By Michael J. McNamara
While these numbers were gathered in August of 2020, they have changed little; the concept remains the same.
U.S. 30-year treasury bond interest rates are at all-time lows. As I write this you can earn a whopping 1.39% per year for the next 30 years if you buy one of these. After you pay taxes and subtract inflation from that 1.39% you are losing money.
If you paid $1,000 for that bond today and hold it until maturity, that $1,000 they give back to you is not going to buy as much then as it does today something to do with inflation. Yet people are fleeing to safety and buying these like they are are going out of style. Makes no sense. But the news gets worse!
When bond interest rates are at all-time lows, that means bond prices are at all-time highs.
If you hold that bond to maturity (the whole 30 years) you will get your money back, guaranteed. What it will buy then is another thing. The good thing about most bonds is that you don’t have to hold them until maturity. You can sell them anytime you want. But what you get back for that $1,000 investment you made depends, it may be greater or lesser than $1,000. The resale value depends upon what interest rates are at the time of sale. An example is in order:
You just invested $1,000 in a 30-year U.S. Treasury bond paying 1.39%. If interest rates go up just 1/2 of 1%, that bond will go down 12.2% in value and be worth $878.03. If interest rates go up 1% soon after you bought that bond, it will go down 24.39% in value and be worth $756.05. This concept is very difficult to explain in a short article like this, but here goes. You walk into the bond market store wanting to sell your 1.39% in a world where the going interest rate is 2.39%. Who would give you $1,000 to get 1.39% when they could buy a new bond paying 2.39% for the same $1,000? Nobody. Said differently, a 1.39er is not worth as much as you paid for it in a world of 2.39ers.
So, you say the heck with that, you are not going to sell your 1.39% bond for a loss in a 2.39er world. Well okay, but when you get your investment statement that month it will say your bond is worth $756.05 whether you sell it or not. If interest rates go up, the value of your bonds goes down.
You don’t really have to understand how all this works, you just have to know that it can. There are several more factors in this equation, but I think you get the idea. By the way, if interest rates went down 1% to 0.39%, your 1.39er would be worth more than you paid for it (up 24% in value or $1,243.95). If interest rates go down, the value of the bonds you already own just went up some. Whoa!
So, bond prices are at an all-time high. Interest rates are at an all-time low. The bonds you already own or choose to buy will fluctuate in value if you choose to sell them before maturity. Their resale value will go up if interest rates go down and down if interest rates go up?
What to do? Talk to a professional and gain more understanding on this subject and how it may affect your investments and financial goals. These days, bonds aren’t as safe an investment as many folks may think. These are not your grandfather’s bonds. And you better know the rules.
Michael J. McNamara, Ph.D., CFP, certified financial planner. Disclaimer: Any financial advice in this article is intended to be generic in nature. Readers should consult with their own financial advisors before implementing any advice or suggestions above.