Chapter 7
Bonds
Stocks and bonds are the most important assets in most portfolios. This book has focused so far on stocks because they provide the long-run appreciation necessary to sustain portfolios. Chapter 2 showed that long-run bond returns are so low that they hardly allow for any growth in wealth over time, at least after the returns have been adjusted for inflation. That chapter focused only on long-term Treasury bonds. This chapter will discuss three types of bonds, U.S. Treasury bonds, other bonds issued in the United States, and bonds issued in other industrial countries. The United States is the largest market for bonds in the world, but the bond markets of the other industrial countries are growing rapidly, particularly the markets in the Euro currency area. The returns on bonds have varied widely over the last few decades, so the chapter will investigate the main determinants of bond returns.
Bonds are often favored by investors because they provide fixed income in contrast to the variable returns offered by equities and by most other assets. A stream of fixed income payments is often viewed as essential to retirees as well as many institutional investors because of their need for continual income. Investors focusing only on yields, however, are too often disappointed by the overall performance of their investments. Bond yields represent part of the total return to fixed income assets, but the variation in yields over time leads to capital gains and losses that sometimes ...
