Getty Images

Investors have short memories. Our recollections about five years ago are hazy. Ten years, and lessons are forgotten. Thirty years ago might as well have been the Big Bang.

Bonds have been in a 30-year bull market, so even some of the most grizzled professionals haven't experienced a prolonged period of pain. But history doesn't forget. The bond market has been here before. And it didn't end well.

Interest rates were kept incredibly low in the 1940s and 1950s to help manage the national debt after World 2. Ten-year Treasury bonds yield almost the exact same today as they did in 1950.


What happened to Treasuries after that? Those who held to maturity received their principal back. But inflation eroded all of the value of interest payments, and then some. And as interest rates rose in the 1970s, the value of existing bonds plunged. The result in real (inflation-adjusted) terms was three decades of sheer misery:

Average annual real returns

Period

10-Year Treasuries

30-Year Treasuries

Corporate Bonds

1950-1959

(1.80%)

(2.67%)

(2.02%)

1960-1969

0.23%

(1.96%)

(1.90%)

1970-1979

(1.19%)

(3.40%)

(1.88%)

Source: Deutsche Bank Long-Term Asset Return Study.

These losses might seem small, but they add up fast. $100 invested in 10-year Treasury bonds lost 40% of its value in real terms by the early 1980s:

Source: NYU, Federal Reserve, author's calculations.

Inflation was out of control in the 1970s and early 1980s -- that wasn't a normal period by any means. But even before the inflation spike, those who purchased Treasuries in 1950s went 20 years without earning a penny in real terms. That's what you get for buying when rates are so low.

Short-term bonds might still make sense for those who need ready access to their money. For all else, the last century gives us a reasonable set of expectations going forward: Bonds are possibly a way to maintain the value of your assets, almost certainly not a way to grow them, and potentially a way to lose a lot of them.

Interest rates have risen over the last month, offering a taste. Pimco High Income Fund is down 10% in the last month. The Vanguard Long Term Corporate Bond Fund lost 4.6%. Mortgage REITS sensitive to the same interest rate risk have been pummeled; Annaly Capital Management shares are off by one-fifth over the last year.

How bad can this get? It can't be stressed enough that we have no idea. Many investors thought Japanese bonds were toast in the early 1990s. Twenty years and dozens of ruined careers later, we're still waiting for the crash.

But when interest rates are this low, the best-case scenario becomes not getting hurt, and getting hurt becomes pretty likely.

If you're on the lookout for high-yielding stocks, The Motley Fool has compiled a special free report outlining our nine top dependable dividend-paying stocks. It's called "Secure Your Future With 9 Rock-Solid Dividend Stocks." Just click here.

The article Bonds: We've Seen This Movie Before. It Doesn't End Well originally appeared on Fool.com.

Fool contributor Morgan Housel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


Increase your money and finance knowledge from home

Asset Allocation

Learn the most important step in structuring an investment portfolio.

View Course »

Introduction to Value Investing

Are you the next Warren Buffett?

View Course »

Add a Comment

*0 / 3000 Character Maximum

1 Comment

Filter by:
wayne0213

PHK has NOT missed a monthly pay day in 10 years. This is just as important as the value moving up and down. In December you could have bought PHK for under $11 and be nursing a gain. If you buy it for cash flow, as I do, why should I worry until there is a change in distributions downward..

June 13 2013 at 4:27 PM Report abuse rate up rate down Reply