Longer term Treasuries (“notes” and “bonds”) are all yielding about 4.5% - 4.6%. We are not rewarded with higher returns for locking ourselves into longer dated maturities. Frankly, a seven or ten year bond yielding 4.6% doesn’t impress us. Yes, this is high compared to recent history, but it is not enough to entice us into buying. After subtracting out the taxes on the interest, we’re left with no real return. Bonds are subject to two forms of tax, a smaller tax that is visible, and a larger tax that is invisible. The visible tax is the income tax. All bonds other than tax-free municipals are subject to federal tax at our highest ordinary income rate, up to 37%. Figure that that consumes 1/3 of our return. The invisible tax of inflation is even more damaging. Inflation obviously isn’t a tax that’s been adopted by statute but it still comes from government through the expansion of the money supply. The more dollars there are competing for a limited supply of goods and services, the more those things will cost. And owning assets that are denominated in dollars (like bonds), means that their purchasing power will fall over time. When we subtract out the income tax and the inflation tax, our “real” return has fallen to zero.

This 0% real rate of return may still be acceptable to some, particularly retirees, who wish to convert part of a large and volatile stock portfolio into bonds that will at least maintain, if not grow, their values. But longer-term bonds yielding in the 4.5% to 5% range, to us, make little sense for an investor who is ten or more years from retirement. As a side note, Warren Buffett, chairman and CEO of Berkshire Hathaway, and by most accounts, the greatest investor of the last century, seemingly agrees. Berkshire’s own portfolio is invested almost entirely in a barbell approach, with the majority of its investments in equities but a massive cash hoard of $167 billion invested in short-term Treasury bills. Longer term bonds, at their current yields, are of little interest to Buffett.

If Treasury notes and bonds aren’t appealing, what about corporate bonds? Before buying corporates, you should understand the concept of the “spread,” the excess of the corporate bond’s yield over the yield of a Treasury bond that is maturing at around the same time. The Treasury will yield less because, unlike the corporate bond, it is default-risk free. The best time to buy corporates is when spreads are high. A high spread would be 1% or more on a single-A or double-A-rated corporate bond compared to the Treasury bond. Spreads go up when investors think the economy will soon fall into a recession. They get compressed when investors view the economy as sound. Currently, the spreads on five-year, high quality, AA-rated and A-rated corporate debt are very low, around 0.30% and 0.50% respectively, which makes them (to us at least) unappealing.