Why Bond Returns Were So High in the 1980s

If you’ve ever looked at historical bond returns and were shocked that bonds used to have great returns, you’re not alone.

From 1978 to 2012, Long-term Treasuries grew at 9.33% per year on average. Long-term corporate bonds weren’t far behind at 9.11%. These bond returns rival stock returns. Anyone would be happy with a 9% return year after year.

So what happened? Why were bond returns so strong during this period? Will bonds ever have this kind of performance again?

In this article, we’ll look at the fixed income return data, explain what drove those results, and give you the honest answer about what it means for bond investors today.

This is Part 1 of a series.

You can read Part 2 covering the ZIRP era (2013 to 2020) here.

What Made 1978 to 2012 Different

To understand the returns during this period, we first have to understand what was happening in the US economy.

Going into 1978, the US had a serious inflation problem. Prices were rising over 5% a year. By 1980, the annual inflation rate hit over 12%.

The Federal Reserve, led by chairman Paul Volcker, decided to raise the federal funds rate (the interest rate the Fed uses to influence all other borrowing costs in the economy) all the way to 20% by 1981. The theory was that by raising rates this high, people would be more likely to save rather than spend. Borrowing also became more expensive, so there would be less money chasing goods and services.

This strategy worked, but it triggered a painful recession and sent unemployment past 10%.

Here’s the important part for bond investors: when rates fell back down over the following 40 years, the value of existing bonds went up. Anyone who locked in a 14% or 15% bond yield in the early 1980s was sitting on something very valuable as rates slowly dropped toward zero. That’s the tailwind that powered bond returns from roughly 1982 all the way to 2020. It’s often called the 40-year bond bull market (a bull market means prices are rising over a long period).

The Federal Reserve was able to raise interest rates this high to combat inflation because the U.S. national debt was manageable at the time. Debt-to-GDP (the size of the national debt compared to the size of the economy) stayed well below 100% for most of this period. That gave the Fed room to raise rates without blowing up the government’s interest payments on the national debt.

For more on how debt shapes the investing landscape, see: Categories of Investment in a High Debt-to-GDP World.

The Return Data: All Five Asset Classes

Here’s how each fixed income asset class performed from 1978 to 2012. CAGR stands for compound annual growth rate (your average yearly return if all gains were reinvested the whole time). Data is sourced from Portfolio Visualizer.

A few things jump out here.

First, the longer the bond, the better it did. Long-term Treasuries at 9.33% beat short-term Treasuries at 6.93% by almost 2.5 percentage points per year. That gap compounds into a huge difference over 34 years. We’ll take a look at this in the section below.

Second, long-term corporate bonds kept up with long-term Treasuries almost exactly. At 9.11%, you got nearly the same return but with slightly more risk that the borrower might not pay you back.

Third, cash was the loser of the group. At 5.37%, it barely beat the growth rate of the money supply. You were earning a return, but you weren’t really building wealth in a meaningful way compared to what longer bonds were doing.

The $10,000 Test

Here’s what $10,000 would have grown to by 2012 if you’d invested it at the start of 1978 in each of these assets.

The gap between cash and long-term Treasuries is striking: $58,800 vs. $196,700.

Even the gap between short-term Treasuries and long-term Treasuries was around $100,000.

Your return all depended on what side of the curve you invested in.

How Bonds Compared to Gold, Inflation, and the Money Supply

Here is each fixed income’s performance compared to three benchmarks: CPI (consumer price inflation), M2 money supply, and gold.

CPI (3.69%): Did You Beat Inflation?

CPI stands for the Consumer Price Index. It’s the government’s official measure of how fast prices are rising. At 3.69% per year over this period, it’s the minimum bar every investor needs to clear just to keep their purchasing power (the ability to actually buy things with your money). I like to call it the increase in the cost of living.

Every fixed income asset in this analysis cleared that bar. Even cash, at 5.37%, beat inflation by more than 1.5 percentage points a year.

So if you were a retiree living off of your bonds, then bonds performed exactly how you wanted them to. You were able to outpace the rate of inflation.

M2 (6.17%): Did You Actually Grow Your Wealth?

M2 is the total amount of money in the economy (cash, checking accounts, savings accounts, and similar deposits). When M2 grows, each dollar you hold becomes slightly less valuable compared to the total pile of dollars out there. Think of it as a second layer of dilution on top of official inflation.

Cash at 5.37% actually fell short of M2 at 6.17%. That means if you just sat in cash or a money market fund, the money supply was growing faster than your savings. You were slowly losing ground even though your balance was going up.

Everything else on the list beat M2. Short-term Treasuries barely edged it out. Long-term Treasuries crushed it by more than 3 percentage points per year.

Each fixed income asset, excluding cash, actually helped grow your wealth during this time period.

Want to understand M2 and what money supply growth means for your money? Read: Analyzing the U.S. Money Supply 1972 to Today.

Gold (6.73%): The Hard Asset Baseline

I use gold as a way to measure dollar debasement. Gold doesn’t increase in value, the dollar loses value. More dollars are needed to purchase an ounce of gold.

Gold returned 6.73% per year during this period. That beats cash. But it trailed every other fixed income asset on the list.

That’s actually not surprising. Gold tends to shine when real interest rates (your interest rate minus inflation) are negative and bonds aren’t giving you much. During the 1978 to 2012 period, bonds were paying real returns. Investors didn’t need to flee to gold. The bond market was working.

For a longer look at how gold has stacked up across different eras, see: Annualized Returns of Major Assets 1972 to Today.

Why the 1980s Bond Boom Can’t Happen Again

This is the part most investment articles skip. They show you the data but don’t tell you why the setup that created those returns is gone.

Volcker’s rate hikes worked because the U.S. government could afford them. At the time, the national debt was a manageable share of the economy. When rates went to 20%, the government’s interest payments went up, but the economy was big enough to handle it.

Today’s situation is very different.

The U.S. national debt is approaching $40 trillion. The annual interest payment on that debt is already over $1 trillion per year. If the Fed raised rates anywhere near 20% today, the interest cost on the national debt would explode.

The government would have to borrow more money just to pay the interest on the existing debt. This would increase the national debt more, leading to more borrowing…rinse and repeat.

This is sometimes called fiscal dominance. It means the government’s debt burden starts to limit what the central bank can do with interest rates. The Fed may want to fight inflation aggressively by raising rates, but doing so would make the debt problem even worse.

So the conditions that created the extraordinary bond returns from the 1980s to 2010s were unique:

• A manageable debt load that gave the Fed full freedom to raise rates
• A starting point of extremely high yields in the early 1980s that investors could lock in
• Thirty years of slowly falling rates that pushed existing bond prices higher

None of those conditions exist today. The debt is too big, rates can’t go that high without blowing up interest payments, and there’s no 30-year falling-rate tailwind waiting in the wings.

For a deeper look at how the national debt shapes investment returns, read: The National Debt: Feature, Not Bug.

What This Means for You

This article is the historical baseline. The 1978 to 2012 period is when bonds worked the way they were supposed to. They paid real returns, beat inflation, and rewarded investors who went further out on the maturity curve.

What came next was something very different. From 2013 to 2020, the Federal Reserve held rates near zero in a policy called ZIRP (zero interest rate policy). The rules changed almost completely.

You can read that analysis here: Fixed Income ETF Performance 2013 to 2020 (The ZIRP Era).

Understanding this history doesn’t mean you should avoid bonds, but it does mean you should have realistic expectations about what bonds can do going forward. The golden era of fixed income was built on a very specific set of conditions which no longer exist.

For a broader view of how different assets have performed across different eras, check out: Asset Class Returns 1986 to Present.

Conclusion

Bond returns from 1978 to 2012 were exceptional by almost any measure. Long-term Treasuries and corporate bonds delivered returns that beat inflation, beat the money supply, and beat gold by a wide margin.

However, they were the result of a specific moment in history: a central bank with full freedom to crush inflation, a manageable national debt, and a 30-year tailwind from falling interest rates.

The country’s fiscal situation today looks nothing like it did then. That’s not a reason to panic about bonds. It is a reason to understand what you’re actually buying when you invest in fixed income, and what it can realistically do for your portfolio going forward.

Frequently Asked Questions

Why were bond returns so high in the 1980s?

Two main reasons. First, Paul Volcker pushed interest rates to nearly 20% in 1981 to fight inflation. Investors who bought bonds at those high rates locked in strong income for years. Second, as rates fell over the following three decades, the value of those existing bonds went up. That combination of high income plus rising bond prices produced outstanding total returns.

What is CAGR and why does it matter?

CAGR stands for compound annual growth rate. It’s the average yearly return on an investment over a set period, assuming all gains were reinvested the whole time. It’s the most useful number for comparing investments over long periods because it smooths out the good years and bad years to show you the underlying growth rate.

Why did long-term bonds outperform short-term bonds?

Long-term bonds are more sensitive to changes in interest rates. When rates fall, long-term bond prices go up more than short-term bond prices. Since rates trended down for most of this period, long-term bonds got the biggest price boost on top of their already higher interest payments.

Could the Fed raise rates to 20% again today?

It’s extremely unlikely. The U.S. national debt is now approaching $40 trillion, and annual interest payments are already over $1 trillion. Raising rates to 20% would cause those interest payments to explode. It would make the debt problem dramatically worse and could trigger a financial crisis. The debt load has effectively become a ceiling on how aggressively the Fed can raise rates.

Should I avoid bonds because of this?

Not necessarily. Bonds still offer stability, regular income, and diversification benefits in a portfolio. The point is simply to have realistic expectations. The 9% annual returns of the 1978 to 2012 era were extraordinary and were tied to conditions that no longer exist.

What happened to bond returns after 2012?

After 2012, the Fed held rates near zero as part of zero interest rate policy (ZIRP). That completely changed what bonds could deliver for investors. The full breakdown is in our Fixed Income ETF Performance 2013 to 2020 analysis.

Sources

• Portfolio Visualizer: Asset Class Return Data
• Federal Reserve Bank of St. Louis (FRED): M2 Money Supply
• U.S. Bureau of Labor Statistics: Consumer Price Index Historical Data