Risk and Return

Bond debt is reported under seven major categories by the Bond Market Association. In order of magnitude the categories are mortgage-backed securities (23.6 percent), corporate bonds (19.7), Treasury notes (16.7), money market funds (13.5), federal agency bonds (10.2), municipal bonds (8.6), and asset-backed instruments (public and private placements—7.6 percent of total). Money market funds are commercial loans, bankers' acceptances, and large time deposits. These instruments represent different mixtures of security, time commitment, and return. Mortgage-backed securities are long-term debt on homes and other real estate and thus well-secured. Corporate bonds depend on the bond rating and may be quite secure or risky ("junk bonds"). Treasury notes are considered the most secure debt instruments of all; they are short-term instruments. Municipal bond yields are tax-free and hence desirable for that reason.

Bonds carry a rating set by rating agencies such as Moody's Investor Service, Standard & Poors, Fitch Bond Rating Agency, and others. Using Moody's ratings, a bond rated Aaa has the highest quality; Aa is high quality, A is strong, and Baa is medium grade; all of the above are "investment grade." Bonds rated Ba, or B are speculative "junk grade" bonds, those classified as Caa/Ca/C are highly speculative junk bonds, and a rating of C means that a junk bond is in default. S&P and Fitch use D to indicate a bond in default. The label "junk" in all cases indicates that the bond holder is in some kind of financial difficulty. The investor, therefore, is not left to fend for him- or herself. Those who trade in junk bonds typically know (or think they know) what they are doing.

LONGER-TERM TRACKING

Viewed over a number of decades, the literature on investment displays a see-saw of opinion in which optimistic and realistic views are applauded all depending on the volatile moods of the market. Thus in the high-flying 1990s, James Glassman and Kevin Hasset, in a 2000 book titled Dow 36,000 promoted what Harvard Professor John Campbell calls the "revisionist" view. "In recent years," Campbell wrote in a paper cited below, "it has become commonplace to argue that equities are actually relatively safe assets for investors who are able to hold for the long term." Campbell himself does not subscribe to this view but sides with the realists who hold that the high returns of stocks compensate investors for the high risks.

Data published in the Statistical Abstract of the United States,, based on research conducted by Global Financial Data (GFD), clearly show the longer-range differences between stocks and bonds—and between Treasury notes and other bonds. In the 1970 through 2004 time frame, GFD calculated total return on stocks and bonds by periods, expressed as percentages based on real (inflation-adjusted) dollars. In the period 1970—1979 and 2000—2004, returns on stocks were negative—producing a percentage loss of 1.38 in the first and 4.67 in the second decade shown. In the 1980—1989 and 1990—1999 periods, however, stocks had very nice returns of 11.85 and 14.85 percent respectively. During these same decades, Treasuries and bonds invariably provided positive returns. Both Treasuries and bonds had their highest performance in the 1980—1989 period, returning 9.13 and 13.01 percent to investors. During that period, money was moving into the stock market and borrowers, consequently, had to lift returns to attract money.

Investors, of course, have the option to put their money where they expect the best return. Therefore money tends to move between investment vehicles depending on the economic weather. In the world of "risk and return"—as in so many other areas—change is a constant, alertness is rewarded, no system of gambling ever works, and there are no silver bullets.

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