next 10 years, that investor who purchased at $24 received a little over $12 in dividends over the next 10 years.

So although the S&P 500’s price declined significantly from 1928 to 1938, the combination of deflation and $12 in total dividends just barely gave investors positive real returns over that period.


B)    Bonus for Income-Oriented Investors

Many investors have a goal of setting up a retirement portfolio that produces an amount of income that they are able to live off of, without withdrawing from their account. This may mean buying dividend stocks, or bonds with a certain yield to produce a certain level of income. Although this method may be sub-optimal (we’ll get into exactly why in our next blog post), this data provides some interesting insights for you.

When accounting for inflation, 10-Year Treasuries have been a pretty bad at maintaining your investments purchasing power. Let’s use the same numbers from our first example to illustrate a point.

A retiree with $2 million needs $60,000 in annual income in retirement. With today’s 10-year bond yielding 3%, they think that all they can have a risk free retirement collecting interest payments from their “risk-free” treasuries. But they are not considering the impacts of inflation!


Sure the first year their treasury bonds produce $60,000, and inflation’s impacts are not really felt. But by year 10, that $60,000 really has the purchasing power of just $32,400!

That is almost a 50% reduction in the standard of living that our retiree can afford.


This represents a huge risk for fixed income investors. Your payments are fixed.


Historically, dividends have done a much better job keeping up with inflation.

Over the last 137 years, dividends have averaged a 20% total increase every 10 years. Or, a 1.5% annualized increase.

Of course, it’s important to remember that dividends can be reduced as well. There have been 39 periods where the S&P 500’s dividend was lower 10 years later.  But like the long term returns on stocks, dividends have tended to rise much faster than treasury interest payments over long periods of time.

Below are some slides from a recent webinar I put on with Lorman Education on dividend investing that uses this same data. This helps illustrate the benefit of using dividends for long term investment income rather than solely bonds:



Putting together the data for this post has led to about 100 other blog post ideas.

If you are interested in more, give us a follow on Twitter or Facebook to keep in touch!

Matt Hylland