Opinion

Felix Salmon

Why bonds aren’t good investments

By Felix Salmon
November 30, 2009

If a home is not an investment, what about a Treasury bond? In my comments, Dan responds forcefully to Urban Legend, who was trying to make the case that low interest rates do a lot of harm to those poor millionaires looking to live on their risk-free interest payments alone:

If you think it is reasonable to get a 5% return on top of inflation without taking risk, I have some oceanfront property in Nevada to sell you. That may have been possible in the past, but we are in a new world now.

Investing is not about loaning your funds out to a government, completely abdicating responsibility for finding meaningful uses for the capital and then expecting a substantial return above inflation. Our governments are nearly bankrupt.

If you lend to a nearly bankrupt and profligate entity, you deserve to lose a lot of money. You are like a bartender serving a drunk who is drinking himself to death. You are not innocent. You are part of the problem, and your investments are making the world worse. You don’t deserve a good return for that.

How to invest? If you really want risk fee, go for TIPs, but don’t expect much beyond inflation. Better yet, learn basics of business and investing and carefully loan out to local small businesses. Or be a landlord, watching your profit and dividends every month. Or invest in important and useful companies via the stockmarket. Or invest in making your house energy efficient. Or invest in your childrens’ and grandchildrens’ educations. Or donate it for research to invest in everyone’s future.

Whine about the Fed if you want. Your treasury buys make all these games possible.

I just made a significant investment in Apple, but I didn’t touch the stock: instead, my house now sports two brand-new computers, and already the returns on those computers are proving higher than I’d anticipated. (Although if you’re in NYC and are willing to trade knowledge of Mac OS X Server for good food and wine, I think I have a deal for you.)

There are lots of ways to invest well, and most of them don’t involve buying securities which rise in value. I often feel that stock-picker types are missing the point, rather — especially nowadays, when the future of the capital markets has never been cloudier.

If you really want to play a game where the person with the best-performing stock portfolio wins, then fine. But other kinds of investing, like for instance Dan’s idea of providing much-needed funds for a small local business, can be more rewarding in other ways. The world of securitization and capital markets turns out not to have been nearly as good at capital allocation as most of us thought it was. So maybe we should go back to making our own real-world investment decisions, rather than trusting in the markets to get it right.

Comments
10 comments so far | RSS Comments RSS

There’s a reason that economists generally distinguish between (A) saving–acquiring financial assets to allow for the redistribution of consumption over time–and (B) investment–purchase of real capital for the purpose of running a business. We’re probably more willing to accept risk in (B) than in (A). So it’s probably appropriate to refer to buying financial assets (bonds, stocks, what-have-you) as acts of saving. And to some of the things to which Dan refers as investment. Contra Dan, if the federal government does actually declare bankruptcy and default, I wouldn’t expect private financial assets to be doing all that well…

Posted by Donald A. Coffin | Report as abusive
 

I think Urban Legend made something close to a personal finance comment and Dan answered it on a different wavelength. Urban wants to know whether something like a million can provide security, Dan says no your goal should be to support my philosophy.FWIW, I think the recent book “A Million Is Not Enough” got it right in the title, less so in the body of the work. Actually though, in the body I believe the author was basically piling on risk because A Million Is Not Enough.The take-away is probably that a million is a meagre endpoint these days, as daunting as that might seem. You need more like $3-5 million if you want to stop taking risks.And of course when you get to the high end of that range you have more freedom to support philosophies … your own, or Dan’s.

 

John –If you have built your plan, as millions have, on reaching “the number” and then coasting risk free after that without ever denting principal, that concept is shot through. Long term bonds have no guarantee of ever ending with a positive return after inflation. T-Bills return as little as 0.01% as Bill Gross noted. Even on 5 million, that will be $500 per year. Good luck with that.So yes, this leaves you with some inevitable philosophical questions. Do you take more risk, as you must if you want a meaningful real return in the markets? Do you find opportunities to invest within the realm of what you can actually control, such as direct stakes in property or local businesses? If you were trying to maintain a pile to bequeath to the grandkiddies do you invest in them now?The government can be a pretty poor substitute for the collective micro-scale investment decisions of millions, and if millions are forced out of treasuries, the effect should be positive.I agree with Donald’s point about savings (A). In a lower return world, it is still reasonable that some mix of financial assets can at least be a good store for savings, hopefully keeping ahead of inflation if not making you rich. As for the United States being bankrupt, it would appear that we cannot pay our debts except in devalued money. Admittedly it’s a different kind of haircut than what emerging markets dish out when debt is denominated in another currency. But creditors don’t enjoy either one.

Posted by Dan Hess | Report as abusive
 

The theoretical “cash rich, but risk adverse” investor could go all TIPS, as long as they are issued. We should just be honest about how high a “number” that plan requires.The potential tragedy for lesser folk, is that they will start that slide to higher risk investing without actually understanding it. It is more likely to be “gut” in this environment than “plan.”On local businesses, is the 90% fail number still good?

 

I think john personna has a great point about small businesses. They are treated in the financial press as some kind of holy grail. I suppose this could be true, but I’m skeptical. To the extent that corporate America is outsourcing business processes to small contractors all they do is cannibalize existing jobs, reduce salaries, and cut benefits. That’s our definition of efficieny.

Posted by Neil D | Report as abusive
 

Thanks for sharing with us.Your blog is very informative.keep posting.. capital loans

 

Konzcal had a post a little while back pointing out Fama claiming Wall Street didn’t believe in efficient markets. Konzcal then built on that to come to the conclusion that for efficient markets to work all the actors really have to believe they don’t. If everyone trusts the market then there won’t be enough people enforcing the will of the market through skeptical investing/purchasing/selling. If I trust that someone else will do the research necessary to correctly price items and everyone else does the same then price no longer reflects anything but individual hunches.Has securitization broken the market?

Posted by zach | Report as abusive
 

I have some good food and wine, Felix. What MacOS knowledge are you prepared to offer for it?

 

“If you have built your plan, as millions have, on reaching “the number” and then coasting risk free after that without ever denting principal, that concept is shot through.”Of course the bigger reason this concept is shot through has nothing to do with technical details of risk-return ratios and inflation probabilities; it has to do with the fact that 99% of all humans are never happy with their situation.Once you have made that $3 million you figured was your number, you look at the people around you and start wondering if maybe you really deserve a house that’s 30% larger, a car that’s 20% fancier, and a wife that’s 60% hotter — you are, after all, not an animal, so why should you live like one, flying coach, or having to buy groceries at Walmart? And so it continues at $30 million and $300 million. Remember all those sob stories a year ago of poor investment bankers who had lost their jobs and had expenses of $100,000 a month to maintain their households.Oh sure, you’ll be one of the 1% that is content; you’re a true Buddhist in your heart, and you have zero interest in comparing yourself to your friends and colleagues. Perhaps — there are a few such people. But I wouldn’t bet on it.There are basically two ways to play this game. You can chase the money for the rest of your life, or you can be really really serious about bailing out — which means, TODAY, living within the restrictions you envisage for the rest of your life; no bullshit about cutting back on expense “when you retire”. If you aren’t serious about that latter, resign yourself to the former — don’t waste your time imagining their is some delusional number that will one day change everything, and doing social damage in the process, telling yourself “just for one more year”.

Posted by Maynard Handley | Report as abusive
 

I think it’s fair to say I got a small egg and bailed out, Maynard. Sometimes I second-guess that, and sometimes I just go for a nice mountain bike ride.By the way, I returned to this comment stream because I saw this as related:“When I hear folks like New York University Professor Nouriel Roubini talk about asset bubbles and “money chasing commodities,” I want to ask, what money? Where is all the money chasing stocks, commodities, high-yield bonds and emerging- market stocks coming from if it’s sitting in banks’ accounts at Federal Reserve banks?Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago, thinks he has the answer: portfolio shifts.“Investors, rather than borrowing dollars, are selling U.S. Treasury securities they own, ultimately to capital- concerned/constrained banks, and are then investing the proceeds in higher-yielding foreign government securities,” not to mention lesser-quality stocks and bonds, Kasriel writes in his Nov. 13 Economic and Interest Rate Outlook.”It’s from Commentary by Caroline Baum, Dec 1, 2009

 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •