Income: Treasuries vs. IBonds vs. TIPS

The returns on 20-year U.S. Treasurys have been amazing over the past decade (2002-2011) and over the past 30 years (11.03% vs. 0.05% for the S&P 500). This marks the first time that over any given 30-year period, Treasurys outperformed the S&P. For 2011, these long-term bonds had a total return of 28%; for 2008 the total return was 26%. These Treasurys have not seen a better year since 1995.

At the beginning of 2011, the yield was 3.3%; by the end of 2011 it was 1.9%. To match 2011 returns, the 10-year note’s yield would have to drop to 1.05%. Over the past 50 years, the record low for 10-year Treasurys was 1.72% (September 2011). The surprise about Treasurys is how they fare compared to inflation. For example, inflation was ~ 3.4% for 2011. If someone bought a 10-year Treasury at the beginning of 2012 and held it to maturity, adjusted for inflation, the investor would lose ~ 1.5% annually—and this does not include the impact of taxes.

Treasury yields can stay below inflation for extended periods. From 1942 through 1951, the Treasury Department “forced” the Federal Reserve to keep 10-year rates below 3% as the country sought to pay off its massive WWII debt. During this period, investors of 5-year Treasurys lost 4.5% each year after adjusting for inflation (worse if income taxes are factored in). Analysts generally agree that the Fed’s massive rounds of quantitative easing are keeping rates artificially low.

I Bonds

As of early January 2012, 3-month Treasury bills were yielding 0.02% while a one-year bank CD was paying 0.8%. FDIC bank money market funds were yield-ing 0.4% while mutual fund money market accounts were offering 0.02% (source: iMoneyNet). During the middle of the 2008 financial crisis, Warren Buffet sold $5 million of T-bills maturing in four months for $5,000,090.70, meaning the buyer was willing to lose $90.70 over four months (to ensure he did not lose even more in something else).

TIPS