U.S. Treasuries are the new social media rage

Bond yields made major headlines last week when the yield on 10-year U.S. Treasury notes reached 5.35% – the highest level we’ve seen since 2002.

Anytime something makes 24-year highs, it’s going to be in the news. That’s to be expected.

What did surprise me, however, was how many new age “financial gurus” I saw pop up on social media, urging people to capitalize on this so-called opportunity with posts like:

Or:

Technically, their math isn’t wrong. But that doesn’t make their logic right.

Even though bond yields are at a generational high, going all-in on U.S. Treasuries right now is very likely to leave long-term investors disappointed. There are very few (if any) get-rich-with-no-risk schemes out there, and this time is no exception.

Yes, they might be your best bet if you have millions of dollars’ worth of liquidity and want to generate very safe 5%+ returns on that money. But even then, that’s with the understanding that these yields are stagnant. They stay the same year-in and year-out through maturity.

In which case, the headline yield isn’t the most important number to consider.

That 5.35% headline figure only accounts for nominal returns. So it ignores such things as inflation, taxes, fees, and trading costs.

The U.S. Bureau of Labor Statistics’ most recently put inflation at 3.40%. Subtract that from the 10-year bond yield, and your return drops down below 2%.

And even if the Federal Reserve does tame inflation quickly and the 10-year average falls closer to its 2% annual target, you’ll still have to at least pay taxes. Those vary state to state, of course. But rest assured…

There’s little chance you’ll walk away with anything above a low-single-digit annual return after everything’s said and done.

So let me rephrase that first question I kept seeing on social media last week:

I’m fairly certain your resounding response would be a big, fat “No!”

And you shouldn’t be surprised that we’ll find a similar conclusion for the second question. Turning $1,000,000 into $1,535,500 over a 10-year period sounds nice at first glance.

But that’s a mere 4.38% total-return compound annual growth rate (CAGR). It’s nothing compared to what you can get in a decent array of stocks.

Take the State Street S&P 500 ETF Trust (SPY), which invests in every single one of those listed companies. Over the past decade, its net asset value (NAV) has compounded at a 15.3% rate.

So here’s what would happen if SPY continues to compound at this rate moving forward:

Admittedly, the last decade has been exceptional for stocks. The much longer-term picture – as in 100-years view – shows the S&P 500 producing a total return CAGR much closer to 10.4%, or about 7% when adjusted for inflation.

So let’s scrap 15% altogether and go with the much more conservative 10% as our theoretical average. In that case, a $1 million SPY investment would turn into $2.6 million over the next decade.

This means you could still expect an additional $1 million by investing in stocks instead of bonds… even when the 10-year Treasury yield is at a 24-year high.

That’s a lot of money to be leaving on the table with an all-bond portfolio, to say the least.

For those who really want to believe in the power of Treasuries – and they do have some power, to be sure – yes, I’m fine admitting that my previous SPY projection still deals with historical averages. There’s no guarantee the S&P 500 will do so well going forward.

For all we know, we’re about to enter a “lost decade” period where stock gains slow down considerably under the weight of any number of detrimental factors. But that’s not likely.

Analysts expect the S&P 500 to compound its earnings per share (EPS) at a 20% rate – or more – over the next 3–5 years. That’s very important to acknowledge.

Of course, it’s equally important to note how I’m talking to a largely income-focused crowd here at Wide Moat Research.

For outright income-dependent investors such as retirees, one million dollars into SPY only generates about $10,000 annually. And I know that’s not enough to live off of.

So let’s shift our stocks vs. Treasuries comparison instead to the most popular dividend growth ETF: the Schwab US Dividend Equity ETF (SCHD). It sports $108 billion assets under management (AUM) and a 13.1% total return CAGR since its inception in October 2011.

SCHD’s 10-year total return CAGR is 12.44%. That’s approximately 300 basis points (bps) below the S&P 500’s total return CAGR. So in this conservative scenario, let’s assume about 7% annual returns from SCHD over the next decade.

This still doubles your money over 10 years, resulting in roughly $500,000 extra dollars at the end of the experiment… while generating $32,300 in annual income, since SCHD’s current dividend yield is 3.23%.

I know I would sacrifice around $20,000 per year of income to produce an extra half million dollars of wealth. And I suspect you would, too.

Moreover, if SCHD’s returns over the next decade are anything like they were during the last 10 years, then we’re not talking about an extra $500,000. We’re talking about an extra $1.6 million.

At a 12.4% total return CAGR, $1 million turns into $3.2 million, well above the $1.535 million produced by 10-year Treasury notes.

This is the power of compounding – something that stagnant bond yields just can’t compete with.

Believe it or not, my point here isn’t to totally bash bonds.

I truly do understand why 5.35% risk-free yields are attractive. And for certain investors, allocating a portion – maybe even a significant portion – of their portfolios toward bonds might make sense in today’s economic environment.

But as always, diversification is key here.

Whether we’re talking about stocks, bonds, precious metals, crypto, or any other kind of investment, it never makes sense to put all your eggs into just one basket. That’s true even when we’re talking about the “guaranteed” returns associated with U.S. Treasury notes.

The risks might be intensely lower, but so are the rewards in the end.

Remember, over the long-term, U.S. stocks have outperformed U.S. bonds by a wide margin. That’s even true on a risk-adjusted basis.

So before you go all in on social media posts talking about amazing bond-market opportunities that you’d be crazy to pass up on… don’t forget about diversification. Or the fact that, over the long-term, stocks have outperformed bonds by a wide margin on a total return basis.

Just because something is labeled “risk-free” doesn’t make it worthwhile – even if social media tells you otherwise.

Best wishes,

Nick Ward
Analyst, Wide Moat Research