Both stocks and bonds did well in the first half of 2014, especially bonds. Vanguard Total Bond Market Index Fund returned 3.9% in six months ended on June 30 whereas Vanguard Total Stock Market Index Fund returned 7% in the same period. If we get a repeat in the second half, it will be 8% return in bonds and 14% return in stocks. That would be great, wouldn’t it?
The good returns from bonds were a surprise to the pundits. Interest rates were supposed to go up, not down. The stock market and the bond market going up together has led some to question which market is wrong, and whether good returns from bonds are telling us something (stocks are going to crash?). I don’t think either market is wrong or telling us anything. Supply and demand determine asset prices. Prices and interest and dividends determine returns. That’s all. See also: Yes, Stocks and Bonds Can Rise Together by Ben Carlson.
I put a big chunk of money into PenFed 5-year 3% CDs in December 2013 and January 2014. Those CDs certainly didn’t return 3.9% in six months. They returned only 1.5%. Does that mean it was wrong to invest in CDs instead of bonds?
Suppose I kept my money in bonds and got 3.9%. If sell them after getting this surprisingly good return and buy CDs now, the best I can get is 2.3% for the remaining 4-1/2 years. This means over the full 5 years, $10,000 will turn into $10,000 * (1 + 3.9%) * (1 + 2.3%) ^ 4.5 = $11,509. $10,000 in my PenFed CDs will turn into $10,000 * (1 + 3%) ^ 5 = $11,593.
If you bought PenFed 5-year CDs at the same time as I did, you are still better off in CDs after bonds turned in surprisingly good returns. If tides turn the other way you are even more better off. The good thing is that you don’t have to pray for any good surprises or worry about any bad surprises. CDs are as boring and as predictable as there can be. Usually you have to settle for low returns when you want predictability. When you are able to get equal or better returns than bonds without risk, that’s very nice.
[Photo credit: Flickr user Nicholas Laughlin]