The investment world is caught in a gap between the collapse of long-term interest rates and the relentless (if underestimated) increase in the cost of living.
Some $ 16 trillion in global bonds yields less than zero, and the fall in returns seems to only increase. While textbooks say that should inflate the value of other investments, the action says otherwise this past week. The dive in Treasury returns hit the stock market Wednesday and sent
Dow Jones industrial average
into an 800-point swoon.
Market Data Center: Bonds
What's more, just when the 10-year benchmark benchmark portfolio fell below 1.50% and the 30-year bond yield dipped below 2% for the first time, inflation ticked higher. So these returns fell below the Federal Reserve's inflation target of 2%.
Based on the Consumer Price Index – the inflation meter most commonly used, except the Fed -, prices jumped at a 3.6% annual cut in July. Using the "core measure", which excludes food and energy prices, the increase year over year was 2.2%, or more than could be gained from any salable treasury security. The overall CPI was up 1.8% from the previous year's level, ahead of all except the longest government securities.
Among Treasury Inflation-Protected Securities, which, as the title indicates, should hold on to the loss of purchasing power, the 10-year maturity fell to a real rate of minus 0.2% on Thursday.
But small savers can actually do better in protecting the purchasing power of their savings than the large institutional investors who manage the global markets. And it's as sexy as a minivan.
I refer to inflation-indexed savings bonds, or I-bonds, as the Treasury debates them. They are currently paying 0.50%, plus the change in the CPI, adjusted every six months. This is equivalent to 1.90% through October – more than all except the longest T-bonds. To be sure, there are limitations to this seemingly free lunch. Individuals are limited to buying $ 10,000 of I-bonds each year, making them unattractive to the country's 1%.
For those who hit the 401 (k) ceiling ($ 19,000, plus an additional $ 6,000 for those over 50), I can attach bonds to a tax-deferred retirement investment plan. The main function of an interest rate component of a portfolio is to provide a buffer to the regular and unavoidable drawbacks in risk conditions, as is happening now.
In Barron's Round tables from previous years, I remember listening to Peter Lynch, the then Fidelity Magellan Fund's skipper, who repeated that stock prices tumble once every year, and that's only part of to invest. Having a portion of a portfolio that never goes down should help tremulous investors keep the race going through such downturns.
Each financial advisor pushes younger investors to upload the most risky investments – especially stocks – on the seemingly reasonable assumption that they have time to ride out bear markets. But it applies to perfectly rational gay Economicus, a species that is rarer than Big Foot.
As Rob Arnott & # 39; s Research Affiliates work has shown, younger investors tend not to follow the optimal path, often paying 401 (k) because it is good. Real people change jobs, get debt, need down payment for a house, have medical expenses or get divorced. They then lose retirement accounts, pay fines and lose future returns.
In normal times, a typical bond portfolio would dampen market declines or those episodes when life's best-laid plans go awry. But these days, bonds (at least treasury bills) pay little and can't keep up with inflation.
And inflation shows signs of life, despite airy claims about its demise, when Danielle DiMartino Booth reminded subscribers to her Daily Feather missive last week. The inflation-derivative market (yes, there is such a thing) is priced at a 2.0% long-term price increase in the US, against 1.2% for the Eurozone and 0.1% for Japan.
She also calculates that the prices of necessities trace the heading of the CPI much closer than the personal consumption deflator, the meter preferred by the Fed. The PCE deflator only runs at a 1.4% annual rate, in part because it incurs healthcare costs based on Medicare and Medicaid reimbursement rates, which are far below what is paid by private insurance plans.
So, inflation-indexed savings bonds stay ahead of falling interest rates and rising prices, while helping investors tear out uneven patches. Other pluses: The return from inflation adjustment of I-bonds is taxable only when the securities are redeemed, as opposed to TIPS, whose inflation compensation is taxable annually. And I-bond returns can be tax-free, within income limits, if used for educational expenses. As with all government securities, income is exempt from state and local taxes. Details can be found on the TreasuryDirect website.
It is rare for small investors to get a better deal than the big money. Even better is what keeps them invested during the inevitable shifts in the stock market … and life.
Write to Randall W. Forsyth at firstname.lastname@example.org