Buy long term treasuries in 1981?

[nydad]

I was looking at the following graph:


and asking myself a question - sorry if it's a stupid one. When 30 year treasuries were yielding upwards of 10/11%, why didn't investors just load up on them, and hold them for 30 years? I know inflation was also high, but I find myself wishing for a time machine... For those of you who were investing in those days, what prevented you from buying and holding these bonds (or if you did, how happy are you??). Was it fear that inflation would continue to rise and eat away at the nominal value of those bonds (and result in a negative yield?) - or were equities still more attractive in that environment? I've just never been an investor in high interest rate environments and am wondering about the psychology and decision making in those times...

[mikep]

Why take all the interest and duration risk when savings accounts were paying about the same yield with zero duration risk?

[MN Finance]

And equities were about to start the greatest bull run in history, so the rear view mirror is quite clear.

[MBMiner]

I remember it well managing trusts and investment advisory accounts. The fear was that inflation would become even worse and interest rates would go higher. It's easy to forget the psychology of that era.
Bruce

[Clive]

Taxes. 15% yield, 15% inflation, 33% tax = -5% real. As soon as yields declined, for some it was better to take the capital gains.

[Quasimodo]

I wasn't smart enough (or brave enough!) to buy long term bonds in the early 80's when they were paying double digit returns. For awhile though, our company savings plan offered a guaranteed 11% annual return along with a 50% match for your 401k contribution, so I picked that instead of taking a chance on the bond market. Aetna Life and Casualty was offering that deal, probably so they could invest in junk bonds and earn an even higher return. A friend who had a similar deal where he worked lost his entire savings when the insurance company that underwrote his savings plan went belly up, so I switched to a money market fund instead so I wouldn't have to worry about safety, and still earned 9% for the next year.

Ultra-safe short term treasury bonds actually had double digit returns for a number of years during the 1980s.

Someday we'll look back at today and wonder why we didn't see the investment chance of a lifetime right in front of us, whatever that turns out to be.

John

[livesoft]

When 30 year treasuries were yielding upwards of 10/11%, why didn't investors just load up on them, and hold them for 30 years?

Mostly because 5-year CDs were paying more like 12-16%.

[jsl11]

Even in hindsight, it was better to buy equities than bonds in 1981. IIRC, the DJ industrial Average was somewhere near 600.
Jeff

[statsguy]

We did invest in treasury bonds in 1981 (also in 1980, 1982, 1983) those bonds are now finally reaching maturity. I find myself worrying that with the FED policies I might get a second opportunity in my life to buy treasuries yielding 10+%. From todays viewpoint looking back at those 1981 bonds it looks like a no brainer. In 1981 those bonds were considered really bad since we were seeing inflation go up every month. No one wanted to own a bond earning just 10% when next year the new ones would be earning 12%.

Stats

[nisiprius]

I didn't actually consider anything like that, but if I had, I'd have been afraid to lock in a 10-11% rate. Who knew how much higher inflation and interest rates might go?

[MBMiner]

Even in hindsight, it was better to buy equities than bonds in 1981. IIRC, the DJ industrial Average was somewhere near 600.
Jeff

No, it was higher than that in 1981. DJIA began the year at 972 and ended at 875.
Bruce

[Watty]

For those of you who were investing in those days, what prevented you from buying and holding these bonds ...

I didn't have any money to speak of and I was trying to save up the downpayment for my first house.

As I recall the big push back then was to hurry up and get a mortage to lock in the double digit mortage interest rates before they got even higher.

Bonds were considered very risky back then because people had gotten burned badly holding low interest rated bonds when inflation and interest rates went up.

[peppers]

For those of you who were investing in those days, what prevented you from buying and holding these bonds ...

I didn't have any money to speak of and I was trying to save up the downpayment for my first house.

As I recall the big push back then was to hurry up and get a mortage to lock in the double digit mortage interest rates before they got even higher.

Bonds were considered very risky back then because people had gotten burned badly holding low interest rated bonds when inflation and interest rates went up.

We bought our house in 1983, 30 year fixed @ 12.25%...and the first born male.

[bobcat2]

LT bonds were a very good deal in 1981 and were a better deal than stocks over the next 30 years. But at such high interest rates in '81 that there was a lot of reinvestment risk, which did come to fruition over the 30 year period. You certainly have not been able to reinvest those coupon payments at anything like 11% over the last 20 years and thus the total return on the bonds has been much less than 10%.

Now had you been able to buy zero coupon LT Treasuries in 1981 that would really have been a sweet deal. But, IIRC, they were as scarce as hen's teeth in the early 80s.

BobK

[SSSS]

Yes, if you actually have the means to do so, I would consider buying long term treasuries in 1981 to be a wise investment move. The biggest risk would be for investors not yet born in 1981, who might butterfly effect themselves out of existence.

[joe8d]

i did get a 15% 3 year CD for my IRA back then.

[nydad]

I didn't actually consider anything like that, but if I had, I'd have been afraid to lock in a 10-11% rate. Who knew how much higher inflation and interest rates might go?

I guess I'm trying to understand the psychology here. Several posters have noted that savings accounts also had high yields, so no need to risk a 30-year term. However, a savings account doesn't guarantee that yield for 30 years!

And in the case above, if you had locked in a 10% rate for 30 years, even if interest rates do rise above that, what does it matter? if you buy and hold till maturity, you get your 10% - why does it matter if you miss the top?

Now, if you're afraid inflation would continue to go higher and stay above 10% for 10/20 years or so I could understand that, but I don't understand why one wouldn't have wanted to lock in historically high interest rates guaranteed - even if they weren't at the (eventual) top...

[bobcat2]

Hi nydad,
You wrote.

And in the case above, if you had locked in a 10% rate for 30 years, even if interest rates do rise above that, what does it matter?

LT bonds were a very good deal in 1981 and were a better deal than stocks over the next 30 years. But at such high interest rates in '81 that there was a lot of reinvestment risk, which did come to fruition over the 30 year period. You certainly have not been able to reinvest those coupon payments at anything like 11% over the last 20 years and thus the total return on the bonds has been much less than 10%.

Now had you been able to buy zero coupon LT Treasuries in 1981 that would really have been a sweet deal. But, IIRC, they were as scarce as hen's teeth in the early 80s.

BobK

This is the point of reinvestment risk. You didn't get 10% or 11%. With coupon bonds the total return is not locked in as you seem to think it is. When those coupons came due and you reinvested those coupons in those same Treasuries they were not yielding 10%, but something smaller than that. And in the last several years the reinvested coupons were yielding a lot less than 10%. The total return of those Treasuries over the 30 years was probably in the range of 8% to 8.5%. That's a handsome 30 year total return, but it is not 10-11%.

As I noted previously the only way you could have locked in the 10-11% returns was with 30 year zero coupon bonds in 1981. Unfortunately, there were either very few or none of those available to individual investors in 1981.


* Definition of reinvestment risk
The risk that future coupons from a bond will not be reinvested at the prevailing interest rate when the bond was initially purchased. Reinvestment risk is more likely when interest rates are declining. Reinvestment risk affects the yield-to-maturity of a bond, which is calculated on the premise that all future coupon payments will be reinvested at the interest rate in effect when the bond was first purchased. Zero coupon bonds are the only fixed-income instruments to have no reinvestment risk, since they have no interim coupon payments.

It is common for neophyte investors to have difficulty understanding this.

BobK

[atfish]

Did not have extra monies for bonds nor CDs.

[Bonnan]

Ah! 1981 I remember it very well. In the prime of my career at 45, making good money and the steel industry collapses and I lose my Job. Took my qualified money and invested it at 11% in an IRA Annuity for next 25 years. Without a job at the time I did it more on emotional factors than rational thinking. Turned out to be the best investment in my lifetime. Note that bond rates went up from 1960 to 1981 and down from there.

[WendyW]

When 30 year treasuries were yielding upwards of 10/11%, why didn't investors just load up on them, and hold them for 30 years?

My dad did. Not because he was a clever investor, but just because he was lucky.

30 years later, he's still talking about his best investment ever.

[Wagnerjb]

The fear was that inflation would become even worse and interest rates would go higher. It's easy to forget the psychology of that era.
Bruce

Yes, it is very easy to forget (or not be aware of) the psychology of the era. I guess that helps the rear view mirror look a lot clearer. The question reminds me of one I saw several years ago at Morningstar. Somebody noted that Russian equity mutual funds had done fabulous over a 5 period, and was wondering why so few people had invested in them 5 years ago. When you looked it up, you saw that the beginning of the 5-year period was when the Russian economy almost imploded in the Asian Currency crisis (or near that time), and their stock market had plunged something like 85%. It would have taken some serious fortitude to invest in Russian equities at that time......but in hindsight it seemed like such an obvious outperformer

Best wishes.

[BBL]

but I find myself wishing for a time machine...

Well, nydad if I can ever get the flux capacitor working on the DeLorean we'll take a cruise back to 1981 and you can load-up on those long treasuries - I'll make a stop at my full service broker and grab a round lot of BRKA while I wait for you. Sound good?

[nydad]

As I noted previously the only way you could have locked in the 10-11% returns was with 30 year zero coupon bonds in 1981. Unfortunately, there were either very few or none of those available to individual investors in 1981.

Ah ok, I see your point - thanks and I realize I wasn't thinking this through fully. So you do get 10% guaranteed, but just on the original balance of the bond - so the overall CAGR is less than 10% due to reinvestment at lower rates.

[bobcat2]

Ah ok, I see your point - thanks and I realize I wasn't thinking this through fully. So you do get 10% guaranteed, but just on the original balance of the bond - so the overall CAGR is less than 10% due to reinvestment at lower rates.

Yes - unless it is a zero coupon bond.

If you look at your original chart you can see that the reinvestment rates from 2000 on were a great deal lower.

The prudent investor in 1981 would have realized that there were two opposing risks in buying LT bonds. On the one hand, there was interest rate and inflation risk if inflation accelerated or even stayed high. OTOH, if inflation decelerated there was going to be reinvestment risk as interest rates fell. In either case the real total return on these bonds if held to maturity were unlikely to be as high as 7% and could be much lower than that.

What actually happened is that inflation declined and the reinvestment risk materialized as interest rates fell dramatically over time. LT 30 year bonds from 1981 with 11% coupons probably had real total returns of between 5%-6% if held to maturity. A result that would not have surprised 1981's prudent investor.

The above doesn't mean the 1981 LT bonds weren't a good deal, but they weren't as great a deal as you thought they were.

BobK

[baw703916]

Essentially, buying 30 year Treasuries in 1981 was a bet that Volker's "whatever it takes" policy on interest rates would be able to get inflation under control. It did, and so that bet turned out great in hindsight. But at the time, there had been various policy measures over more than a decade which had tried to do this (remember "W.I.N. (whip inflation now)"?) and the record of success was pretty dismal. So not too obvious at the time.

For myself in 1981, college tuition (to the extend I could contribute) seemed like a much more important investment. It is still paying dividends, even though the 1981 30 year Treasuries have matured.

[bobcat2]

Another thing to keep in mind is that in 1981 401k accounts were just starting and few people had them. IRAs had begun in the late 1970s and few people had them and even fewer had any substantial room in their IRAs to place large bond holdings. So in 1981 most individual investors would have had to purchase any substantial amount of LT bonds in a taxable account. So the 30 year total real return on the bonds held to maturity before taxes was probably between 5% and 6%. But the after tax total real return of these bonds held in a taxable account to maturity would have only been about 4% real and perhaps less than that.

To put it another way, 1981 thirty year Treasuries held to maturity had higher before tax total returns than investing in the stock market over the 30 years. If both the Treasuries and the equities were held in taxable accounts over the 30 years, it is not clear which had the higher after tax total returns. It may have depended on the investors marginal tax rate.

LT bonds with coupons of 10% or 11% are throwing off a lot of taxable income every year.

BobK

[alec]

Bobk,

Although there were tax deferred bond like savings vehicles like fixed deferred annuities and E/EE bonds, both had similar re investment risk - just look at the savings bonds rates from the early 1980's on. My grandfather used the fixed deferred annuities and used to remind us every visit that said insurance company was paying for our trip and dinner.

[bobcat2]

Bobk,

Although there were tax deferred bond like savings vehicles like fixed deferred annuities and E/EE bonds, both had similar re investment risk - just look at the savings bonds rates from the early 1980's on. My grandfather used the fixed deferred annuities and used to remind us every visit that said insurance company was paying for our trip and dinner.

Hi Alec,

One would think that nearly all highly rated LT fixed income securities (particularly securities backed by the US government) that did not have reinvestment risk would have been good investments in 1981. And even better if, like US Savings Bonds, they had tax advantage properties.

Personally I think the important idea that comes out of this thread is that many people ignore and perhaps don't understand reinvestment risk. Whether it is prudent for people who don't understand reinvestment risk to be investing on their own is a very good question IMO.

BobK

[555]

I don't get this "reinvestment risk". When you get the coupon payments you just reinvest them in more 1981 treasuries.

[baw703916]

I don't get this "reinvestment risk". When you get the coupon payments you just reinvest them in more 1981 treasuries.

You'll have to pay quite a bit more than face value for them!

[bobcat2]

I don't get this "reinvestment risk". When you get the coupon payments you just reinvest them in more 1981 treasuries.

Yes, but if interest rates have fallen the 1981 bonds are now selling at a premium, above the $1,000 face value you bought them at the auction in 1981. So the yields on the reinvested coupons are today's yields - not the coupon yields you originally purchased the bonds at.

As a simple example lets assume the original coupon rate is 10% and interest is paid just once a year to keep this simple. If interest rates have fallen 2 years later you buy more bonds not at $1,000 but rather at a premium price of say $1,250. But the new bonds will still pay $100 in interest once a year - not 10% of your $1,250 purchase price.

Bond prices fluctuate on the secondary market to reflect changes in interest rates.

BobK

[555]

I don't get this "reinvestment risk". When you get the coupon payments you just reinvest them in more 1981 treasuries.

"Yes, but if interest rates have fallen the 1981 bonds are now selling at a premium, above the $1,000 face value you bought them at the auction in 1981. So the yields on the reinvested coupons are today's yields - not the coupon yields you originally purchased the bonds at.
As a simple example lets assume the original coupon rate is 10% and interest is paid just once a year to keep this simple. If interest rates have fallen 2 years later you buy more bonds not at $1,000 but rather at a premium price of say $1,100. But the new bonds will still pay $100 in interest once a year - not 10% of your $1,100 purchase price.
Bond prices fluctuate on the secondary market to reflect changes in interest rates. BobK"

Wait! You're missing something obvious. You reinvest the coupon payments in more 1981 treasuries in 1981.

[bobcat2]

I don't get this "reinvestment risk". When you get the coupon payments you just reinvest them in more 1981 treasuries.

"Yes, but if interest rates have fallen the 1981 bonds are now selling at a premium, above the $1,000 face value you bought them at the auction in 1981. So the yields on the reinvested coupons are today's yields - not the coupon yields you originally purchased the bonds at.
As a simple example lets assume the original coupon rate is 10% and interest is paid just once a year to keep this simple. If interest rates have fallen 2 years later you buy more bonds not at $1,000 but rather at a premium price of say $1,100. But the new bonds will still pay $100 in interest once a year - not 10% of your $1,100 purchase price.
Bond prices fluctuate on the secondary market to reflect changes in interest rates. BobK"

Wait! You're missing something obvious. You reinvest the coupon payments in more 1981 treasuries in 1981.

Yes - I believe you understand it perfectly now.

BobK

[baw703916]

Better get the Delorean working!

[555]

"Yes, if you actually have the means to do so, I would consider buying long term treasuries in 1981 to be a wise investment move. The biggest risk would be for investors not yet born in 1981, who might butterfly effect themselves out of existence."

Right. This is more of a concern than "reinvestment risk".

[Spirit Rider]

One thing to keep in mind. Unlike now, in 1981 30 year Treasuries were callable. Most if not all were called when interest rates went single digits.

[Valuethinker]

One thing to keep in mind. Unlike now, in 1981 30 year Treasuries were callable. Most if not all were called when interest rates went single digits.

This is exactly what I remember.

Someone here challenged me on that and I couldn't provide a persuasive reference.

Do you have one?

[Valuethinker]

I was looking at the following graph:


and asking myself a question - sorry if it's a stupid one. When 30 year treasuries were yielding upwards of 10/11%, why didn't investors just load up on them, and hold them for 30 years? I know inflation was also high, but I find myself wishing for a time machine... For those of you who were investing in those days, what prevented you from buying and holding these bonds (or if you did, how happy are you??). Was it fear that inflation would continue to rise and eat away at the nominal value of those bonds (and result in a negative yield?) - or were equities still more attractive in that environment? I've just never been an investor in high interest rate environments and am wondering about the psychology and decision making in those times...

Short term interest rates were running 20% (Canada Savings Bonds paying 21% that year).

In the previous 30 years anyone holding long bonds had been *destroyed*.

It's like all those charts in 2000 showing that Stocks in the Long Run were a no brainer. The last 13 years has been anything but no brainer.

People are backward looking. We didn't believe the Fed, the Bank of Canada and the Bank of England would get inflation under control. That was the year (1982) that B of E introduced inflation linked bonds (indexed linked gilts). There were predictions of Israeli style hyperinflation.

Look right now we have seen the re-emergence of '100 per cent. equities' threads. What does that tell you about the backward looking nature of human foresight?

[Valuethinker]

I don't get this "reinvestment risk". When you get the coupon payments you just reinvest them in more 1981 treasuries.

"Yes, but if interest rates have fallen the 1981 bonds are now selling at a premium, above the $1,000 face value you bought them at the auction in 1981. So the yields on the reinvested coupons are today's yields - not the coupon yields you originally purchased the bonds at.
As a simple example lets assume the original coupon rate is 10% and interest is paid just once a year to keep this simple. If interest rates have fallen 2 years later you buy more bonds not at $1,000 but rather at a premium price of say $1,100. But the new bonds will still pay $100 in interest once a year - not 10% of your $1,100 purchase price.
Bond prices fluctuate on the secondary market to reflect changes in interest rates. BobK"

Wait! You're missing something obvious. You reinvest the coupon payments in more 1981 treasuries in 1981.

And it was just about that time (1978?) that Merrills invented the stripped US Treasury Bond (Tigers and something).

Basically strip the bond into coupons (Interest Only - IO) and Principal repayment (PO). Sell them separately, with the security that a custody vehicle (depositary receipt) still holds the underlying bond.

So what you bought in 1981 was the 30 year Zero Coupon Treasury - you bought the PO. Yield to Maturity of 13% to 2010.

And you were a very brave soul to have so done. Brave or a gambler .

[Valuethinker]

I was looking at the following graph:

and asking myself a question - sorry if it's a stupid one. When 30 year treasuries were yielding upwards of 10/11%, why didn't investors just load up on them, and hold them for 30 years? I know inflation was also high, but I find myself wishing for a time machine... For those of you who were investing in those days, what prevented you from buying and holding these bonds (or if you did, how happy are you??). Was it fear that inflation would continue to rise and eat away at the nominal value of those bonds (and result in a negative yield?) - or were equities still more attractive in that environment? I've just never been an investor in high interest rate environments and am wondering about the psychology and decision making in those times...

BTW it was even more blindingly 'obvious' that you should have gotten out of CDs paying double digits, and gone into stocks-- you'd have made over 10x your money by now.

[plats]

One thing to keep in mind. Unlike now, in 1981 30 year Treasuries were callable. Most if not all were called when interest rates went single digits.

This is exactly what I remember.

Someone here challenged me on that and I couldn't provide a persuasive reference.

Do you have one?

According to the Securities Industry and Financial Markets Association: "In fact, the U.S. Treasury has not issued “callable” securities since 1985."

http://www.investinginbonds.com/learnmo ... d=25&id=99

[BBL]

Better get the Delorean working!

Don't I know it!

[Levett]

"When 30 year treasuries were yielding upwards of 10/11%, why didn't investors just load up on them, and hold them for 30 years?"

I fear my response will disturb the Bash the Broker types, but here--in brief--is my true story.

In 1981 I came into what then was regarded as a goodly amount of money. I used a BROKER (RIP: Richard Deron Seahawk) who knew I wanted to fund the education of 3 children. He used the entire sum to buy zero coupon Treasuries + AAA munis--all yielding double digits.

As each child neared college age, we started liquidating the bonds. Every kid went through college debt free and received a nice sum after graduation--all due to the smarts of one broker who had the best interests of the kids in mind and refused to allow their father to fritter away the money.

The last of the money was liquidated in 1993 when the the final child began university. And this is why I didn't "hold them for 30 years," but the benefits of the university education carry on to the present day--thanks to one man (not me).

Lev

P.S. As I recall (and some veterans who post here may recall as well), good old Gummy's wife told him to grab the high payout of SPIAs in the 90s and Gummy never looked back! This, of course, suggests that some insurance companies did, indeed, buy and hold.

Lev

[leo383]

30 years from now, there will be investors looking at us and asking why we didn't see the obvious.

[Y]

I had purchased real estate in early sixties as investment and paid it off with mucho inflated dollars in seventies . Hind sight only teaches you what can happen not what will happen as so many people assume when it comes to investing. You need to educate yourself as much as you can and then decide what path your going to take and then you will need the luck of timing. Because the luck of timing in life still dictates the outcome of most things . The future cannot be predicted and that includes the timing so that leaves you with luck as a big factor as how your choice of investments will perform.

[l2ridehd]

I really felt I had a plan that was no fail. I had a job move in 1981 at the worst possible time and my home interest rate was 17%. I also bought two 10K 7 year cd's at 15.5%. About a year or so later when rates dropped I did a refinance on the home. I remember saying to the bank, just leave the payment the same as I am used to making it and drop the term. The term went from 29 years remaining to 11 years. I cant recall the new interest rate, maybe 8 or 9%, something like that. But boy was I happy with those cd's. Another job move in 1984 and the rates were under 6% so I thought buy the biggest house possible. Unfortunately I was in Buffalo NY and homes did not appreciate because of the closing of Bethlehem Steel. My next move went from Buffalo to Ramsey NJ and a 5500 sq foot new home in Buffalo went to a 2000 sq foot 40 year old home in NJ and I had to add another 150K to the mortgage. One year later moved again and made a 45% return on that home. And the person who bought it to tear it down and build two new homes because of the large lot. In a matter of 8 years I had a real estate and financial education that taught me a lot of valuable information. So today I firmly believe that the Government deficit spending will at some point repeat those lessons with much higher unemployment, interest rates and inflation. The trick is know when it will happen and be positioned to take advantage of the inevitable changes.

[Levett]

"The trick is know when it will happen and be positioned to take advantage of the inevitable changes."

I have found that the "trick," if there really is one, is to be lucky. But we like to think we are clever.

Lev

[nisiprius]

"The trick is know when it will happen and be positioned to take advantage of the inevitable changes."

I have found that the "trick," if there really is one, is to be lucky. But we like to think we are clever.

Lev

+1.

The absolute devil of it is that as far as I can tell all investment histories are best described as "episodic." That may be, and probably is, the after-the-fact pattern that we superimpose on it. But the point is that there are huge differences from one twenty-year period to another. The idea that everything settles down and stabilizes to some mean over periods like twenty or thirty years is completely bogus. That means that our personal investing results are averages over, effectively, just a couple of samples, and even the vaunted CRSP data only amounts to maybe half-a-dozen independent, non-overlapping samples.

One can no more talk about the average bear market than one can talk about the average war.

[555]

"30 years from now, there will be investors looking at us and asking why we didn't see the obvious."

Could you please be more sepcific about what will be obvious 30 years from now?