Once Upon A Time Bonds Were Cool For A Bit!

Sometimes Bonds Deserve a Moment of Love!

This might seem a bit ironic for us to state considering one of the main themes at Genvest when it comes to investing is equity but once upon a time bonds were actually cool. However, they were really only the cool kids on the block for a short period of time until equity took back the throne which is Why Equity is King historically. 

The story of how fixed income (bonds) was able to temporarily dethrone equity begins with an economic concept called stagflation. This was kind of a big deal during the late 70’s and early 80’s and the most appropriate measure to combat hyperinflation was by having the Federal Reserve Bank (US Central Bank) raise interest rates substantially. 

Something that is occurring as of 2022-23 again with inflation taking off to new highs not seen in decades. 

Why Raise the Rates?

We are now venturing into the role of the Federal Reserve and it will not hurt to understand “The Fed” a bit as an investor.  When the economy is running hot and inflation starts to pick up, the Fed will restrict the money supply in the system by increasing the cost of borrowing (rates). 

The cost of borrowing is actually the definition of an interest rate. On the contrary, when the economy is sluggish the Fed will decrease interest rates so the money supply increases in order to ignite economic activity. 

Think about it like this, as a coach it is sometimes best to slow down or pull your best players out of the game so they do not end up hurting themselves. In some instances, your best player just might need a little motivation to get their confidence back and start moving forward again. 

The situation in the late 70’s and early 80’s was very unique since inflation peaked at 14.8% with an unemployment rate of 7.2%. The Fed Funds Rate hit 20% in response to the inflation rate.

How did this make Bonds Cool for a Bit?

To understand how this helped bonds take the spotlight from equity for a moment it is important to understand what the Fed Funds Rate is and how it plays into the yield (return) on bonds. 

Let us keep it simple but the Fed Funds Rate is essentially the standard interest rate set for the economy as a whole which is why it has such a direct impact. 

This rate is determined by the FOMC (Federal Open Market Committee) and as mentioned earlier is set based upon various economic indicators or the current state of the economy. 

Important note, this standard rate is not directly enforced so rates will still differ but by and large should not fall too far away from this. Thus, bonds became king for a short period of time with a Fed Funds Rate of 20%. This means you could be getting a 20% return on Government Bonds and for Corporate Bonds the return could be even higher. 

Remember, with a bond you as the investor are actually a lender to the entity. They will pay you a coupon annually(the rate) on the invested principal and on a maturity date return the invested(lent) principal in full back to you. They also call this an IOU (Kind of like I owe you!)

GenVest QuickTake

Equity(common stock) has historically proven to be the most rewarding investment product for investors over the years providing superior returns. Even though rates were at all time highs during the early 80’s, electing to stick it out with equity still would have provided you with a higher return on investment than bonds being issued at this time. 

While fixed income is considered a safer investment, the upside is limited unlike equity because fixed income is well fixed. This means that when issued at par ($100/$1,000) your fixed payment (coupon) is already predetermined and no entity will reward you extra when they are doing well financially. 

Equity allows you to reap the benefits when a company is doing very well with unlimited upside but also will hurt you on the downside.

When it comes to protecting against inflation, it is important to remember that investing in equity does a better job of fighting inflation from eating away at your cash because of The Wonders of Compound Return. 

Fixed Income does not hold this feature and falls subject to what investment professionals refer to as real interest rates vs nominal interest rates. Let us make this simple for you.

• Mr. Nominal says, “Hey there, this bond will pay a 5% coupon rate annually until its maturity date!”

• Mr. Real says, “Hey there, hate to be the bearer of bad news but do not forget inflation here. Truth is you are really only going to get a 3% coupon rate with inflation running at 2% annually.”

Mr. Real gives you the real breakdown and further confirms why equity is the better investment over the long-term. 

If bonds are being issued at rates of 15%-20%, we will give you a pass if you elect to invest in bonds as opposed to equity because this has historically been rare. 
Genvest hopes all in all you will consider The Mighty S&P and begin your venture into equity investing but it all boils down to what you as investor are most comfortable with when it comes to investing.