Asset No. 2: Bonds

ON SEPT. 30, 1981, the yield on the benchmark 10-year Treasury note hit a high of 15.84%. Almost four decades later, on Aug. 4, 2020, the yield plunged to 0.52%. And that, in many ways, was the big financial story of the past four decades. As interest rates fell, bond prices rose. That enriched existing bondholders, while also boosting enthusiasm for stocks, which appeared more attractive as bond yields declined. The fall in interest rates made it cheaper for almost everybody to borrow, including corporations, governments and homebuyers.

But the big decline in interest rates is over. From the 10-year Treasury note’s current yield, there’s limited room for interest rates to fall further—and ample room for them to rise. That means that, from here, all bond investors can reasonably expect to earn is the yield on the bonds they buy. Just purchased a high-quality bond yielding, say, 4%? You shouldn’t expect to collect anything more than that.

Moreover, that yield may not keep pace with inflation, plus the ride in the years ahead may be rough. Interest rates could climb further, driving down the price of existing bonds. Remember, interest rates and bond prices move in opposite directions, so rising rates mean lower prices for existing bonds. How high could rates climb? Historically, bond yields have closely tracked nominal economic growth. For instance, if nominal (including inflation) GDP grows at 5% over the next few years, yields on the 10-year Treasury note will likely be around that level.

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