Investing: The Debt Bet

by | Sep 25, 2002

If you’re thinking of bailing out of the stock market, you’re not alone. Frantic investors are moving their money out of stocks and into bonds and money-market funds – that is, out of equity and into debt. Investing demands choosing, and, instead of owning pieces of businesses, many investors have chosen to lend money to […]

If you’re thinking of bailing out of the stock market, you’re not alone. Frantic investors are moving their money out of stocks and into bonds and money-market funds – that is, out of equity and into debt. Investing demands choosing, and, instead of owning pieces of businesses, many investors have chosen to lend money to them, and especially to governments. Lending is a lot less risky in the short term than owning.

New figures released by the Investment Company Institute show the trend dramatically. For the first time since 1995, Americans in July had less money invested in stock funds than in bond and money-market funds. At the height of the boom in 1999, stock (equity) funds had $4 trillion in assets while money-market and bond (debt) funds had $2.4 trillion. Now, debt funds lead equity funds, $3.3 trillion to $2.8 trillion.

Is this trend sensible? Probably not.

As I have written, oh, about a million times in this space, history shows clearly that stocks return far more than bonds in the long term, and carry roughly the same risk. In the short term, debt is much less risky than equity, and there are stretches where debt returns more as well.

Unfortunately, after talking to bond experts, my strong suspicion is that most of the money pouring out of equity and into debt is long-term – retirement assets, for instance – and ought to be more patient capital. The people who are flocking to bonds and cash (that is, very short-term debt, including money-market funds, Treasury bills, bank certificates of deposit and so on) may intend to get back into the market when things start looking up, but they are doing what most sensible financial advisers tell them not to do – they are trying to time the market with their long-term savings.

But who can blame frightened investors for abandoning a sinking stock market and seeking refuge in the apparent safe harbor of bonds?

Rather than admonish readers for their lack of discipline, I’ll try this week to guide them to a sweet refuge or two.

First, however, understand the problem right now with debt: You don’t get much for your money. When the economy is sluggish, the best companies aren’t doing much borrowing, so the demand for loans is low. In addition, when times are tough, the Federal Reserve pumps liquidity (cash) into the economy to try to get it going again. The supply of money for loans is abundant, and when the supply of anything is high and the demand is low, the price – or, in this case, the interest rate – is low, too.

In fact, rates are abysmal. On Friday, a U.S. Treasury bond (technically called a note, but let’s keep it simple), maturing in 10 years, was yielding (that is, fetching an interest rate of) just 3.8 percent. A five-year bond was yielding 2.8 percent; a two-year bond, 1.9 percent.

Prefer to make more money by lending your cash to a U.S. company with a high credit rating? Ten-year, AAA-rated corporate bonds last week were yielding 4.8 percent; two-year bonds, 4.8 percent.

What about international debt? On Friday, a British government bond maturing in 10 years was yielding only 4.4 percent; a French government five-year bond, 3.7 percent; a Japanese 10-year bond, 1.3 percent. Low, low, low.

Meanwhile, U.S. Treasury bills (those are bonds that mature in a year or less) are yielding only 1.6 percent, the lowest rate in 34 years. Think about this yield for a second. Figures released Wednesday show that the inflation rate over the 12 months ending Aug. 31 was 1.8 percent. If that rate continues over the next year, then the money you put into a T-bill now will actually decline in purchasing power when the government repays your principal. And it gets worse. If you are in a 30 percent federal tax bracket (interest on all Treasurys is exempt from state and local taxes), your after-tax yield is just 1.1 percent. Invest $10,000 and you will clear $110 after taxes for a total of $10,110, but, meanwhile, thanks to inflation, something that costs $10,000 today will next year cost $10,180.

T-bills and other forms of interest-bearing cash investments are merely parking places for your money. But, on average since 1926, investors have earned 3.8 percent from such vehicles, or about 0.7 percent more than inflation. At today’s rates, cash just isn’t very attractive.

What is? I have a few suggestions:

Ambassador Glassman has had a long career in media. He was host of three weekly public-affairs programs, editor-in-chief and co-owner of Roll Call, the congressional newspaper, and publisher of the Atlantic Monthly and the New Republic. For 11 years, he was both an investment and op-ed columnist for the Washington Post.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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