Historic Bond Returns Explained
In this article I take a look at historic bond returns.
Bonds don’t grab the daily headlines like stocks! In fact, when you get into it, there’s an argument that they are just about the most boring investment you can make.
Worse still, bond returns don’t usually measure up to those of stocks. When you step back and think about it, you could begin to question the reasoning behind investing in bonds as all.
But the fact is, most investors need bonds in their portfolio.
Bonds provide safe steady income. Their prices don’t charge around like stocks, and even better they don’t tend to move in parallel with stock prices either, which mean they can help to even out the bumps when stocks hit a rough patch.
There are many different types of bonds out there, but perhaps the most common are developed market government bonds, investment grade corporate bonds, and non investment grade bonds.
Developed market government bonds
Also called treasury bonds or high quality government bonds.
These are highly rated bonds of developed market governments such as the US, UK and Germany. The interest payments you receive are low but so too is the risk. In fact, they are often described as riskless or risk free.
Whether that’s true is debatable but its pretty much agreed that they are just about as safe an investment as you can make.
Many investors hold these as a diversifying assets, because they tend to hold their value if not go up when stocks go down.
The most famous developed market government bonds are Treasuries and Gilts.
Treasuries are the name used to describe US government bonds. The vast majority of investors have some treasuries in their investment portfolio.
You’ll often hear the terms: Treasury bills, Treasury notes, Treasury bonds and TIPs. The difference for the first three is the time you hold the bond, usually called the maturity.
Bills have maturities of one year or less, notes have maturities between 2 and 10 years, bonds have maturities between 10 and 30 years and TIPS are Treasury Inflation-Protected Securities. As the name suggests, TIPS have a return that fluctuates with inflation.
Gilts are British government bonds. The unusual name comes from the fact that they used to have gilded edges.
Investment-grade corporate bonds
Also called high quality or highly rated corporate bonds.
Investors lend money to high quality companies, and get interest payments in return. Investment grade means these companies are unlikely to default, meaning there’s a good chance you will get your money back!
Investment grade corporate bonds are likely to be from big name companies that you’ve heard of, such as Apple or Microsoft.
Even though the chances of them defaulting is low, it is still likely to be higher than a developed market government, so the yield is likely to be higher too in order to compensate you for the additional risk you’ll be taking on when you buy this type of bond.
A bond’s risk is rated by agencies like Standard & Poor’s and Moody’s.
A Standard & Poor’s rating of BBB or above and a Moody’s rating of Baaa3 or above signifies investment grade (IG). Ratings below these are considered non-investment grade.
Non-investment grade bonds
Also called low quality corporate bonds, junk bonds or high yield bonds.
The clues are in the names. This type of bond generally pays more interest, hence high interest! But that’s because it is more likely for something to go wrong meaning you might not get your money back, hence low quality or junk!
Non investment grade bonds making double digit interest payments aren’t too hard to find, but high interest payments suggests high risk.
So in theory, the key differences between these three types of bonds is the trade off between risk and reward. Developed market government bonds should provide the lowest returns, but also the lowest level of risk. Investment grade corporate bonds add a little risk and a little return and non investment grade bonds add a lot of risk and a lot of return.
You’ll notice I said in theory!
Historic bond returns
See the chart and table below. They show US stock and bond returns from 1979 until 2018.
| Asset | Initial Balance | Final Balance | Compound Annual Growth Rate | Inflation Adjusted Compound Annual Growth Rate |
| Developed Market Government bonds | $10,000 | $295,092 | 8.72% | 5.2% |
| Investment grade corporate bonds | $10,000 | $291,553 | 8.68% | 5.17% |
| Non investment grade bonds | $10,000 | $253,803 | 8.31% | 4.81% |
| Stocks (S&P 500) | $10,000 | $858,332 | 11.62% | 8.01% |
Source: Portfoliovisualizer
As you might expect stocks provided the biggest compound annual growth rate, but contrary to expectations the bond returns have come out in reverse. Developed market government bonds had a compound annual growth rate of 8.72% compared to 8.31% for non investment grade bonds.
Non investment grade bonds are much risker than developed market government bonds. You’d expect much higher returns, not less. Yes, the difference isn’t that great, but the key point is that you haven’t been compensated for taking on the extra risk.
It is no wonder there’s a school of thought out there that says simply stick to government bonds and that any additional risk you take on should be done by increasing your allocation to stocks.
For example, if you have a traditional 60/40 split between stocks and bonds you could increase your stock allocation and reduce your bonds to say 70/30.
It certainly would have made sense over the last forty years.
That said, just because something happened in the past is certainly no guarantee that it will happen again in the future. Nobody knows what the future holds. Non investment grade bonds may beat stocks over the next forty years.
At the end of the day, this was one chapter in history in one country.
Triumph of the optimists
Elroy Dimson, Paul Marsh, and Mike Staunton in their book Triumph of the Optimists looked at historic returns over a century. Global government bonds were much lower than they have been in the US over the last forty years.
After adjusting for inflation, very short term government bonds (bills) returned 1% and long government bonds returned 2%. Historic returns for global stocks over the same period were around 5%. It makes you wonder why people bother with bonds at all!
I like to frame it like this: Bonds probably aren’t the best way to grow your wealth, but they are a great way to help preserve your wealth.
The bottom line
Bond returns haven’t measured up to those of stocks historically.
But, unless you really know what you are doing a fund of bonds alongside a fund of stocks is a safe solution for most investors.
Developed market government bonds are considered the safest investment you can make.
And in the past investors haven’t necessarily been compensated for taking on the additional risk associated with other types of bonds.
Your own country’s bonds avoid currency risk, so the developed market government bonds of the country where you live are usually your best option.
If you live in or are planning to retire in a country without developed market government bonds a fund containing a basket of different developed market government bonds might be a good choice.
You can read more about bonds here.