By The White Coat Investor, originally published at The White Coat Investor.
By
Jim Dahle,
WCI Founder
<!–Bonds are having a bit of a moment in the media. Like most things with high-quality bonds, this is all driven by changes in interest rates. Consider this historical chart showing the yield on the 10-year Treasury bond:
When you zoom way out, the most impressive time for historical bond yields was the early ’80s when interest rates peaked after the Fed, led by Paul Volcker, cranked up interest rates to smash the inflation of the 1970s. After that, interest rates gradually decreased for decades, affecting all of our daily lives (and boosting bond returns). For example, the mortgage rates on the homes Katie and I purchased or refinanced:
- 1999: 8%
- 2001: 7.25%
- 2006: 6.25%
- 2010: 4%
- 2015: 2.75%
But if you just zoom in on the last couple of decades, we can tell the story of bonds over the course of most of our investment lifetimes.
Basically, bonds seem as attractive as they ever have been for most of us because their yields of about 5.2% are as high as we have ever seen them. In reality, bonds have just now returned to “normal.” Mortgages are still available at an interest rate lower than our first couple of big loans, but the bizarre “Zero Interest Rate Policy” (ZIRP) years now seem behind us. Anyone expecting a 2.5% mortgage anytime soon is probably delusional.
Bond Yields, Bond Prices, and Interest Rates
Some people find bonds super complicated, but in reality, they’re pretty darn easy to understand. A bond is a loan—typically to a corporation, a government, or to large groups of individual mortgage borrowers. The long-term source of return is the interest paid on the loan. The two main risks with bonds are
- That the borrower won’t pay you back
- That interest rates change (go up) and new bonds offering higher yields will make your old, lower-yielding bond a less attractive and, thus, less valuable investment
We call the first credit or default risk and the second interest rate or term risk. You minimize the first by only lending to really high-quality borrowers (such as the US Treasury with its powerful military and ability to tax its wealthy citizens) and the second by keeping the maximum length of your loan (bond) to only a few years.
Maturity is the length of the loan, but a better measurement of the sensitivity of that loan to changes in interest rates is called duration. So, a short-term bond or fund of bonds has a duration of perhaps two years, an intermediate-term bond fund has a duration of seven years, and a long-term bond fund has a duration of 13 years. If interest rates go up 1%, the first will lose 2% of its value (wiping out six months of interest), the second 7% of its value (wiping out 18 months of interest), and the third 13% of its value (wiping out about three years of interest).
The most terrible year for US bond investors in history was 2022. While trying to rein in the inflation caused by massive COVID-related government stimulus that lasted too long, combined with ZIRP, the Fed raised interest rates about 4% over the course of six months in 2022. That had never happened before, and it had a devastating effect on the value of bonds.
For instance, these very well-run bond funds from Vanguard had the following 2022 returns:
- Short-term (VBIRX): -5.63%
- Intermediate-term (VBILX): -13.27%
- Long-term (VBLAX): -27.22%
There are even longer-term bond funds than the Long-Term Bond Index Fund, such as the “Extended Duration Treasury ETF” with a duration of 24 years, which lost 41.56%. Almost 42%! That would be a catastrophe even for equity investors. The stock markets haven’t dropped 42% since the Global Financial Crisis of 2008. Even with a worldwide pandemic, the US stock market only fell about 25% and recovered very rapidly (thanks at least in part to all that stimulus). Even inflation-indexed bonds like TIPS got walloped in 2022 due to the rapid rise in interest rates (including real interest rates, which are the ones that matter to inflation-indexed bonds). The Vanguard TIPS Fund (VAIPX), with a duration of 6 1/2 years, fell almost 12% in value in 2022.
The bottom line is that any time period that includes 2022 is going to show a terrible return for bonds. Unfortunately, due to the natural human desire to chase performance, that has caused people to shy away from bonds for years. I mean, as of Labor Day weekend 2026, the five-year return for VBILX is -0.23%. That’s basically no return at all for five years, and if you adjust for inflation, it’s a return of -4.28% per year. You’ve lost almost 1/4 (23%) of your purchasing power by investing in bonds over the last five years.
However, the returns of bonds (what you earned in the past) and the yields of bonds (how much they pay now) move in opposite directions. And the best predictor (although nowhere near perfect) of FUTURE bond returns is the current yield. Thus, just like with stocks, you should buy bonds when “blood is in the streets,” i.e., when past returns have NOT been very good. That’s why it’s no surprise we’ve been seeing financial news, blog posts, social media, and forum discussions talking about buying bonds again.
More information here:
The Yield Curve
Another interesting change with bonds, again driven by changes in interest rates, is that the yield curve is no longer inverted. An inverted yield curve has predicted something like 35 of the last 15 recessions (read that carefully to understand what I’m saying), but more importantly, an inverted yield curve means that those who take on more term risk are not being rewarded for it with higher current yields. It suggests that, for whatever reason, interest rates are likely to fall. Well, the yield curve was inverted for quite a while, basically from late 2022 until late 2024. But it really didn’t revert all that much until 2025-2026. Now, like interest rates, it’s back to “normal.”
The current Treasury yield curve looks like this:
- 1-Year Treasury Yield: 4.11%
- 5-Year Treasury Yield: 4.52%
- 10-Year Treasury Yield: 4.77%
- 30-Year Treasury Yield: 5.25%
US Stock Returns
Meanwhile, stocks, especially AI-related US large cap growth stocks, have had one of their best performance periods ever. The Vanguard 500 ETF bottomed out in March 2020 as the pandemic hit at a value of $204. Today, it trades at $710, 3 1/2 times higher. And that doesn’t even include the dividends it has paid for the last six years. I’ve never met so many decamillionaires as I have in 2026, and people are feeling a need to “lock in” their gains.
The normalization of the interest rate/bond environment with rising interest rates (including in 2026), the reversion of the yield curve, and a sense that stocks (like trees) cannot grow to the sky is driving significant interest in bond investing again.
More information here:
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What Should You Do About the Bond Revival?
We see people talking about moving money into bonds, particularly TIPS, now that 30-year TIPS are yielding as much as 3% real (after inflation). The 30-year TIPS were issued from 1997-2001, and then not again until 2010. The most they ever yielded was in 2000, just before the dot.com crash when the yield was 4.4%. But since they were reintroduced in 2010, the current yield of about 3% is as high as it has ever been.
So, people interested in building a TIPS ladder to deal with Sequence of Returns Risk by matching cash flows to their liabilities can get a better deal on this purchase than they have ever had before. Even if you just want to buy a boring old total bond market fund, it now yields 4.7%, significantly more than current inflation (3.4%) as measured by CPI-U. However, people are still arguing to “take your risk on the equity side” by not buying bonds at all. I mean, risk-free cash is yielding 3.63%. Those people argue you should keep a few years of spending in cash and put the rest in stocks.
What should an investor do? I have no idea.
You see, predicting future interest rate changes is really no easier than predicting future stock returns. I discovered many years ago that I am not talented enough and that my crystal ball is not clear enough to invest in a way that requires me to know anything specific about the future. I needed a method of investing that was highly likely to be successful in most (and certainly a wide range of) likely future economic scenarios.
The best way to do that, in my humble opinion, is a static asset allocation. That is to say, a mix of investments that doesn’t change over time. Many years ago, we chose a portfolio where we put a certain percentage of it into a variety of different investments. Then, we just try to keep it balanced at those same percentages over time. Most of the portfolio is invested in low-cost, broadly diversified index or index-like funds, so we always get the market return for that particular market. That means we own investments at the worst possible time to own them—like bonds in 2022. It also means we own investments at the best possible time to own them, like small value stocks in 2026.
Over time, we do just fine, and we have actually far exceeded all of our financial goals. Pick a reasonable plan, fund it adequately, and stick with it long term. It really is that simple. Our particular plan (60% stocks, 20% real estate, 20% bonds) looks like this:
- 25% Total US Stock Market
- 15% US Small Value Stocks
- 15% Total International US Stock Market
- 5% International Small Value Stocks
- 10% Private Equity Real Estate
- 5% Private Debt Real Estate
- 5% Public Equity Real Estate
- 10% TIPS
- 10% Nominal Bonds
We didn’t change our plan in 2008. We didn’t change it in 2011. We didn’t change it in 2018. We didn’t change it in 2020. We didn’t change it in 2022. Why would we change it in 2026? You know why all the market timers and performance chasers and stock pickers compare their strategies to a buy-and-hold strategy? Because deep down inside they know that 1) it is easy to implement and 2) it works well. Why not just do that? We couldn’t think of a reason not to two decades ago, and we still can’t. Our crystal ball is still just as cloudy as it was in 2007 and 2019. We’re no smarter now than we were then, but that hasn’t stopped us from reaching all of our goals.
Investing is a single-player game: you against your goals. So, I’m going to tell you the same thing I said when the market dipped in 2011, 2018, 2020, and 2022. I’m going to tell you the same thing I told you in 2018 when everyone said interest rates HAD to go up and they couldn’t go down any further (and then proceeded to do so). I’m going to tell you the same thing I said in 2022 when interest rates were climbing.
Stay the course!
Jack Bogle said:
“Stay the course. No matter what happens, stick to your program. I’ve said, ‘Stay the course,’ a thousand times, and I meant it every time. It is the most important single piece of investment wisdom I can give to you.”
He was right. Yes, if you had a functional crystal ball, it would be wise to change your course in accordance with what it is telling you. But you probably don’t. I know I don’t. We had 10% in TIPS in 2008 (and were glad about it). We had 10% in TIPS in 2020 (and were glad about it). We had 10% in TIPS in 2022 (and weren’t glad about it). We have 10% in TIPS now. Ask me in five years if it was the “right move” or not, because right now I have no idea. But we don’t have to know “the right move” because we don’t move.
I don’t think you should either. If you don’t have a reasonable investing plan, get one. If you do have one, stick with it. If you’re having trouble doing that, hire someone good to help you. It will be worth the cost.
What do you think? Are you changing your fixed-income investments in response to higher interest rates, the reversion of the yield curve, or the outstanding recent stock market returns? Why or why not?
The post Bonds Are as Attractive as They Have Been in 20 Years: What Should You Do About It? appeared first on The White Coat Investor – Investing & Personal Finance for Doctors.
Dr. Jim Dahle
WCI Founder
James M. Dahle, MD, FACEP, FAAEM is a practicing emergency physician and the founder of The White Coat Investor. After multiple run-ins with unscrupulous financial professionals early in his career, he embarked on his own self-study process to become financially literate. After seeing the benefits of financial literacy in his own life, he was inspired to start The White Coat Investor to assist his colleagues. At the time, there was nobody providing unbiased financial education to doctors at any point in their training. Now, more than a decade later, financial wellness is widely recognized as a critical life skill for all physicians and similar professionals. Dr. Dahle remains committed to the original mission of The White Coat Investor to “help those who wear the white coat get a fair shake on Wall Street.”
He currently serves as the CEO, a columnist, and the host of the podcast. Dr. Dahle is a proud father of 4 children and spends his free time adventuring around the world. If you can’t find him, he is probably hiding in the mountains or desert of his home state of Utah.
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