Why a Government Bond Investment Stinks

These days, I get lots of calls asking “How should I invest right now? Government bonds?” I always try to answer by giving a little history lesson.  On May 15, 1984, the Treasury department auctioned $5 billion of 30-year bonds (callable after 25 years) with a fixed coupon rate of 13.25%. This means you could have purchased government bond investment and been guaranteed a double-digit return for a minimum of 25 years.

Today, that looks absolutely incredible.

Why were government bonds paying so much in May 1984? Well, try to remember the splendor of the 1970s.  We had the energy crisis, double-digit inflation, stagflation and recessions. It wasn’t a lot of fun.  That, coupled with the failure of Continental Illinois National Bank and Trust during the same month, made people hesitant to lock up their money at a fixed rate. To get money out of the mattress, the government had to offer a very high interest rate.

With the benefit of hindsight, buying and holding that 30-year government bond would have been a brilliant investment for many investors. But today, we face almost the exact opposite situation with the 30-year bond. The yield is below 3%, yet investors are clamoring to buy it. Are investors who buy 30-year bonds at today’s low yields making the same mistake as investors who were too scared to buy 30-year bonds at a 13.25% yield 25 years ago? In other words, are they doing the wrong thing at the wrong time?

As an advisor, I find it instructive to look at how times change and how fear plays a role in the value of investments. Back in 1984, people were fearful of locking their money up at a historically high interest rate with the memory of the previous decade’s bad news still fresh in their minds. Today, the fear of losing money has driven down the yields of 30-year bonds to near historic lows as investors seek out the safest investments.

All this leads us to the stock market. It is possible that the declines we have seen in the stock market over the past year have led us to a situation similar to the May 1984 bond market. Specifically, fear and legitimate economic woes have caused the stock market to drop dramatically, but will we – perhaps 10 years from now – look back and say, “Oh my gosh, it would have been a brilliant investment to go long in the stock market back in 2009”?

It may take years before we know the answer to that question, but, at a minimum, it is important to put the current maelstrom in historical context. This is especially important if you are looking for the best IRA investment, because that’s very long-term money. As George Santayana said, “Those who cannot learn from history are doomed to repeat it.”

What do you think?  Is this the best or worst time to invest in the stock market?