Fixed Income Returns: Bonds vs. Inflation & M2 (1986-2024)
Fixed income investments are important to analyze because they are a key component of the global financial system and of individual investor’s portfolios.
Financial managers typically recommend an allocation to fixed income such as bonds because they offer a guaranteed return and are supposed to protect your portfolio if stocks go into a downturn.
One of the most recommended portfolios for long term investors is the 60/40 portfolio.
The 60/40 portfolio (60% equities, 40% bonds) is a classic investment strategy that tries to capture the long term growth of stocks while balancing it with the stability that bonds bring.
Fixed income is also used by people close to or in retirement.
If you are only a few years away from retirement, it might be too risky to be solely invested in equities. Fixed income offers diversification in a portfolio.
This article will examine common US fixed income investments and compare their returns to Consumer Price Inflation (CPI) and the M2 Money Supply.
By doing this, we can get a better understanding of the real returns of fixed income over the years.
- What Are Different Types of Fixed Income?
- US Fixed Income CAGR Analysis (1986 – 2024)
- Real Returns: Fixed Income CAGR vs. Inflation (CPI) CAGR
- Wealth Creation vs. Wealth Dilution: Fixed Income CAGR vs M2 Money Supply CAGR
- Important Caveat: The 40 Year Bond Market
- Conclusion: Are Bonds Good For Long Term Investors?
Note: Cash and the 10 Year Treasury can be analyzed since 1972, but they were the only fixed income choices that had available data then. I chose to start in 1986 because there was more data for me to analyze.
What Are Different Types of Fixed Income?
My analysis focuses on seven different types of fixed income investments.
- Cash
- Short Term Treasuries
- 10 Year Treasury
- Long Term Treasuries
- Short Term Investment Grade
- Long Term Investment Grade
- High Yield Corporate
Cash and Cash Equivalents (Treasury Bills)
Cash doesn’t refer to the dollar bills in your wallet. In fixed income terms, it refers to holding 3 month treasury bills issued by the US government.
3 month treasury bills are also known as “cash equivalents” because they are very short term, extremely liquid, and not very sensitive to interest rate changes.
US Treasury Bonds (Short, 10 Year, and Long Term)
Short Term Treasuries have maturities of about two years. They should have higher yields than cash, but they also have more risk.
The 10 Year Treasury has a maturity of 10 years. They should have higher yields than Short Term Treasuries and Cash, but are risker than both.
Long Term Treasuries have maturities of 20 to 30 years. They should have the highest yields offered by the US government because they carry the most risk.
Investment Grade and High Yield Corporate Bonds
Investment Grade and High Yield Corporate Bonds are different than bonds offered by the US government. Corporations always have the risk of going bankrupt and not being able to pay back the money you lent them.
The United States will always pay back your money at the end of your bond’s duration (if they can’t then we have bigger problems to worry about).
Because of this, bonds offered by companies carry more risk than bonds offered by the US government.
Here are the different types of fixed incomes offered by companies.
Short Term Investment Grade bonds are offered by strong companies with credit ratings of BBB or higher. These bonds have maturities of 1 to 5 years.
Long Term Investment Grade bonds are offered by strong companies with credit ratings of BBB or higher. These bonds have maturities of 10 to 30 years.
High Yield Corporate bonds are offered by companies that have a greater risk of default. They have credit ratings of BB or lower. These bonds have maturities of 1 to 10 years.
US Fixed Income CAGR Analysis (1986 – 2024)
All fixed income investments had a positive nominal CAGR from 1986 to 2024. This meant that your investment did not lose any money throughout the years.
Performance Ranking by Best CAGR
High Yield Corporate (6.94%), Long Term Investment Grade (6.77%), and Long Term Treasuries (6.33%) had the best performance from 1986 to 2024.
The 10 Year Treasury (5.64%), Short Term Investment Grade (4.88%), and Short Term Treasuries (4.23%) followed.
Cash (3.17%) had the lowest return.
Growth of $10,000: Compound Interest in Action
Here’s what $10,000 invested into each fixed income asset would have returned after 38 years with the specific CAGR.
I’ll always note that the percentage differences in CAGRs might not seem like a lot, but when you compound them, the differences begin to show.
For example, let’s compare Short Term Treasuries to Long Term Treasuries.
Short Term Treasuries had a CAGR of 4.88% with a dollar nominal return of $48,275.
Long Term Treasuries had a CAGR of 6.33% with a dollar nominal return of $120,523.
That 1.45% difference in CAGR accounted for a difference of $72,248!
Real Returns: Fixed Income CAGR vs. Inflation (CPI) CAGR
We went over the nominal returns of US fixed income, but now compare it to the Consumer Price Index (CPI) CAGR. This will give us a better idea of how holding fixed income assets did against consumer price inflation.
The CAGR of the Consumer Price Index (CPI) from 1986 to 2024 was 2.81%.
This means that the cost of surviving increased by 2.81% per year.
All US fixed incomes outperformed CPI from 1986 to 2024.
High Yield Corporate (4.13%), Long Term Investment Grade (3.96%), and Long Term Treasuries (3.52%) performed the best.
Cash (0.36%) barely outpaced the increase in CPI.
These are great numbers for people in retirement or living off of fixed incomes. No matter what fixed income asset you invested in, you were able to keep up with the increase in costs measured by CPI.
That’s how bonds should be viewed. In an ideal world, you’d want to invest in assets that grow your wealth over time and then live off of your fixed income investments.
Wealth Creation vs. Wealth Dilution: Fixed Income CAGR vs M2 Money Supply CAGR
Fixed income outperformed CPI, but let’s look at how it did compared to the M2 Money Supply.
The M2 Money Supply CAGR from 1986 to 2024 was 5.59%. This means that the dollar was diluted by 5.59% per year.
Here’s how each fixed income class did compared to the M2 Money Supply.
Comparing Fixed Income CAGR vs. M2 Money Supply CAGR tells a different story than when we compared it to CPI.
Fixed income wasn’t a great way to grow wealth from 1986 to 2024.
High Yield Corporate (1.27%), Long Term Investment Grade (1.10%), and Long Term Treasuries (0.66%) were the only bonds that were able to outperform the CAGR of the M2 Money Supply.
These assets were able to grow wealth, albeit slightly more than M2.
10 Year Treasuries (-.03%), Short Term Investment Grade (-.78%), Short Term Treasuries (-1.44%), and Cash (-2.50%) increased in nominal terms over the years, but they did not keep up with money printing.
These assets did not create any real wealth over time.
Important Caveat: The 40 Year Bond Market
While US fixed income was able to give positive nominal returns and keep up with CPI, there’s a very important caveat to mention.
After the United States got rid of the gold reserved in 1972, inflation became a problem.
Typically, when inflation rises out of control, the Federal Reserve raises interest rates. If interest rates are high, people are more likely to save rather than spend. Less spending means prices don’t increase as fast.
In the early 1980s, the Federal Reserve raised interest rates to as high as 19%!
At the start of 1986 (when my data collection and analysis began), the Federal Funds Rate was 8.14%.
The 10 Year Treasury was yielding 7.22% at the beginning of 1986.
Basically, fixed income was in a once in a lifetime situation from 1986 to 2024. The Federal Funds Rate has never been that high since the 1980s.
Why There Won’t Be Another Bond Bull Market
The Federal Reserve was able to raise interest rates that high because the US Debt to GDP was more manageable at 33% in 1980. Today, US Debt to GDP is over 120%!
In 2024, the US Government paid $880 billion in interest payments for the national debt.
The interest rate on the national debt was at 3.32%.
If the Federal Reserve raises rates, or keeps them high, then the interest rate on the national debt increases. This worsens the deficit the US is already in, and forces the US Government to borrow even more money just to pay the interest on the debt!
It’s very important to look at the analysis with this in mind because I don’t think fixed income will ever do this well again.
Yields on US Treasuries (specifically Cash and Short Term Treasuries) can’t go too high because it would send the US further into a debt spiral.
Long Term Treasuries aren’t as influenced by the Federal Funds Rate, so we could see an instance where short term yields decrease while long term yields increase. It’s just something to keep an eye on.
Conclusion: Are Bonds Good For Long Term Investors?
Because of all this, it’s hard to agree with the classical wisdom of keeping bonds in a portfolio if you are investing for the long term.
From my previous analysis, we know that the M2 Money Supply CAGR is 6.63% since the ending of the gold standard.
The issues with the national debt will force the Federal Reserve to keep interest rates low. There’s no way that US Treasury yields (at least short to intermediate term) will be anywhere near 6.63%.
Long Term Treasuries have the potential to have higher yields because investors might demand higher yields if the Federal Reserve has to cut interest rates to keep the debt manageable.
My outlook on bonds will change as I get closer to retirement, but for now I’m going to invest in assets that can create real wealth.
Overall, fixed income is still important to analyze.
Bonds aren’t going to create real wealth like other asset classes, but they are still great for people nearing or in retirement.