- Jonathan Poyer
Inverted Yield Curves' Impact on Long-Term Performance
Wealth Management (Bond Investors Shouldn’t Gamble on the Inverted Yield Curve | Wealth Management) has a great article on inverted yield curves and longer-term performance.
From the article,
(Bloomberg Opinion) -- Long-term bonds usually pay a higher yield than shorter-term ones to encourage investors to lend for longer. But sometimes the so-called yield curve inverts, as it has now, and short-term bonds offer the highest yield. When that happens, it’s tempting to move money to short-term bonds, or even cash, to grab that extra yield. Now that the yield on cash is nearly 5%, why bother with long-term bonds offering 3.5%?
The answer is that for most bond investors, particularly those who own bond funds, yield is only one component of total return, the other being changes in bond prices. When bond prices decline, total return will be lower than the yield, a reality investors encountered last year when interest rates surged, sending bond prices lower (interest rates and bond prices move in opposite directions). Inversely, rising bond prices add to yield, all of which is confirmed by the fact that bond funds’ yield and total return almost always differ.
If you look at 1981, the 2 year was at a 17% and the 30 year was at a 15%. If you bought the 2 year at 17% it was a great return for 2 years but interest rates declined from there and you weren’t able to reinvest at the same level. If you bought the 30yr at a 15% you were locked in for 30 years plus the total return due to falling interest rates, which made it a significantly better investment over the long term.